Recognizing Loss from Damaged Inventory
The IRS allows recognition of loss on damaged inventory as long as the cause was due to a sudden event that was swift and unexpected. It is an occurrence that is not a day-today event that it took some time for the business entity to contain or mitigate the negative event. The tax agency further recommends two ways for the loss to be reflected in the books of the company. The loss may be recognized as a reduction of total purchases or a reduction of the merchandise inventory on hand.
An unexpected flash flood hit a community, which adversely affected a garment manufacturing firm’s raw materials inventory amounting to $28,000. Although the raw materials were covered by an insurance policy, there was a deductible of $5,000. In addition, the entity was able to sell the damaged raw materials to a scrap dealer for $3,000.
The calculation for the amount of loss is as follows:
- Purchase Cost - $28,000
- Less: Reimbursement from Insurance – ($ 23,000)
- Loss on Damaged Inventory - $ 5,000
Less: Sale from Disposal of Asset – ($3,000)
- Amount of Casualty Loss - $ 2,000
(a) To record the loss from damaged raw materials inventory.
Dr. Casualty Loss from Inventory due to Flash Flood - $5,000
Dr. Insurance Claims Receivable - $23,000
Cr. Purchases or Merchandise Inventory - $ 28,000
(b) To record the insurance reimbursement received
Dr. Cash $ 23,000
Cr. Insurance Claims Receivable - $ 23,000
(c) To record sale of damaged raw materials to scrap dealer
Dr. Cash - $ 3,000
Cr. Casualty Loss from Inventory due to Flash Flood - $3,000
(d) To explain the effects of the entry in the general ledger book:
- The value of the raw materials damaged reduced the amount of purchase costs for the year.
Technically, the reimbursement received from the insurance company ($23,000) plus the money received from the sale ($3,000) of the damaged raw materials, can be used to buy the replacement for the damaged goods.
- The insurance claim receivable was zeroed-out.
- The casualty loss which initially represented the $5,000 insurance deductible was reduced to $2,000, since a salvage value of $3,000 was realized by the Sale from Disposal of Asset.