Insurance Policy Method of Depreciation


Insurance Policy Method of  Depreciation:

Learning Objectives:

  1. Define and explain the insurance policy method of depreciation.

Definition and Explanation:

Insurance policy method is a slight modification of the depreciation fund method or sinking fund method. Under this method the amount represented by the depreciation fund, instead of being used to buy securities, is paid to an insurance company as premium. The insurance company issues a policy promising to pay a lump sum at the end of the working life of the asset for its replacement.

The advantage of insurance policy method is that risk of loss on the sale of investment and the trouble and expense of buying investment are avoided, while disadvantage lies that the interest received on the premiums paid is comparatively very low.

When insurance policy method is employed the policy account will take the place of the depreciation fund investment account and no interest will be received at the end of each year, but the total interest on the premiums will be received when the policy matures.

Entries:

Every years two entries will be made:

1. In the beginning:
Depreciation insurance policy account
     To Cash account
(Being the payment of premium on depreciation policy)
2. At the end of the year:
Profit and loss account
     To Depreciation fund account
(Being the amount of depreciation charged to profit and loss account)

When the policy will mature i.e., to say the amount of the policy will be received. The entry is:

3. Cash account
     To Depreciation insurance policy account
(Being the policy amount realized)

The depreciation insurance policy account will show some profit. This will be transferred to depreciation fund account, the entry being.

4. Depreciation insurance policy account
     To Depreciation fund account
(Being the policy amount realized)

The asset account will have been shown throughout at its original cost. It now be written off by transfer to depreciation fund account. The entry is:

5. Depreciation fund account
     To Asset account

Insurance Policy Method Example:

On 1st January, 1990 a business purchases a three year lease of premises for $20,000 and it is decided to make a provision for replacement of the lease by means o an insurance policy purchased for annual premium.

Show the ledger accounts dealing with this matter.

Solution:

Leasehold Account

Dr. Side

Cr. Side

1990 1990
Jan. 1 To Cash 20,000 Dec. 31 By Depreciation fund 20,000

Depreciation Fund Account

Dr. Side Cr. Side
1990 1990
Dec. 31 To Balance c/d 6,400 Dec. 31 By Profit and loss a/c 6,400


1991
Dec. 31 To Balance c/d 12,800 Jan. 1 By Balance b/d 6,400
Dec. 31 By Profit and loss a/c 6,400


12,800 12,800


1992 1992
Dec. 31 To Leasehold Property 20,000 Jan. 1 By Balance b/d 12,800
Dec. 31 By Profit and loss a/c 6,400
By Leasehold 800


20,000 20,000


Leasehold Policy Account
Dr. Side Cr. Side
1990 1990
Dec. 31 To Cash 6,400 Dec. 31 By Balance c/d 6,400


1991 1991
Jan. 1 To Balance b/d 6,400 Dec. 31 By Balance c/d 12,800
Dec. 31 To Cash 6,400


12,800 12,800


To Balance b/d 12,800 By Cash 20,000
To Cash 6,400
800


20,000 20,000


You may also be interested in other articles from “accounting for depreciation” chapter:

  1. Definition and Explanation of Depreciation
  2. Causes of Depreciation
  3. Need for Depreciation
  4. Depreciation, Depletion and Amortization
  5. Difference Between Depreciation and Fluctuation
  6. Basic Factors of Determination of Depreciation
  7. Depreciation Methods / Methods for Providing Depreciation
  8. Fixed Installment Method / Straight Line Method / Original Cost Method
  9. Diminishing balance/written Down Value/Reducing Installment Method of Depreciation
  10. Annuity Method of Depreciation
  11. Depreciation Fund Method or Sinking Fund Method
  12. Insurance Policy Method of Depreciation
  13. Revaluation Method of Depreciation
  14. Sum of the Years’ Digits Method of Depreciation
  15. Double Declining Balance Method of Depreciation
  16. Depletion Method of Depreciation
  17. Basis of Use System of Depreciation
  18. Depreciation Of Various Assets
  19. Depreciation Accounting – General Questions and Answers

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