Various Types of Transactions – Collection from Other Source of Revenue and Income, Compensation Received for Loss of Assets (Part 4e)

Business entities may encounter some unfortunate events such as fire, flood or others that cause damage to their assets. After assessment of the damages caused, the insurance companies will then pay the relevant compensation to these business entities. If the assets damaged are fixed assets, the relevant double entries involved in the recording of the loss of the assets have been illustrated in my post: Various Types of Transactions – Pat 4d, Collection from Other Source of Revenue and Income (Proceeds from Disposal of Assets).However, if the damaged assets are inventories or stocks, the carrying value of the inventories or stock should be deducted against the compensation received to determine the net loss:-

$

Compensation received

XXXX

Carrying value of inventories

(XXXX)

Loss on damaged inventories

(XXXX)*

*Loss is shown here because the amount of compensation paid by the insurance company would normally not exceed the carrying value of the inventories.

The double entries involved in the recording of the recognition of the loss of damaged inventories are different, depending on the method of recording inventories in the general ledger, i.e. Perpetual Method or Periodic Method. Please refer to my post: Inventories or Stocks – Part 2, Methods of Recording in General Ledger for detailed illustrations of these two methods.

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 1 January 2006, ABC Co. Ltd paid cash to purchase 1,000 trading goods of $20 each. On 31 July 2006, 800 units were sold at $25 each. On 30 September 2006, 100 units were damaged due to flood. On 15 October 2006, ABC Co. Ltd received a cheque of $1,800 from the insurance company as compensation.

Perpetual Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

20,000

Cash at bank

20,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales

16,000

Inventories

*16,000

*800 units X $20 per unit

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

$

Sales

20,000

A

Less: Cost of Sales

16,000

B

Gross profit

4,000

C = A – B

Other income

Operating expenses: –
Loss on damaged inventories (2,000 – 1,800)

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

Periodic Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales – Purchases

20,000

Cash at bank

24,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Cost of sales – Transfer to loss on damaged inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

5. On 31 December 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

*2,000

Cost of sales – Closing inventories

2,000

*This closing inventories balance is usually determined by way of conducting a stock counting exercise at year end – 100 units X $20 each.

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

$

Sales

20,000

A

Less: Cost of Sales
Opening inventories

Purchases

20,000

Transfer to loss on damaged inventories

-2,000

Closing inventories

-2,000

16,000

B

Gross profit

4,000

C = A – B

Other income

Operating expenses
Loss on damaged inventories (2,000 – 1,800)

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

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