Advanced Accounting Intellect - I UNIT-1
Advanced Accounting Intellect - I UNIT-1
Advanced Accounting Intellect - I UNIT-1
Sem-5
Advanced Accounting Intellect – I
UNIT-1
Insurance – Insurance is a contract under which the insurer (insurance company) in consideration of
a sum of money paid (premium) by the insured (the person whose risk is insured) required all the
essentials of a valid contract according to the law of contract.
Characteristics of Insurance
It is a cooperative device
It is sharing or transfer of risk
Large number of insurance persons & properties
Payment of happening of a specified event
It is preceded by evaluation of risk
It is a protection against risk
The amount of compensation depends on amount of loss
Contractual Relationship
Contract of insurance is a contract of indemnity
It is a means of converting uncertainty into certainty
It is neither a charity nor gambling
It is regulated under certain law
Minimum two parties
Purpose of Insurance
Reduction of worries
Reimbursement of losses
Opportunity for investment
Credit enhancement
Opportunity for employment
Regular savings
Retirement
Promotion of efficiency and motivation
Importance of Insurance
Protection against possible uncertainties.
Eliminates risks and losses are shared.
Reduces the impact of losses.
It helps in uninterrupted business operations and facilitates smooth trade.
It serves as an agency of capital formation.
Principles of Insurance
Principle of insurable interest
Principle of Utmost Good Faith (Uberrimae Fidei)
Principle of indemnity
Principle of Subrogation
Principle of Contribution
Principle of Causa Proxima
Classification of Insurance
Life Insurance
Non-life Insurance (General Insurance)
o Marine Insurance
o Fire Insurance
o Personal Accident Insurance
o Motor Vehicle Insurance
o Fidelity Guarantee Insurance
o Crop Insurance
o Burglary Insurance
o Cattle Insurance
o Cash in transit Insurance
Insurance Claims -
Business, in the course of its operation, confronts several types of risks which may result in huge
losses. No business can overcome such risks and it is necessary that such risks are insured.
Business suffers heavy loss of assets on account of happening of certain events such as fire,
earthquake, flood, theft, etc. To cover up the risk of loss against these uncertain events, the business
enterprises take insurance policy with insurance company.
Whenever a business enterprise suffers a loss from an insured event, it files a claim of compensation
against such losses. Such claims are known as Insurance Claims.
All insurance except life insurance are contract of indemnity. In such contract the claim accepted by
the insurance company is restricted to the lower of the actual loss or policy value.
Sometimes business enterprises get themselves insured against the loss of profit which is known as
Loss of Profit Policy or Consequential Loss Policy.
Average Clause – Some unscrupulous businessman may resort to under-insurance of stocks in order
to save some amount of premium. Under-insurance means insuring for lesser value. It is resorted to
because usually the loss will not be total and therefore in spite of under-insurance, the businessman
can cover his loss. To prevent misuse of insurance, the policy incorporates an ‘average clause’.
By inserting average clause, the insured is called upon to bear a portion of loss himself in the event of
under-insurance. The main object of this clause is to discourage under-insurance and encourage full
insurance and to accurately value the property before insurance.
Value of claim = (Policy Value X Loss of Stock) / (Value of stock of the date of fire)
Illustration 1
Goods of Rs. 1,60,000 of M/s. R & Sons are insured for Rs. 1,40,000. Loss due to fire is assessed for
Rs. 32,000. Calculate the claim of M/s. R & Sons against the insurance company. The policy is subject
to average clause.
Solution
Value of claim = (1,40,000 * 32,000) / (1,60,000)
= Rs. 28,000
Illustration 2
Value of insurance policy is Rs. 15,00,000 and at the date of fire, value of stock in hand is Rs.
18,00,000, out of which approx. worth of 12,00,000 of stock is destroyed. The policy is subject to
average clause. Calculate the value of the claim admitted.
Solution
Value of Claim = (15,00,000 * 12,00,000) / 18,00,000
= Rs. 10,00,000
Deductible or Excess - With respect to each type of policy, the insurance company may deduct a
specified amount at the time of paying claim. This is known as ‘deductible’ or ‘excess’.
Survey Expenses - When a claim is made on the occurrence of a loss, the insurance company
appoints a surveyor to assess the loss, so that the claim may be admitted and eventually paid. He has
to be paid fees, which, in some cases is paid by the insured in the first instance and later reimbursed
by the insurer.
Journal Entries
Sometime information about total stock is not available, which can be calculated by preparing
Memorandum Trading Account
(for the period ending…….)
Particulars Amount (Rs.) Particulars Amount (Rs.)
To Opening Stock ---- By Sales ----
To Purchases ---- By Stock on the date of fire ----
(Balancing figure)
To Direct Expenses (If any) ----
To Gross Profit ----
---- ----
OR
Computation of Loss Stock on the date of fire
Stock in the beginning of the accounting year (Opening Stock) -----
Add: Purchases from the beginning of the accounting year till the date of fire -----
Less: Cost of Goods Sold (from the beginning of the accounting year till the date of fire) -----
Value of the stock on the date of fire -----
Less: Salvaged Value of stock (---)
Value of stock due to fire -----
Value of Salvaged Stock
Value of stock as calculated from above will be reduced by the value of salvaged stock to arrive at the
value of Insurance Claim.
Remember
Gross Profit can be calculated with the help of sales and rate of gross profit which are given in
the question or preceding year’s rate can also be considered.
In case, where gross profits of the last several years are given, average gross profit should be
taken to determine the gross profit of the current year.
In case, where stock is not valued at the cost, first it will be valued at the cost in the last year
trading account and then in the memorandum account of the current year.
Cost of the sample given free of cost or withdrawal of stock by proprietor or partner of the
firm for personal use, it should be adjusted in the Trading Account of the last year as well as
in the current year’s memorandum trading account.
An average clause will be applied when the value of insurance policy is less than the value
of stock on the date of fire.
Illustration 3
On 30th November, 2019 a fire occurred in the premises of a firm which carried on the business of
general merchandise. From the various books, which were saved from fire, it was ascertained that
Sales from 1st April to 30th November Rs. 12,80,000
st th
Purchases from 1 April to 30 November Rs. 8,40,000
st
Stock on hand on 31 March, 2019 Rs. 2,36,000
Gross profit for the past five years had averaged at 35% on sales.
The value of salvaged stock was agreed at Rs. 30,000. Calculate the amount of claim. There was no
average clause in policy.
Solution
Memorandum Trading Account
(for the period ending 30th November, 2019)
Particulars Amount (Rs.) Particulars Amount (Rs.)
To Opening Stock 2,36,000 By Sales 12,80,000
To Purchases 8,40,000 By Stock on the date of fire 2,44,000
(Balancing figure)
To Gross Profit 4,48,000
(12,80,000*35) / 100
15,24,000 15,24,000
Illustration 5
Fire occurred on the business premises of ‘Fashion India’ on 30 th June, 2020 and most of the stock
destroyed. Please ascertain the insurance claim from the following given particulars –
Amount Amount
Particulars
(Year 2019) (01 April to 30 Jun 2020)
Sale 25,00,000 7,50,000
Purchases 18,00,000 3,50,000
Opening Stock (01-04-2019) 2,70,000
Closing Stock (31-03-2020) 4,98,750
Direct Expenses (Freight & wages) 1,50,000 30,000
Stock as on 01-04-2019, valued 10% less at the cost.
Stock as on 31-03-2020 value 5% more at the cost.
Value of stock salvaged Rs. 45,000.
Insurance policy (for fire) was for Rs. 3,00,000.
Solution
Fashion India
Trading Account
(for the period ending 31st March, 2020)
Particulars Amount (Rs.) Particulars Amount (Rs.)
To Opening Stock 3,00,000 By Sales 25,00,000
(2,70,000 * 100) / (100-10)
To Purchases 18,00,000 By Stock 4,75,000
(4,98,750 * 100) / (100+5)
To Direct Expenses 1,50,000
To Gross Profit (29%) 7,25,000
(7,25,000 * 100)/25,00,000
29,75,000 29,75,000
Illustration 5
A fire occurred in the premises of Hiren on 25th Nov, 2019 where as a large part of stock was
destroyed. Salvage was Rs. 15,000. He gives you the following information for the period April 1,
2019 to Nov 25, 2019:
Purchases Rs. 85,000; Sales Rs. 90,000; Goods costing Rs. 5,000 was taken by Hiren for personal use;
Cost price of stock on April 1, 2019 was Rs. 40,000.
Over the past few years, Hiren has been selling goods at a consistent gross profit margin of 33.33%.
The insurance policy was for Rs. 50,000 including average clause.
Hiren asks you to find out the amount of claim to be made on the insurance company.
Solution
Example
Date of fire = 1.5.2020 and period of dislocation = 5 months
IPT = 1.5.2020 to 1.10.2020
ST = 1.5.2019 to 1.10.2019
AT = 1.5.2019 to 30.4.2020
Note − All figures given above are related to the last accounting year.
3. In case where all the standing charges are not insured, amount of net loss need to reduce as –
= (Insured Standing Charges * Net Loss) / All standing charges
5. Increased Cost of Working − Increased cost of working means, certain additional expenses those
have to be incurred by insured person to keep the business in running condition during the indemnity
period.
Least of following figures will be considered as increased cost of working
= (Net Profit + Insured Standing Charges) * (Increased Cost of Working) / (Net Profit + All
Standing Charges)
Loss of profit = Loss of Net Profit + Standing Charges + Increased cost of working
= Rs. 38,413
Least of the above three figures i.e. Rs. 20,000 is allowable.