Insurance Policy Method of Depreciation:
Learning Objectives:
-
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 |
| |
|
|
|
|
|
|
|
