Professor Vipin 2014
Insurance Claims
A business enterprise normally gets itself insured against the loss of asset on the happening of certain
events such fire, flood, theft, earthquake etc. Sometimes, an enterprise also gets itself insured against
consequential loss of profit due to decreased turnover in addition to loss of asset. Hence this chapter
deals with two types of policies.


Claim for loss of asset.
Claim for loss of profit.
Insurance contracts (except life insurance) are contracts of indemnity whereby one party, called the
insurer, undertakes to indemnify the loss suffered by the other party, called the insured, on the
happening of some unforeseen event in consideration of a fixed sum of money, called the premium.
Loss of Stock Policy
To determine claim for loss of asset, the value of asset at the date of fire is considered. The value can be
obtained from accounting records. But in case of loss of stock, the value of stock is to be estimated if
stock ledger are destroyed by fire or not maintained.
To estimate value of stock following procedure is adopted
Step I – Prepare Memorandum trading A/c
This account is prepared from starting date of accounting year till the date of fire to ascertain the closing
stock for the purpose of claim.
Particulars
To Opening Stock
To Purchases
To Direct Expenses
To Gross Profit


Amount
Particulars
By Sales
By Closing Stock
Amount
Closing stock comes as a balancing figure.
Gross profit is calculated as:
1. Same as last year
2. Analysing trend and taking average or weighted average of past years gross profit ratios
3. Preparing last accounting year trading account.
Note: Before taking previous year gross profit rate one must consider that:
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1. Previous year opening and closing is valued at cost.
2. Any price level changes are eliminated in current year figures.
3. If there are any abnormal items, then they are separated and treated as:
Particulars
To Opening Stock
To Purchases
To Direct Expenses
To Gross Profit
Amount Amount
(Normal) (Abnormal)
Particulars
By Sales
By Closing Stock
Amount Amount
(Normal) (Abnormal)
4. Sometimes goods are recorded as purchases but not received physically or recorded as
sales but not yet dispatched. In such cases principle to be applied is that whether goods
were there in godown at date of fire. Example: goods sold but not yet dispatched are
deducted from sales OR Goods received but not recorded as purchases are added to
purchases.
5. Goods not for sale such as withdrawn for personal use, theft of stock, free samples etc.
should be ascertained and adjusted to derive a reasonable estimate of value of stock
lost in fire.
Step II – Determine Claim for loss of asset
Particulars
Value of stock on the date of fire
Add: Cost of Abnormal stock (if any)
Less: Value of salvaged stock
Amount of loss of stock
Amount
Step III – Application of Average clause Why and when it is applied?
As general insurance is a contract of indemnity, claim for loss of asset is restricted to the value of asset
destroyed by the fire. For this purpose value of stock on the date of fire is known as Insurable Amount
and actual amount insured is given in the question. Therefore two situations may arise:1. Insured amount > Insurable amount, i.e., Over – Insurance, claim is admissible to full amount of
loss.
2. Insured amount < Insurable amount, i.e., Under – Insurance, average clause is applicable as
follows.
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Loss of Profit Policy
Besides, loss of asset, fire results in dislocation of the business. It affects production, sales and
consequently profits during dislocation period. A normal fire insurance policy covers the material
damage to the property like building, machinery and other plant against the risks of destruction by fire.
However in the event of fire, it is not possible for him to erect new buildings and it may take months or
years to do so. Moreover there are some fixed expenses known as standing charges which are to be paid
irrespective of business activity. Thirdly to fulfill orders on time he may have to incur extra cost. For
these purpose, a business enterprise takes a policy called “Loss of profit” OR “Consequential loss” policy
to cover the following:


Net profits before Taxation. Loss on account of standing charges. The standing charges to be
covered as follows:
 Interest on debentures, mortgages, loans & bank overdrafts
 Rent ,rates & taxes
 Salaries to permanent staff & wages to skilled employees
 Company’s contribution to the provident fund, gratuity fund
 Director’s fees , auditors fees, legal expenses
 Traveling expenses, motor car expenses
 Insurance premium, advertising
 Office expenses
 Postage, telegrams & telephone, printing & stationery
 Electric energy and / or power charges
 Maintenance of building, plant & machinery
 Depreciation (excluding stocks and stores)
 Miscellaneous standing charges not exceeding 5% of the amount of the standing
charges specified. Increased cost of workings.
Increased cost of workings
A claim for loss of profits can be established only if:
1. The insured’s premises, or the property therein, are destroyed or damaged by the peril defined
in the policy; and
2. The insured’s business carried on the premises is interrupted or interfered with as a result of
such damage.
Terms Used
1. Period of claim: It is the indemnity period or dislocation period whichever is earlier.
2. Loss of turnover (Short sales): Standard turnover – Actual turnover
3. Standard turnover: It is turnover for the corresponding period in the preceding year and
generally adjusted for the trend of business by including “Special Circumstances Clause”
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Steps to calculate claim for loss of profit
Step I – Ascertain Period of Claim
Step II – Calculate gross profit ratio based on the trading results of last year
Give due regards to any “Special Circumstances Clause”.
Step III – Calculate turnover lost in claim period.
Particulars
Turnover for corresponding claim period in preceding
year
Add/Less: Special circumstances clause (if any)
Less: Actual turnover during claim period
Turnover lost during the claim period
Amount
Step IV – Calculate Gross profit during claim period
Step V – Calculate sum insurable
Particulars
Turnover for the 12 months preceding the date of
fire
Add/Less: Special circumstances clause (if any)
Adjusted Turnover
Agreed GP Ratio
Sum Insurable
Amount
Step VI – Calculate amount of net claim for increased cost of working
Particulars
Amount
Gross Claim
Less: Savings insured standing charges
Net Claim for increased cost of
working
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Gross Claim is Lower of following



Actual expenses
Proportionate increased cost of working
Maximum saving of liability of the insurer
Step VII – Calculate total claim by adding

Gross profit lost during claim period (step 4)

Net claim for increased cost of working (step 6)
Step VIII - Application of average clause
Notes:
1. Unless otherwise stated, all standing charges should be treated as insured standing charges.
2. Unless otherwise stated, actual turnover in the claim period should be deemed to be reduction in
turnover avoided.
Example 1
From the following data compute the consequential loss claim:
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Financial year ends on 31st December, Turnover Rs. 200000
Indemnity period: 6 months
Period of interruption – 1st July to 31st October
Net Profit: Rs. 18000
Standing charges: Rs. 42000 out of which Rs. 10000 has not been insured
Sum assured: Rs. 50000
Standard turnover: Rs. 65000
Turnover in the period of interruption Rs. 25000 out of which Rs. 6000 was from a rented place
at Rs. 600 per month
Annual turnover: Rs. 240000
Savings in standing charges: Rs. 4725 per annum
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k. Date of fire – night of 30th June
l. It was agreed between the insurer and the insured that the business trends would lead to an
increase of 10% in the turnover.
Solution 1
Particulars
Computation of Short of Sales:
Standard Turnover
Add: 10% increase in turnover
Amount
Less: Sales during the dislocation
period
Short Sales
Gross Profit on short sales @ 25%
Add: Increased cost of working, limited
to GP of Rs. 6000
Less: Savings in Expenses or Standing
Charges (4725/3)
Gross Claim
65000
6500
71500
25000
46500
11625
1500
13125
1575
11550
Since the sum assured is less than the amount for which the policy should have been taken, the average
clause shall apply.
Amount for which policy should have taken:
25% of Rs. 264000 (240000 + 24000) = Rs. 66000
Amount of claim = 11550 x 50000/66000 = Rs. 8750
Working Note:
Particulars
Gross Profit Rate: Net Profit
Add: Insured Standing charges (4200010000)
Gross Profit
Turnover
Gross Profit Rate
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Amount
18000
32000
50000
200000
25%
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Increased Cost of Working (Lowest of the following)
= 2400 x 50000/66000 = Rs. 2000
Gross Profit on additional sales: 25% of Rs. 6000 = Rs. 1500
The amount of Rs. 13125 (gross profit on short sales and increased working expenses) is within the
overall limit of 20% of Rs. 71500
Example 2
A fire occurred in the premises of a businessman on 31st January 1997, which destroyed most of the
building. However, stock worth Rs. 5940 was salvaged.
The company’s insurance covers the following:
Stock: Rs. 900000; Building: Rs. 1200000; Loss of profit (including standing charges): Rs. 375000; Period
of indemnity: 6 months
The summarized P&L is as follows:
Particulars
Turnover
Closing Stock
Opening Stock
Purchases
Standing charges
Variable expenses
Amount
Amount
3000000
787500
3787500
618750
2718750
251250
120000
3708750
78750
The transactions for month of January 1997 were as under:
Particulars
Turnover
Payment to Creditors
Trade Creditors: Balance on 1/1/97
Trade Creditors: Balance on 31/1/97
Amount
150000
160020
226000
230980
The company’s business was disrupted until 30/04/97 during which period the reduction in the turnover
amounted to Rs. 270000 as compared with the turnover of same period corresponding to the previous
year.
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Building was worth Rs. 1500000 on the date of the fire and three-quarter of its value was lost by fire.
You are required to submit the claim for insurance for loss of stock, loss of building and loss of profit.
Solution 2
Claim for Loss of Stock
Memorandum Trading Account for month ending Jan 31st 1997
Particulars
To Opening Stock
To Purchases (note 2)
To Gross Profit @ 15%
Amount
787500
165000
22500
Particulars
By Sales
By Closing Stock (bal
fig)
975000
Particulars
Closing stock
Less: Stock salvaged
Claim for Stock
Amount
150000
825000
975000
Amount
825000
5940
819060
Claim for Loss of Profit:
Particulars
Short Sales
Gross Profit (note 3)
Gross Profit on Short
Sales
Amount
270000
11%
29700
Claim for Loss of Building
Loss of building (3/4th of 1500000) Rs. 1125000. The building is insured for Rs. 1200000 only. Hence the
claim is subject to the average clause presuming that the policy contains such a clause.
= 1125000 x 1200000/1500000 = Rs. 900000
Total claim (Rs. 819060 + Rs. 29700 + Rs. 900000) = Rs. 1748760
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Working Notes
1. Rate of Gross Profit for the year ending 31st December 1996
Trading Account
Particulars
To opening stock
To Purchases
To Gross Profit
Amount
618750
2718750
450000
Particulars
By Sales
By Closing Stock
3787500
Amount
3000000
787500
3787500
2. Rate of gross profit comes to 15% (Rs. 450000/3000000)
Particulars
To Bank
To Bank Balance c/d
Amount
160020
230980
391000
Particulars
By Balance b/d
By Purchases (bal fig)
Amount
226000
165000
391000
3. Calculation of gross profit ratio for loss of profit
Particulars
Sales for 1996
Net Profit + Insured Charges:
Net Profit
Standing charges (Assumed all
insured)
Rate of GP (11%)
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Amount
Amount
3000000
78750
251250
330000
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