Accounting for insurance claims

Type of claims

• 1. claims for loss of assets including stock

• 2. claims for loss of profits or

consequential loss.

Calculation of loss of assets

• calculation of loss of assets is simple because of the value of assets can be find out from from the accounting records.

• These assets are recorded in accounts at the time of their acquisition.

• Therefore the claims can be calculated easily

Calculation of claims for loss of stock

• It is difficult to calculate because –• It includes many items and purchase are made

at varying rate.• It become more difficult when stock registers

are not maintained properly and destroyed in the fire.

Value of stock on the date of fire

• 1. gross profit ratio – gross profit ratio for the current year (year of fire) is estimated on the basis of gross profit ratio of preceeding year

• or

• Average of past few years

Valuation of stock• 2. information upto the date of fire• Information related to opening stock,purchases

,sales and direct expenses from closing of last accounting year upto the date of fire.

• If accounting record are destroyed then collect information from documentary proofs like purchase book, sales book, sales bills ,purchase bills, pass books or customer ledger etc.

Calculation of stock

• Gross profit ratio on the sale of normal items upto the date of fire is calculated on the basis of gross profit ratio calculated earlier.

• After this memorandum trading account is prepared from the first day of memorandum trading current year to the date of fire.

• Balancing figure of memorandum trading account is STOCK ON THE DATE OF FIRE.

Memorandum trading account

Particulars Amount Particulars Amount

To opening stock By sales

To purchases By stock on the date of fire(Balancing figure)

To direct expenses

To gross profit(% on sales)

Claim for the loss of stock

• It is claimed by preparing statement of claim for loss of stock.

Statement of claim for loss of stock

PARTICULARS AMOUNT

value of stock on the date of fire

Less salvage value of stock

Amount of claim for loss of stock

Average clause

• The main objective of this clause is to encourage the businessman to have full insurance of their stock and discourage under insurance.

• Average clause is applicable when the amount of insurance policy is less then the value of stock on the date of fire.

• Net claim= loss of stock policy amount• stock on date of

fire

Claim for loss of profits or consequential losses

• Fire insurance policy only covers loss of stock but not the loss of profits.

• To cover the loss of profits one has to take a seperate policy called loss of profit policy or consequential loss policy with the first one.

Risks covered under loss of profit policy

• Loss of profits due to dislocation period• Payment of standing charges under

dislocation period e.g. rent ,salaries, director fees, depreciation,interest,taxes lighting charges etc.

• Increased cost of working during the dislocation period to continue the business operations smoothly.

Indemnity period

• It starts on the date of fire and ends when the normality is restore in business.

• The duration does not exceed twelve months.• Fire insurance policy must be in force at that

time of loss by fire.

Standard sales

• Standard sales are the sales of during that period in twelve months immediately preceeding the date of fire which corresponds with indemnity period.

• For example—date of fire july1, 2012• Indemnity period—4 months• Standard sales– from july1, 2011 to october

30, 2011.

Short sales

• It means the loss of sales due to dislocation of business due to fire.

• Short sales = standard sales – actual sales(indemnity period)

Steps involved in the computation of claim for loss of profits

1.CALCULATION OF GROSS PROFIT RATE

Net profit for the previous yeargr

Add insured standing charges of the previous year

Gross profit

GROSS PROFIT RATE= GROSS PROFIT *100 SALES

Calculation of short sales and loss of gross profit

• Short sales= standard sales –actual sales during indemnity period

• Loss of gross profit=• short sales * gross profit rate

Admissible increased additional expenses

• Least of the following amount will bal additie admissible-

• Actual additional expenses incurred to reduce the loss of sales

• Gross profit on annual sales becoming possible due to increased cost of working

• When all standing charges are not covered by the insurance policy

• Increased cost of working *net profit +insured standing charges

Formula of admissible increased additional expenses

• Increased cost of working *net profit +insured standing charges

• --------------------------------------------------------------

• net profit +standing charges

Statement of claim

Loss of gross profit

Add admissible increased admissible expences

Less saving in insured standing charges

Gross claim

Average clause

• Net claim =

• Gross claim policy amount • gross profit on annual sales