Insurance Realisation on Abnormal Loss Stocks

... From Page 20

   
 

How does the Insurance Company make profits?

The insurance company gets revenue in the form of "Insurance Premium". This is a small amount that the insurance company collects from the insured for assuring the payment of the insurance amount. The premium that the insurance company collects is a small amount (0.1% to 1% of the value insured for).

Say there are 10,000 trucks transporting some goods all of which are insuring their trucks. The value of each truck is around Rs. 10,00,000. The premium for insuring the trucks is 1% of the value insured for. This would amount to Rs. 10,000. The amount that the insurance company collects from all the 10,000 trucks is Rs. 10,00,00,000 (ten crores). The insurance company needs to pay the insurance amount only when there is an accident and the truck has been damaged. Say there are 100 accidents in the period for which the trucks have been insured. 10 of these accidents have resulted in the trucks being destroyed completely and the rest 90 accidents resulted in the trucks getting damaged to various extents (on an average 50%).

The contract of insurance is a contract of indemnity. [Indemnity = A sum of money paid in compensation for loss or injury]. The insurance contract makes good the loss incurred by the truck owner. Just because the truck has been insured for Rs. 10,00,000, the truck owner would not be given the Rs. 10,00,000 whenever there is an accident. The truck owner would be given that much of amount which would enable him to place himself in a no loss position i.e. the amount required to make good his loss on account of the accident. Therefore the insurance company pays Rs. 10,00,000 each to the 10 truck owners whose trucks were completely destroyed and Rs. 5,00,000 on an average to the rest 90 truck owners whose trucks have been partly damaged. This would amount to a total payment of Rs. 5,50,00,000 (Rs. 1,00,00,000 + Rs. 4,50,00,000). The insurance company would be left with a balance amount of Rs. 4,50,00,000 from which it meets its expenses and the rest would be its profit.

General Insurance vs. Life Insurance

A contract of life insurance is a contract of guarantee whereas a contract of insurance is a contract of indemnity. In case of life insurance it would be like the insurance company saying "We will guarantee you a payment of Rs.xx if this person dies". The amount being the amount for which the persons life had been insured. In case of a general insurance contract whatever may be the amount insured for, the insurance company would not pay an amount greater than the loss incurred by the insured. If the same aspect had been insured with more than one company the total amount of loss made good by all the insurance companies together would not be greater than the loss incurred by the insured. This would not be the case with the life insurance where if a persons life had been insured by more than one company, all the companies would be paying their respective amounts guaranteed.

One other difference between general insurance and life insurance is with regard to how we treat the premium paid. In case of general insurance the premium paid each year gets exhausted or used by by the end of the year. However in case of life insurance, the amount of insurance paid is like a deposit made with the insurance company. For this reason, the general insurance policy does not have a surrender value. Whereas, the life insurance policy is capable of being surrendered at any time and get back a certain value from the insurance company (which we call the surrender value of the policy).

Say Rs. 10,000 premium paid to insure the truck every year is useful only for the year insured. This cannot be reclaimed back from the insurance company by canceling the policy. If a life insurance policy is taken by paying a similar amount as premium, it can be surrendered (canceled) and some amount recovered from the insurance company. The surrender value of a life insurance policy in the initial year would be generally nil. This is so because the company would have to cover the expenses it incurred in making efforts to sell the policy to the insured. The surrender value as a % of the total amount paid till that time would increase as the age of the policy increases. [For example, 0% in the first year, 10% in the second year, 25% in the third year, 50% in the fourth year, 80% in the fifth year and 100% from the sixth year and so on..]

Insurance only for Abnormal Loss Stocks

The insurance company can make profits only if the loss does not occur in all cases. This is not possible if the insurance company insures normal loss. Normal Loss by its nature itself occurs every time the transaction takes place. Therefore we should understand that when we talk of insurance of loss we mean abnormal loss and not normal loss.

Who insures the stock?

The stock may be insured either by the consignor or the consignee. This would be included in the expenses paid by the consignor or the consignee.

Who receives the insurance amount?

The insurance amount may be realised by the consignor or the consignee. The insurance amount since being received from an organisation would in general be received in cheque. However, the insurance company having accepted the payment of the insurance amount and the amount still to be received is also a possibility.

For the amount of insurance realisation:
30. June 26th: received from the insurance company by the consignor for the abnormal loss stock (in transit)
Rs. 1,000.
31. June 26th: received by the consignee for the abnormal loss stock (in storage) Rs. 800
32. June 26th: agreed to be paid by the insurance company for the abnormal loss stock (in storage) not yet
received, to be received by the consignee Rs. 500

Consignor's Books Hide/Show

Accounts Effected by the Transaction » Identification & Analysis:

  • Credit »

    • 30, 31, 32: Abnormal Loss a/c

      Since the insurance amount would be received in relation to the abnormal loss stock, it would amount to receiving the amount by replacing/selling the asset by name abnormal loss stock.
      [Abnormal Loss a/c – Real a/c – Credit what goes out.]
  • Debit »

    • 30: Bank a/c

      The insurance amount would be realised by the consignor by a cheque, therefore the "Bank a/c" is to be debited.
      [Bank a/c – Personal a/c – Debit the benefit receiver.]
    • 31: M/s Maruthi Traders a/c

      The insurance amount is realised by the consignee, therefore the consignee stands in the position of the benefit receiver. "Consignee a/c" is to be debited.
      [Consignee a/c – Personal a/c – Debit the benefit receiver.]
    • 32: Insurance Company a/c

      The insurance company has accepted to pay the insurance amount and has not yet paid up. The insurance company from the moment it has accepted to pay up becomes the debtor of the consignor. Therefore the "Insurance Company a/c" is debited.
      [Insurance Company a/c – Personal a/c – Debit ...]

      Note:

      1. It would be sometimes convenient to explain the debit and credit by logical reasoning rather than by the principles of debit and credit.
      2. The amount receivable from the insurance company may not be recorded till the amount is received from the insurance company in which case, the consignor would not record the last transaction in his books. However if the consignor is in need of deciding the net loss on account of the abnormal loss stock he needs to record this transaction.
      3. The fact that the insurance amount is to be received by the consignee would also not of relevance here since the consignee can be made responsible for the payment of the insurance amount only if he receives it from the insurance company. Therefore, till the amount is received by the consignee, only the insurance company can be assumed to be the debtor by the consignor.

The effect of the transactions can be summarised as
19 :(i) Normal Loss a/c and (ii) Cash/Bank/Outstanding Expenses a/c
30 :(i) Abnormal Loss a/c and (ii) Bank a/c
31 :(i) Abnormal Loss a/c and (ii) Consignee a/c
32 :(i) Abnormal Loss a/c and (ii) Insurance Company a/c

 
DrAbnormal Loss a/cCr
Date Particulars J/F Amount
(in Rs)
Date Particulars J/F Amount
(in Rs)




26/06/05
26/06/05
26/06/05

By Bank a/c (30)
By M T a/c (31)
By Ins. Co. a/c (32)
 




 

1,000
800
500
 

 
DrM/s Maruthi Traders a/cCr
Date Particulars J/F Amount
(in Rs)
Date Particulars J/F Amount
(in Rs)

26/06/05
 

To Ab. Loss a/c (31)
 


 

800
 




 
DrInsurance Company a/cCr
Date Particulars J/F Amount
(in Rs)
Date Particulars J/F Amount
(in Rs)

26/06/05
 

To Ab. Loss a/c (32)
 


 

500
 




 
Journal in the books of M/s __ for the period from ____ to _____
Date V/R
No.
L/F Debit Amount
(in Rs)
Credit Amount
(in Rs)
June 26th Dr
1,000
1,000
June 26th Dr
800
800
June 26th Dr
500
500

Consignees Books Hide/Show

Accounts Effected by the Transaction » Identification & Analysis:

Since the consignee receives the insurance amount on behalf of the consignor, the transactions where the consignee is involved would have to be recorded in the books of the consignee.
  • Debit »

    • 31: Bank a/c

      Since the amount is received by a cheque the "Bank a/c" is debited.
      [Bank a/c – Personal a/c – Debit the benefit receiver.]
  • Credit »

    • 31: M/s Innova Steels a/c

      The amount being received from the insurance company on behalf of the consignor, the consignor stands in the position of a creditor. Therefore the "Consignor a/c" is to be credited. The consignor being the benefit giver here his account would be credited.
      [Consignor a/c – Personal a/c – Credit the benefit giver.]

32:

The fact that the consignee would receive the insurance amount accepted to be paid by insurance company would be of no relevance in the books of accounts of the consignee. He will accept his due only after he receives the amount from the insurance company.

The effect of the transactions can be summarised as
31 :(i) Consignor a/c and (ii) Bank a/c

 
DrM/s Innova Steels a/cCr
Date Particulars J/F Amount
(in Rs)
Date Particulars J/F Amount
(in Rs)




30/06/05
 

By Bank a/c (31)
 


800
 

Author Credit : The Edifier ... Continued Page 22

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