STOCK INSURANCE • Every business unit has to keep a sufficient quantity of stock in the business premises for meeting the requirements of sales or manufacturing the goods . • The stock kept in the business premise is subject to risk of loss by fire . • For protecting itself against such loss , a business unit takes a fire insurance policy covering the loss of stock by fire . • A fire insurance policy which covers a loss of stock by fire is known as LOSS OF STOCK POLICY in which the insurance company undertakes to compensate the business unit for loss of stock by fire in consideration of a payment called PREMIUM
Calculation of amount of claim to be lodged for the loss of stock by fire • STEP 1:The most important point is the percentage of gross profit on sales .(Trading A/c of previous year) • STEP 2: The next step is to prepare Memorandum Trading Account of the current year up to the date of fire . • STEP 3: The next step is to deduct the value of stock salvaged • STEP4: Average clause – If the value of stock insured on the date of fire is more than the amount of policy taken , the full value of stock destroyed does not become payable but it is paid proportionately as
TRADING ACCOUNT FOR THE YEAR ENDED………….
PREPARE MEMORANDUM TRADING ACCOUNT OF CURRENT YEAR MEMORANDRUM TRADING ACCOUNT UPTO………………………..
AVERAGE CLAUSEValue of stock destroyed* value of insurance policy value of stock on date of fire
Important notes If the stock in trade of the last year was not valued at cost , it should be adjusted to cost to ascertain the correct percentage of gross profit on sales to be applied to the current year .
If there is a poor selling line stock in opening and / or closing stock , such stock should be eliminated from the Trading Account of the last year to get the gross profit ratio to be applied to the current year . Any sale of poor selling line should also be deducted from the total sales to find out normal sales because gross profit ratio is to be applied to the normal sales . The same procedure is to be followed for poor selling line stock and sales in case of Memorandum Trading Account .
When gross profit ratios for a number of years is given , an average of these ratios may be ascertained for finding out the gross profit ratio to be applied to the current year . But it is not advisable to take the average gross profit ratio in case of a continuous and persistent fall in the rate of gross profit as compared to the previous should be applied in the current year .
FIRE FIGHTING EXPENSES: Such expenses incurred on the date of fire for the purpose of salvaging the goods from fire are to be deducted ( if allowed ) before calculating the total loss or gross claim and applying the average clause .
CONSEQUENTIAL LOSS OR LOSS OF PROFIT INSURANCE • Consequential loss insurance indemnifies the insured any loss if profit suffered by him consequent on the destruction of business properties by fire . An ordinary fire insurance policy covers the loss on account of stock or properties destroyed by fire , but it does not cover loss of profit due to inability to produce or sell on account of fire . Therefore a separate policy known as consequential is taken to cover the following losses due to fire : • (a)Loss of profit due to inability to produce and sell . • (b)Loss of standing charges due to their non-recovery or loss recovery because of no production or less production as a result of fire . • (c)Increased cost of working as a result of fire such as renting a new business place temporarily for conducting the business operations .
EXPLANATION OF CERTAIN TERMS • Gross Profit – It is calculated by adding the amount of insured standing charges to the net profit . In case of net loss , gross profit is the amount of insured standing charges such a proportion of any net trading loss as the amount of the insured standing charges bear to all standing charges (I e . INSURED + UNINSURED ) of the business . • Net Profit – In order to calculate net profit of the business , due provision should be made for all standing and other charges including depreciation but before any deduction of any taxation chargeable on profits from the net trading profits resulting from business of the insured business . • Insured Standing Charges – These charges are specified in the policy which the insured desires to recover in case of an accident .Such charges include:Rent , rates and taxes not related with profits of the business ,Interest and debentures and loans ,Salaries of permanent staff,Wages of skilled workers , Directors fees,Auditors fees ,Advertising ,Travelling,Unspecified standing charges . • Turnover – The money paid or payable to uninsured for goods sold and delivered and for services rendered .
EXPLANATION OF CERTAIN TERMS • Annual Turnover-The turnover during the twelve months immediately proceeding the date of the damage . • Standard Turnover – the turnover during that period in the twelve months immediately before the date of damage corresponding with the indemnity period. • Rate of gross profit-the rate of gross profit earned on the turnover during the financial year immediately before the date of the damage. • Indemnity period-the period beginning with the occurrence of damage and ending not later than 12 months thereafter .
LOSS OF PROFIT / CONSEQUENTIAL LOSS POLICY • Calculate Short Sales Period of dislocation/Period of indemnity *Short sales are calculated for period of indemnity or dislocation which is less . Standard sales Less : sales for period of dislocation / indemnity Result= short sales *If increasing trend in sales is given , add it first to standard sales . • Calculate G .P Ratio Result = G.P Ratio = Net profit + Insured standing charges 100 sales of previous financial year • Apply G . P Ratio To Short Sales Result = LOSS OF PROFIT • Add Increasing Cost Of Working To Loss Of Profit (a) Actual increased cost of working * minimum is (b) Net profit + insured standing charges increased cost of to be added to net profit + all standing charges working loss of profit. (c) G.P on Sales due to increased cost of working • Deduct Any Savings In Expenses RESULT= Gross Claim • Apply Average Clause If Applicable Gross claim X amount of policy g.p on adjusted sales for 12 months immediately preceeding the date of fire
Let us takes an example • STEP 1 SHORT SALES=STANDARD SALES + INCREASE IN TREND – DECREASE IN TREND– SALES DURING PERIOD OF DIS LOCATION = =360000-72000 -60000 =228000 • STEP 2 CALCULATION OF GP RATIO = NP + INSURED STANDING CHARGES / SALES OF PREVIOUS YEAR X 100 =56000+ 120000/800000 X 100 =22 % - 2 % (DECREASE IN GP RATIO) = 20%
STEP 3 APPLY GP RATIO TO SHORT SALES= SHORT SALES X GP % = 2,28000 X 20 /100 =45600 • STEP 4 CALCULATE ANY INCREASE IN WORKING CAPITAL= A) ACTUAL EXPENSES = 1,40,000 B) NP + INSURED STANDING CHARGES / NP + ALL STANDING CHARGES X ACTUAL EXPENSE =56000 + 120000 / 56000 + 140000 X 140000 =1,25,714 C)GP on sales due to increase cost of working =20/100 X 60000 =12000
ACCOUNTING ENTRIES FOR FIRE CLAIMS 1. ON ADMISSION OF FIRE CLAIM : (a) If The Claim Relates To Loss Of Stock : Stock losses can be of two types , namely : • LOSS ON ACCOUNT OF STOCK DESTROYED – where goods are totally lost . • LOSS ON ACCOUNT OF STOCK DAMAGED – when goods are not totally lost but may be damaged to some extent by fire .The entry for claim admitted in case of stock is : (i) INSURANCE COMPANY dr. To stock destroyed account To stock damaged account (Being entry for the claim admitted for stock destroyed and stock damaged ) . (ii) ENTRY FOR THE ACTUAL COST OF STOCK LOST IS : Stock destroyed account dr. Stock damaged account dr. To trading account ( Being cost of stock destroyed and damaged transferred to trading account ) (iii) ENTRY FOR THE SALE OF DAMAGED GOODS :
ACCOUNTING ENTRIES FOR FIRE CLAIMS Bank account dr. To stock damaged account ( Being amount realized on sale of damaged stock ) (iv) DIFFERENCE OF STOCK DESTROYED ACCOUNT AND STOCK DAMAGED ACCOUNT being loss or profit is transferred to PROFIT and LOSS ACCOUNT : 2. ON ADMISSION OF CLAIM FOR LOSS OF PROFIT : Insurance Company Account dr. TO PROFIT AND LOSS ACCOUNT ( Amount of loss of profit relating to current year ) TO PROFIT AND LOSS SUSPENCE ACCOUNT (Amount of loss of profit pertaining next year) 3. ON ADMISSION OF CLAIM RELATING TO FIXED ASSETS : Insurance Company Account dr. To Fixed Assets ( Being claim admitted by the insurance company for fixed assets destroyed by fire ) 4. ON RECEIPT OF MONEY RELATING TO VARIOUS CLAIMS ADMITTED BY THE INSURANCE COMPANY : Bank Account dr. To Insurance Company
ACCOUNTING ENTRIES FOR FIRE CLAIMS • Difference in book value of assets and claim admitted in relation there to being loss or profit is transferred to profit or loss account .