![]() ![]() Once a recovery meets the requisite recognition threshold (see FSP 23.5), it should be recognized in the income statement. In particular, if the insurance recoveries relate to property damage, the proceeds should not be recorded as a reduction of the cost to rebuild or replace the insured asset. Business interruption insurance recoveries, even if based in part on lost revenue, should not be presented as revenue from contracts with customers as they would not meet the definition of revenue within ASC 606. Judgment should be applied to determine what presentation is most meaningful. However, income statement classification guidance is not provided for many other types of claims (including involuntary conversions). ASC 220-30-45-1 indicates that reporting entities have a choice in how to classify business interruption insurance recoveries as long as the classification is not contrary to other US GAAP. ASC 410-30-45-4 requires credits arising from recoveries of environmental losses to be classified in the same line items as the related loss. The classification of insurance proceeds in the income statement depends on the nature of the insurance claim. Transfers and servicing of financial assets Revenue from contracts with customers (ASC 606) Loans and investments (post ASU 2016-13 and ASC 326) Investments in debt and equity securities (pre ASU 2016-13) Insurance contracts for insurance entities (pre ASU 2018-12) Insurance contracts for insurance entities (post ASU 2018-12) IFRS and US GAAP: Similarities and differences ![]() This leaves a $20,000 balance in the reserve account.Business combinations and noncontrolling interestsĮquity method investments and joint ventures The company later identifies $10,000 of obsolete inventory it writes down the value of the inventory with a $10,000 debit to the inventory reserve contra account and a credit to the inventory account. The terms ‘profit and loss account’ (GAAP) and ‘income statement’ (FRS) should reflect the COGS data. The cost of goods sold is considered an expense in accounting. Sales revenue minus cost of goods sold is a business’s gross profit. This amounts to a $30,000 debit to the cost of goods sold, and a $30,000 credit to the inventory reserve contra account. Cost of Goods Sold (COGS) is the direct cost of a product to a distributor, manufacturer, or retailer. Example of an Inventory ReserveĪBC International's controller decides to maintain a 3% inventory reserve, based on the company's historical experience with inventory losses. This sort of behavior is not condoned, and may be spotted by auditors who want to see a valid justification for any unusual changes to the reserve. You could commit a minor amount of reporting fraud by increasing the size of the inventory reserve during profitable periods and using this inflated reserve to draw down the balance when you need to increase reported profits. Inventory reserves are applicable under virtually all methods of recording the value of inventory, including the FIFO, LIFO, and weighted average methods. Thus, the expense is recognized prior to the identification of a specific inventory issue, which may not occur for some time. ![]() Later, when there is an identifiable reduction in the valuation of the inventory, reduce the amount of the inventory reserve with a debit, and credit the inventory asset account for the same amount. When an inventory reserve is created, charge an expense to the cost of goods sold for the incremental amount by which you want to increase any existing inventory reserve (or use a separate account within the cost of goods sold classification), and credit the inventory reserve account. How to Audit Inventory Accounting for an Inventory Reserve This unexpected one-time charge could have been avoided with an ongoing series of smaller charges to build an inventory reserve over the course of the year. If you were to not use a reserve and also did not make use of cycle counting to provide evidence of inventory counts, then you might be adversely surprised by a lower-than-expected inventory valuation at the end of the year, for which you would have to record a large year-end charge. The use of an inventory reserve is considered conservative accounting, since a business is taking the initiative in estimating inventory losses even before it has certain knowledge that they have occurred. There may be a variety of causes for such a write down, such as the obsolescence, spoilage, or theft of inventory. The account contains an estimated charge for inventory that has not been specifically identified, but which the accountant expects to write down the value at which it is currently recorded. An inventory reserve is an asset contra account that is used to write down the value of inventory. ![]()
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