INSURANCE CLAIMS OBJECTIVES

LESSON - 5
INSURANCE CLAIMS
OBJECTIVES
After studying this chapter, you will be able to
• Know how is the value of stock as on the date of fire ascertained and how is the amount of insurance claim worked out.
• Follow the preparation of proforma trading account, which is necessary to find out the value of stock on the date of fire.
• Know the effects of poor selling line and abnormal happenings on the preparing of trading account for calculating the rate of gross profit.
STRUCTURE
5.1 Meaning of Fire Insurance Claims
5.2 Claim for loss of stock
5.3 Steps to be taken for estimating stock
5.4 Average Clause
Unit Questions

5.1 Meaning of Fire Insurance Claims
Business of any kind is susceptible to risk of either fire or theft or lose of marine. The hazed of fire is so serious that when it occurs, it destroys, partly or wholly , the assets of the business and impairs the day today operations of the business. As the assets like building , machinery, furniture stock, etc., are destroyed in case of a fire accident, it is very difficult for the both fixed and working capital. Therefore, to cover against such risk of fire, a prudent businessman always insures his business. In the interest of the business, he takes a fire insurance policy to indemnify the business against the loss of stock and other assets due to fire.

A fire insurance claim is lodged with the insurance company for the loss of stock and other assets by; fire. If the assets are destroyed, then the actual loss of assets due to fire is claimed from the insurance company.

5.2 Claim for Loss of Stock
It is easy to lodge claim for the loss of all assets except stock –in-trade because accounts are maintained for such assets only. To lodge claim for the loss of stock by fire, the value of stock by fire, the value of stock in- trade on the date of fire has to be determined scientifically.

A fire insurance contract provides for indemnification by the insurer of any financial loss suffered by the insured as a result of damage or destruction of the insured property by fire or other specified perils. The contract is for a specified period, usually a year and the premium paid by the insured represents the consideration for the promise by the insurer. Stocks of al types are important items of asset for any business to insure and more so for the promise by the insurer. Stocks of all types are important items of asset for any business to insure and more so for a trading concern. A major part of the working capital in any business concern is lacked up in stocks and working capital mostly is raised through borrowings. Therefore, if stocks are destroyed or damaged by fire, the financial solvency of the business concern will be very much affected Insurance of stocks, thus , will help the business concern to cover this risk.

5.3 Steps to be Taken for Estimating Stock
The following are the steps to be taken for valuing or estimating stock as on the date of fire.
1. The percentage of gross profit on sales is the most important paint to ascertain the cost of goods sold during the year for fire. In case of inadequate information, the last year’s gross profit rate will be applied to the current year’s sales, i.e the year in which the fire occurred.
2. The second step is to prepare Memorandum Trading Account for the current year upto the date of fire taking into account opening stock, purchases and sales from the beginning of that year to the date of fire and estimated gross profit on the basis of last year’s rate. The estimated value of stock on the date of fire is the balancing figure arrived in the Memorandum Trading A/c.

3. The next step is to find out the actual claim to be lodged with the insurance company, where a salvage value is given. The value of stock salvaged is deducted from the value of stock ascertained in step 2 and the net figure represents the actual value of claim for the loss of stock to be lodged with the insurance company.

5.4 Average Clause
To save some amount of premium , some unscrupulous businessman may resort to under –insurance of stocks. Under – insurance refers issuing for a lesser value. A fire insurance policy usually includes an average clause to discourage the under –insurance of stock or any asset. The effect of this clause is that if the value of stock or any asset insured on the date of fire exceeds the value of policy taken, the full value of stock or any asset destroyed does not become payable to the insured but the stock or any asset on the date of fire. Under this clause, the loss is suffered by both insurer and insured proportionately.

Example:
The value of insurance policy for the loss of stock is Rs.1,50,000 and stock in hand on the date of fire is Rs.2,10,000 out of which stock destroyed is estimated to be Rs.1,05,000 . Ascertain the claim admitted by the insurance company.

Solution:
Claim admitted = Value of stock destroyed x Value of Insurance Policy
Value of stock on the date of fire
= 1,05,000 x 1,50,000

2,10,000
= Rs. 75,000/-

Example :2
On 25th April 1998, a fire occurred in the premises of a company. From the various books saved from fire, the following were ascertained.
Rs.
Stock on 1.1.1998 93,750
Purchases from1.1.1998 to the date of fire 3,75,000
Wages 75,000
Manufacturing expenses 37,500
Sales from 1.1.1998 to the date of fire 5,62,500

The Gross profit ratio for the past five years had average at 15% on sales. The stock salvaged was estimated at Rs.28,125 . Ascertain the amount of claim to be lodged in case of the loss of stock insured.
Solution:
Memorandum Trading Account
For the period ending 25th April, 1998
Rs. Rs.
To Opening Stock
To Purchase

To Wages
To Manufacturing Expenses
To Gross Profit (562500x15 )
100
93,750
3,75,000

75,000
37,500
84,375
6,65,625
By Sales
By Closing stock
(Balancing Figure) 5,62,500
1,03,125




6,65,625


Stock as on 25th April 1998 - 1,03,125
Less: Salvaged Stock - 28,125
Insurance Claim to be lodged - 75,000

Example:3
Fire occurred in the premises of Vijayakumar on 1st April,1998 and a considerable part of the stock was destroyed. The stock salvaged was Rs.28,000 . A fire insurance policy for Rs. 1,71,000 was taken to cove loss of stock by fire. You are required to ascertain the insurance claim which the company should claim from the insurance company for the loss of stock by the firm from the following particulars.
Rs.
Purchased for the year 1997 9,38,000
Sales for the year 1997 11,60,000
Purchase from 1st January 1998 to 1st April1998 1,82,000
Sales from 1st January 1998 to 1st April 1998 2,40,000
Stock on 1st January 1997 1,44,000
Stock on 31st December,1997 2,42,000
Wages paid during the year 1997 1,00,000
Wages paid during 1st January 1998 to 1st April 1998 18,000
Fire also broke out on 21st December,1997 and destroyed stock of the estimated cost of Rs. 50,000
There was a practice in the concern to value stock at cost less 10% . but all of a sudden this practice was changed and stock on 31st December 1997 was valued at cost plus 10%

Solution :
Trading Account of Vijayakumar
For the year ending 31st December 1997
Rs. Rs.
To Opening Stock (1,44,000x100/90)

To Purchase
To Wages
To Gross Profit


1,60,000


9,38,000
1,00,000
2,32,000


14,30,000 By Sales

By Closing Stock (2,42,000x100/110)
By Stock destroyed by fire
11,60,000

2,20,000

50,000



14,30,000

Percentage of Gross Profit on Sales = Gross Profit x 100
Sales

= 2,32,000 x 100
11,60,000

= 20 %

Memorandum Trading Account of Vijayakumar up to 1st April 1998
Liabilities Rs. Assets Rs.
To Stock on 1.1.198
To Purchase
To Wages
To Gross Profit (2,40,000x20/100)
2,20,000
1,82,000
18,000
48,000

4,68,000 By Sales

By Closing Stock (Balancing Figure) 2,40,000

2,28,000


4,68,000

Value of Stock on 1st April 1998 2,28,000
Less: Stock Salvaged 28,000
Stock destroyed by fire 2,00,000

As the value of stock on the date of fire Rs.2,28,000 is more than the sum assured of Rs. 1,71,000 the average clause will apply.
The insurance claim to be lodged will be = Value of policy x Value of stock
Value of stock on the date of fire destroyed.

= 1,71,000 x 2,00,000
2,28,000

= Rs. 1,50,000

Example :4.
Ramu Traders have taken out a fire policy of Rs.2,40,000 covering its stock-in-trade. A fire occurs on 31st March and stock was destroyed with the exception of the value of Rs. 62,040.
Following particulars are available from the books of account of the firm:
Rs.
Stock on 31st December 1997 90,000
Purchases to the date of fire 3,90,000


Sales to the date of fire 2,70,000
Commission paid to the purchase 2%
Carriage paid on purchase 2,400
Average gross profit on cost 50%

The Policy was subject to average clause. You are required to arrive at the i) total loss of stock and ii) amount of claim to be made against the insurance company.
Solution:
Memorandum Trading Account of Ramu Traders
for the period ending 31st March 1998.

Rs. Rs.
To Opening Stock

To Purchase 3,90,000
Add.Commission @ 2% 7,800
Add: Carriage 2,400

To Gross Profit (50% on cost)
½ on cost =1/3 on sales
270000 x 1
------------
3 90,000



4,00,200





90,000

5,80,200 By Sales 2,70,000











5,80,200
Stock on the date of fire 3,10,200
Less: Stock salvaged 62,000
Stock destroyed by fire 2,48,160

Claim on average basis = Value of policy x stock destroyed
Value of stock on the date of fire by fire
= 2,40,000
-------------- x 2,48,160
3,10,200

= Rs.1,92,000.

Unit Questions
1. What is fire insurance?
2. What is average clause?
3. Write short note on average clause in a loss of profit policy and loss of stock policy
4. What are the steps involved in calculating claim for loss of profit?
5. A fire occurred in the business premises of Thiru.Ponnusamy on15th October 1989. From the
following particulars ascertain the loss of stock and prepare a claim for insurance.

Rs.
Stock on1.1.1988 30,600
Purchases from 1.1.1988 to 31.12.1988 1,22,000
Sales from 1.1.1988 to 31.12.1988 1,88,000
Stock as on 31.12.1988 27,000
Purchase from 1.1.1989 to 14.10.1989 1,47,000
Sales from 1.1.1989 to 14.10.1989 1,50,000
The stock were always valued at 90% of cost. The stock saved from fire was worth Rs.18,000.
The amount of the policy was Rs.63,000. There was an average clause in the policy.
6. A fire occurred on September 30 ,1986 in the godown of Mr.Anand from the following
figures ascertain the claim to be lodged.

Rs.
Stock 1.1.1986 17,000
Purchases from 1.1.1986 date of fire 1,70,000
Wages 17,000
Sales from 1.1.86 to date of fire 20,000
The rate of Gross Profit is 25% on cost.
The Salvaged stock was valued at Rs.4000.
7. A fire occurred in the business premises of Raghavan on 19th July 1989. From the following
particulars ascertain the loss of stock and prepare a claim for insurance:

Rs.
Stock on 1-1-1988 36,720
Stock on 31-12-1988 32,400
Sales for 1988 2,16,000
Purchases for 1988 1,46,400
Purchases from 1-1-1989 to 19-7-19 1,76,400
Sales from 1-1-1989 to 19-7-1989 1,80,000

The stock were always valued at 90% of cost. The stock saved from fire was worth Rs.21,600. The amount of the policy was Rs.75,600. There was an average clause in the policy.

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