Insurance Claim for Loss of Stock and Loss of Profit | CMA Inter Syllabus

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Insurance Claim for Loss of Stock

During the course of running the operations, an organization may face different adversities like accidents. Such accidents, may happen in the premises of an organization (viz. factory, godown, shop etc.) and cause damage to various assets used by such organization. The physical assets present in the premises are the fixed assets (viz. building, machineries, furnitures etc.) and stock. To replenish the mutilated assets, the business immediately needs some money. So, to cover the risks of such losses, it takes on a policy with insurance company(s) so as to recover a part or whole of the loss.

The business pays insurance premium yearly or quarterly or as per agreement. If any accidental loss occurs, the business has to compute the amount of loss and file a claim for compensation to the insurance company. The insurance company, in turn, appoints loss assessors to investigate the reasons and extent of the loss. As per the report of the loss assessor, insurance claims are met.

Loss of Stock

Of the different forms of accidental losses, loss by fire is the most common one. A fire insurance policy is usually taken to cover two types of losses: 1. Loss of Stock and 2. Loss of Profits.

As stocks constitute a considerable portion of the working capital of any business and specially for trading concerns, any loss of stock directly affects the solvency of the business. A business has to cover this risk adequately.

Determination of Amount of Insurance Claim

The amount of insurance claim to be made by the organisation which suffered the loss depends on the following factors:

1. Value of stock present at the time of accident: If stock records and stock are destroyed, it becomes difficult to ascertain the amount of stock lost. When the loss suddenly occurs, up-to-date value of stock does not become available. In that case, the value of stock present can be ascertained using relevant information, and by drafting a Memorandum Trading Account. A Memorandum Trading Account is actually a statement (not an account) which is prepared following the proforma of a Trading Account. It has to be prepared starting from the first date of the accounting period in which the accident has taken place and ending on the date of accident. Its specimen is as follows:

Memorandum Trading A/c for the period April 1 of year of accident – Date of accident

Particulars	(₹)	Particulars	(₹)
To Opening Stock	***	By Sales	***
To Purchases	***	By Closing Stock [Balancing Figure]	***
To Gross Profit	***
[Sales × GP rate]	***		***

It is to be noted that in Memorandum Trading Account, the Gross Profit is estimated by multiplying ‘Sales’ for this period with the rate of Gross Profit (GP). The GP rate may be known to the entity or it has to be ascertained. The GP rate is usually estimated on the basis of the details of the last accounting period. The organisation determines the GP rate by preparing the Trading Account for the accounting period immediately preceding the period in which the accident has occurred.

NB: Adjustments may be necessary while preparing the Trading Accounts of the current period and preceding accounting years for slow-moving items, abnormal or defective items not fetching same rate of gross profit, goods distributed as samples, goods taken away by proprietors, over or under valuation of stocks, omission of recording of stocks, etc.

2. Value of stock salvaged: It is the quantity of stock that could be saved from the accident. The value of this salvaged stock is to be deducted from the ‘value of stock present at the time of accident’ for ascertaining the ‘value of stock lost by the accident’ which represents the ‘Gross Claim’ to be lodged.

3. Contents of the insurance policy: The insurance policy includes details like policy value, average clause etc. Policy Value is the maximum amount that can be realized by the insured from the insurance company on the occurrence of the accident. It influences the amount of net claim that can be lodged by the insured. Average Clause simply states that in the absence of adequate insurance coverage, the insurance company will not shoulder the entire risk. It is a tool of the insurance company to discourage under-insurance by the insured. This clause implies that in case of under-insurance, the insured will also have to share a portion of the loss along with the insurance company. It is to be noted that Average Clause will not be applicable if the policy value is greater than or equal to the amount of loss suffered. In case of under-insurance, the net claim from the insurance company will be lower than the Gross Claim. On application of Average Clause, Net Claim will be computed as under:

Net claim* (Policy Value/Value of stock lost on day of accident)

Certain special situations

Goods-in-Transit or Goods sent to branches/ consignee: The cost of Goods-in-transit is to be deducted from ‘Purchases’ figure in Trading A/c or Memorandum Trading A/c, as the case may be. Alternatively, the cost of such goods may also be credited to the Trading A/c or Memorandum Trading A/c.

Goods sold but not yet to be delivered: Sale value of such goods is to be deducted from ‘Sales’ figure in Trading A/c or Memorandum Trading A/c.

Goods sent on approval basis: Cost of such goods is to be deducted from ‘Purchases’ figure in Trading A/c or Memorandum Trading A/c, as the case may be. Further, deduct the sale value of such goods from ‘Sales’ figure in Trading A/c or Memorandum Trading A/c.

Change in price level

For applying the GP rate determined sale of the period in which loss has occurred in the Memorandum Trading A/c, the effect of such price changes have to be nullified from the different items of Memorandum Trading A/c. For this purpose the method of stock pricing (i.e. FIFO, LIFO etc.) is to be considered.

Under-valued or Over-valued stock  

When the stock is valued at a figure higher or lower than the cost, it affects the normal GP rate. When stock is under-valued, amount of under-valuation is added back to the respective stock to arrive at the cost; while in case of over-valuation, the over-valued amount is to be deducted to arrive at the cost of such stock. Further, for calculation of Gross Claim, the unsold portion of such under/ over-valued stocks is to be considered. 

Abnormal/ Defective/ Usual Selling line Items: Goods which cannot fetch the usual rate of gross profit are considered as referred to as unusual or abnormal items. For preparing the Memorandum Trading Account, the portion of the value of such goods which has not yet been written off, should be deducted from the Opening Stock. If any such goods have been purchased in the current period, the Cost Price of such goods should be deducted from purchases. If any portion of such goods have been sold in the current period, the Selling Price should be deducted from current sales. Lastly if any portion of such, goods remains unsold on the date of fire, the agreed value of such portion should be added with the estimated value of normal stock to arrive at the estimated value of (total) stock on that date. Similar adjustments may be required while preparing the Trading Account of the last financial year/s, if abnormal items existed then. As an alternative measure, columnar Trading Account showing normal and abnormal items separately may be prepared.

 Illustration 1

A fire occurred on 15th September 2022 in the premises of Sen & Co. from the following figures, calculate the amount of claim to be lodged with the insurance company for loss of stock.

Particulars	Amount (Rs.)
Stock at cost on 1.1.2021	40,000
Stock at cost on 1.1.2022	60,000
Purchases in 2021	80,000
Purchase from 1.1.2021 to 15.9.2022	1,76,000
Sales in 2021	1,20,000
Sales from 1.1.2022 to 15.9.2022	2,10,000

During the current year cost of purchase has risen by 10% above last years’ level. Selling prices have gone up by 5%. Salvage value of stock after fire was Rs. 4,000.

Solution:

Memorandum Trading Account for the period from 1.1.2022 to 15.9.2022

Particulars	Current Year Rs.	Last Year Rs.	Particulars	Current Year Rs.	Last Year Rs.
To Opening Stock	60,000	60,000	By, Sales	2,10,000	2,00,000
To  Purchase	1,76,000	1,60,000	By, Closing Stock	1,32,000	1,20,000
To  Gross Profit	1,06,000	1,00,000
	(bal. fig.)	(50% of sales)
	3,42,000	3,20,000		3,42,000	3,20,000

Working:

1. Value of Closing Stock

	Rs.
Stock at last years’ level	60,000
Add: 10% increase in cost of purchase	6,000
Amount of Claim	66,000
Closing Stock	Rs.
Less: Stock Salvaged	1,32,000
Actual Value of Stock last	4,000
Actual Value of Stock Loss	1,28,000

∴ Percentage of gross profit on sales = (Gross Profit/Sales) 2100

= (Rs. 60,000/Rs. 1,20,000)×100

= 50%

 Illustration 2

Mr. X’s godown was destroyed by fire on 1.6.2022 when the goods in stock were insured for Rs. 60,000. The following particulars are given:

Balance Sheet (Extract) as at 31st December 2021

Liabilities	Amount Rs.	Asset	Amount Rs.
Creditor for goods	20,000	Stock (including goods held by agent Rs. 2,000)	36,000
		Debtors	70,000

Transactions upto 31st May, 2022 include :

Particulars	Amount Rs.	Particulars	Amount Rs.
Cash Received from Debtors	3,40,000	Cash paid to Creditors	2,20,000
Bad Debt written off	3,500	Discount Received	1,000
Balance on 31.5.2022
Debtors	70,000
Creditors	30,000

Additional information:

(i) Debtors on 31.5.2022, included an amount owing from the agent from sales to date Rs. 4,000 less 10% commission and his expenses amounting to Rs. 100 on 31.5.2022 – the agent still held the said goods valued at Rs. 3,600 (at selling price).

(ii) Sales (total) for the periods include Rs. 1,600 for goods which have the selling price reduced by 50% and also Rs. 6,000 reduced by 25%.

(iii) The normal mark up is 50% on cost and except the above, all sales can be assumed to be at the full selling price.

(iv) All the goods were destroyed and there was no salvage value of the goods.

Calculate the amount of claim.

Solution:

In the Books of Mr. X

Debtors Account

Date	Particulars	Amount in (Rs.000)	Date	Particulars	Amount in (Rs.000)
2022			2022
Jan 1	To Balance b/d	70	May 31	By Cash Received	340
May 31	To Sales (bal. fig.)	340	May 31	To Bad Debts	3.5
			May 31	To Balance c/d (excluding form agent)	66.5
		410			410

Creditors Account

Date	Particulars	Amount in (Rs.000)	Date	Particulars	Amount in (Rs.000)
2022			2022
May, 31	To Cash paid	220	Jan. 1	By Balance b/d	20
May 31	To Discount Received	1	May 3	By purchase (bal. fig)	231
May 31	To  Balance c/d	30
		251			251

Godown Stock Account

Date	Particulars	Amount in (Rs.000)	Date	Particulars	Amount in (Rs.000)
2021			2021	By Cost of Goods Sold	229.066
May, 31	To Balance b/d (Rs. 36,000 – Rs. 2,000)	34	May31	By  Stock at Agents	3.067
May 31	To  Purchase from the Creditors	231	May 31	By  Stock Destroyed by fire (bal. fig)	32.867
		265			265

Thus, amount of claim which will be lodged for Rs. 32,867.

Workings :

1. Bad Debts

Particulars	Amount in (Rs.000)
Sales	4
Less: Commission @10% : 400	0.5
Expenses: 100	3.5

2. Cost of Goods Sold

	Normal Selling Price(Rs.)	Cost (2/3 of Selling Price) (Rs.)
1,600	3,200	2,133
6,000	8,000[6,000 × (100/75)]	5,333
3,32,400 (bal. fig.)	–	2,21,600
3,40,000		2,29,066

3. Stock at Agent

Sales (Rs.)	Cost (Rs.)
4,000	2,667(Rs. 4,000 × 2/3
-	2,400(Rs. 3,600 × 2/3)
Less: Agents’ hand at the beginning	5,067
	2,000
	3,067

Illustration 3

X Ltd. has taken out a fire policy of Rs. 1,60,000 covering its stock. A fire occurred on 31st March, 2022. The following particulars are available :

	₹
Stock as on 31.12.2022	60,000
Purchases to the date of fire	2,60,000
Sales to the date of fire	1,80,000
Carriage Inwards	1,600
Commission on purchase to be paid	@2%
Gross Profit Ratio @ 50% on cost

You are asked to ascertain (i) total loss of stock; (ii) amount of claim to be made against the Insurance Company assuming that the policy was subject to average clause. Stock salvage amounted to Rs. 41,360.

Solution:

In the books of X Ltd.

Memorandum Trading Account

for the period ended 31st March, 2022

Dr.				Cr.
Particulars	(₹000)	(₹000)	Particulars	(₹000)
To, Opening Stock		60	By, Sales	180
Purchase	260		Closing Stock (bal. figure)	206.8
Add: Carriage Inward	1.6
Add: Com. on Purchase	5.2	266.8
(Gross Profit @ 50% on cost or 33 % on sale)		60
		386.8		386.8

Note: Carriage Inward and Com. On Purchase are direct expenses and hence, these are added to purchases.

Loss of Stock:

	₹
Stock at the date of fire	2,06,800
Less: Stock Salvaged	41,360
Loss of Stock	1,65,440

Amount of claim applying Average Clause

Amount of Claim =(Actual Loss × Amount of Policy) / Value of stocks at the date of fire

= ₹ 1,65,440 × (₹ 1,60,000/ ₹ 2,06,800)

= ₹ 1,28,000

Illustration 4

A fire occurred in the premises of Sri. G. Vekatesh on 1.4.2022 and a considerable part of the stock was destroyed. The stock salvaged was Rs. 28,000. Sri Venkatesh had taken a fire insurance policy for Rs. 1,71,000 to cover the 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 fire. The following particulars are available :

	Rs.		Rs.
Purchases for the year 2021	9,38,000	Stock on 1.1. 21	1,44,000
Sales for the year 2021	11,60,000	Stock on 31.12.2021	2,42,000
Purchases from 1.1. 22 to 1.4. 22	1,82,000	Wages paid during 2021	1,00,000
Sales from 1.1. 22-1.4. 22	24,00,000	Wages paid 1.1. 22-1.4. 22	1,80,000

 

Sri Venkatesh had in June 2021 consigned goods worth Rs. 50,000, which unfortunately were lost in an accident. Since there was no insurance cover taken, the loss had to be borne by him full.

Stocks at the end of each year for and till the end of the calendar year 2021 had been valued at a cost of less 10%. From 2021, however there was a change in the valuation of closing stock which was ascertained by adding 10% to its costs.

Solution:

In order to find the rate of gross profit on sales for the year 2021, the following Trading Account is to be prepared for the same year as

Trading Account

For the year ended 31st Dec. 2021

Dr.			Cr.
Particulars	Amount ₹	Particulars	Amount ₹
To, Opening Stock -1,44,000 × (100/90)	1,60,000	By, Sales	11,60,000
To, Purchases	9,38,000	By, Stock lost by Accident	50,000
To, Wages	1,00,000	By, Closing Stock (2,42,000 ×100/110)	2,20,000
To, Profit & Loss A/c (G.P. transferred)	2,32,000
	14,30,000		14,30,000

Rate of Gross Profit on Sales = 2,32,000/11,60,000 × 100 = 20%

Trading A/c for the period (from 1.1. 22-1.4. 22)

Dr.			Cr.
Particulars	Amount ₹	Particulars	Amount ₹
To, Opening Stock	2,20,000	By, Sales	2,40,000
To, Purchases	1,82,000	By, Closing Stock	2,28,000
To, Wages	18,000
To, Profit & Loss A/c (G.P. @20% of sales)	48,000
	4,68,000		4,68,000

Amount of Claim = Stock destroyed – Salvaged

= ₹ 2,28,000 – ₹ 28,000

= ₹ 2,00,000

As the policy amount is less than the value of stock destroyed, the average clause is applicable. Here, the amount of claim will be:

Net Claim = Loss of Stock × (Amount of Policy / Stock at the date of fire)

= 2,00,000 × (1,71,000 / 2,28,000) = 1,50,000/-

 Illustration 5

On 1.4.2022, godown of Y Ltd. was destroyed by fire. The records of the company revealed the following particulars:

	₹
Stock on 1.1.2021	75,000
Stock on 31.12.2021	80,000
Purchases during 2021	3,10,000
Sales during 2021	4,00,000
Purchase from 1.1.2022 to the date of fire	75,000
Sales from 1.1.2022 to the date of fire	1,00,000

In valuing Closing Stock of 2021, ₹ 5,000 was written off whose cost was ₹ 4,800. Part of this stock was sold in 2022 at a loss of ₹ 400, at ₹ 2,400. Stock salvaged was ₹ 5,000. The godown and the cost of which was fully insured.

Indicate from above amount of claim to be made against the insurance company.

Solution:

For ascertaining the rate of Gross Profit

In the books of X Ltd.

Trading Account

for the year ended 31.12.2021

Particulars	₹	₹	Particulars	₹	₹
To, Opening Stock		75,000	By, Sales		4,00,000
“ Purchases	3,10,000		“ Closing Stock	80,000
Less: Purchase of Abnormal items of goods	4,800	3,05,200	Add: Loss on value of abnormal items (Rs.5,000 – Rs.4,800)	200	80,200
“ Gross Profit (bal. fig.)		1,00,000
		4,80,200			4,80,200

Percentage of Gross Profit on sales = (1,00,000/4,00,000)100

Memorandum Trading Account

for the period ended 31st March, 2022

Particulars	₹	Particulars	₹	₹
To, Opening Stock	80,200	By, Sales	1,00,000
“ Purchases	75,000	Less: Sale of abnormal Stock (₹ 2,400 – ₹ 400)	2,000	98,000
“ Gross Profit (@25% on ₹ 98,000)	24,500	“ Closing Stock (bal. fig.)		81,700
	1,79,700			1,79,700

Alternative approach

In a combined form

Trading Account

for the year ended 31st December, 2022

Dr.							Cr.
Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹	Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹
To Opening Stock	75,000	--	75,000	By Sales	4,00,000	---	4,00,000
,, Purchase		4,800	3,10,000	,, Closing Stock	80,200	(-) 200	80,000
,, Gross Profit @25% on sales	3,05,200	--	1,00,000	,, Gross Loss	---	5,000	5,000
	4,80,000	4,800	4,85,000		4,80,200	4,800	4,85,000

Memorandum Trading Account

for 3 months ending 31st March, 2022

Dr.							Cr.
Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹	Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹
To Opening Stock	80,200	(-) 200	4,400	By Sales	98,000	2,000	1,00,000
,, Purchase	75,000	---	75,000	,, Closing Stock (bal. fig	81,700	2,400	84,100
,, Gross Profit	24,500	4,600	29,100
	1,79,700	4,400	1,84,100		1,79,700	4,400	1,84,100

1. 50% of ₹ 4,800 i.e., remaining abnormal stocks are valued at cost.

Amount of Claim	₹
Value of Stock at the date of fire	84,100
Less: Stock Salvaged	5,000
	79,100

 Illustration 6

On 30.09.2022 the stock of Harshvardhan was lost in a fire accident. From the available records the following information is made available to you to enable you to prepare a statement of claim of the insurer:

Particulars	Amount (Rs.)	Particulars	Amount (Rs.)
Stock at cost on 1.4.2021	75,000	Sales less returns for the year ended31.3.2022	6,30,000
Stock at cost on 31.3.2022	1,04,000	Purchase less returns up to 30.09.2022	2,90,000
Purchases less returns for the year ended 31.3.2022	5,07,500	Sales less returns up to 30.09.2022	3,68,100

In valuing the stock on 31.03.2022 due to obsolescence 50% of the value of the stock which originally cost Rs. 12,000 had been written-off. In May 2022, ¾th of these stocks had been sold at 90% of original cost and it is now expected that the balance of the obsolete stock would also realize the same price, subject to the above, G.P had remained uniform throughout stock to the value of Rs. 14,400 was salvaged

Solution:

Memorandum Trading Account

for the period ended 30.09.2022

Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹	Particulars	Normal Items ₹	Abnormal Items ₹	Total ₹
To Opening Stock	98,000	6,000	1,04,000	By Sales (Less returns)	3,60,000	8,100	3,68,100
,, Purchase (Less: Returns)	2,90,000	-	2,90,000	,, Closing Stock	1,18,000	2,700	1,20,700
,, Gross Profit( 25% on Normal Sales)	90,000	4,800	94,800
	4,78,000	10,800	4,88,800		4,78,000	10,800	4,88,800

 

∴ Amount of Claim	₹
Stock at the date of fire	1,20,700
Less: Stock Salvaged	14,400
	1,06,300

Workings :

Trading Account

for the year ended 31.03.2022

Particulars	Amount (₹)	Particulars	Amount (₹)
To Opening Stock	75,000	By Sales (Less: Returns)	6,30,000
,, Purchase (Less: Returns)	5,07,500	,, Closing Stock	1,10,000
,, Gross Profit	1,57,500
	7,40,000		7,40,000

So, Percentage of Gross Profit on sales

1. Closing Stock

Particulars	Amount ₹
Closing Stock	1,04,000
Add: Stock Written off	6,000
	1,10,000

 2. Sale of Abnormal Items of goods

₹ 12,000 ×(3/4) × (90/100) = ₹ 8,100

3. Closing Stock of Abnormal Items

₹ 12,000 × (1/4) × (90/100) = ₹ 2,700

Illustration 7

A fire occurred in the premises of M/s Bad Luck Traders twice during the accounting year 2021-22 that is on 31st August 2021 and again on 30th November, 2021. From the following particulars, calculate the claim to be lodged in respect of the goods lost by fire on the aforementioned date:

1. The stock as at 31st March, 2021 was valued at ₹ 59,000.

2. The purchases from 1st April, 2021 to 31st August, 2021 amounted to ₹ 3,45,000.

3. The purchases from 1st September, 2021 to 30th November, 2021 amounted to ₹ 1,90,000 of which goods costing ₹ 45,000 were received on 10th December, 2021.

4. Sales for the period from 1st April, 2021 to 31st August, 2021 amounted to ₹ 4,71,000.

5. The sales for the period from 1st September, 2021 to 30th November, 2021 amounted to ₹ 2,25,000. It includes sale of old furniture of ₹ 27,000.

The company earns a steady rate of Gross profit at 20% at the beginning of the year 2021. However, the selling price was raised by 20% from the month of April.

The value of the goods salvaged was ₹ 30,000 and ₹ 2,000 on 31st August, 2021 and on 30th November, 2021 respectively.

The firm had taken out a fire insurance policy of ₹ 45,000 on 1st April, 2021. At the time of receiving the insurance claim on 31st August, 2021, no additional premium was paid for restoration of the insurance policy to its original amount. The policy was subject to average clause

Solution:

Amount of stock lost on August 31, 2021

Particulars	Amount (₹)
Value of stock on date of fire (WN-2)	90,000
Less: Value of stock salvaged	30,000
∴ Actual Loss of Stock	60,000

Applicability of Average Clause(for first insurance claim)

 Here, Insurable Value = Value of stock on date of fire = ₹ 90,000; Policy Value = ₹ 45,000. There is under insurance.

∴ Average clause will be applicable 

∴ Net Claim = Actual loss of Stock * (Policy Value/Insurable Value) 

 = 60,000 * (45,000/90,000) = ₹ 30,000

Amount of stock lost on November 30, 2021

Particulars	Amount (₹)
Goods destroyed by fire (WN-3)	43,000
Less: Value of stock salvaged	2,000
∴ Actual Loss of Stock	41,000

Applicability of Average Clause (for second insurance claim)

Here, Insurable Value = Value of stock on date of fire = ₹ 43,000; Policy Value = ₹ 15,000 [WN: 4]

In this case also there is under-insurance.

∴ Average clause will be applicable.

∴ Net Claim = Actual loss of Stock * (Policy Value/Insurable Value) 

= 41,000 * (15,000/43,000) = ₹ 14,302(approx) 

Working Notess:

1. New Rate of GP in 2021-22:

	Sale price	Gross Profit
Normal Price	100	20
Add: Increase in sale Price	20	20
	120	40

∴ Rate of GP in 2021-22 = (40*100) / 120 = 33.33%

 2. Stock on the date of first accident i.e. August 31, 2021

 Memorandum Trading Account for the period Apr. 1 – Aug. 31, 2021 

Particulars	(₹)	Particulars	(₹)
To Opening Stock	59,000	By Sales	4,71,000
To Purchases	3,45,000	By Closing Stock [Bal. Fig.]	90,000
To Opening Stock   [₹ 4,71,000 × 33.33% (WN: 1)	1,57,000
	5,61,000		5,61,000

3. Stock on the date of second accident i.e. November 30, 2021

 Memorandum Trading Account for the period Sept. 1 – November 30, 2021

Particulars		(₹)	Particulars		(₹)
To Opening Stock		30,000	By Sales	2,25,000
To Purchases	1,90,000		Less: Sale of furniture	27,000	1,98,000
Less: Goods-in-Transit	45,000	1,45,000
			By Closing Stock [Bal. Fig.]		43,000
To Gross Profit [₹ 1,98,000 × 33.33%]		66,000
		2,41,000			2,41,000

 4. Policy Value of the fire insurance policy

• For the first insurance claim
  The value of fire insurance policy taken = ₹ 45,000
  
  
• For the second insurance claim
  As the original policy was not restored at the time of receiving the insurance claim on 31.8.2021, the subsequent ‘Policy Value’ will get reduced by the amount of insurance claim received. 
  
  ∴ revised policy value = Original policy value – Compensation received on first insurance claim 
  = ₹ 45,000 – ₹ 30,000
  =  ₹ 15,000

 

Insurance Claim for Loss of Profit

Insurance Claim for Loss of Profit

During regular course of operations an organization may suffer from different types of accidents. Such accidents may occur due to natural calamities, human induced accidents. Such accidents usually hamper the regular operations of the organisation, and thus in turn affecting the organisation’s profitability. To cover such risk, the organization usually enters into a contract with insurance company to cover the risk of loss of profit. Such a policy is known as ‘Loss of Profit policy’ or ‘Consequential Loss policy’.

For determination of the amount of claim for ‘Loss of Profit policy’, the organization needs to ascertain the amount of profit which the organization could have earned. In relation to determination of such loss of profit, the following terms are significant:

● Indemnity period: The period for which normal activities of the business is interrupted is known as indemnity period.

● Standard turnover: The turnover of the previous year corresponding to the period of indemnity after adjustment of trend in turnover.

● Adjusted annual turnover: Turnover during 12 months immediately preceding the date of damage (taking trend into consideration).

● Standing charges: Unavoidable fixed expenses which have to be paid even if there is reduction in sale.

Calculation of the Net Claim under Loss of Profit Policy

The amount of net claim is determined through the following steps:

Step 1	Ascertainment of Gross Profit (GP) for previous accounting period:
	1. In case of existence of Net profit
	GP = Net Profit for Previous Accounting Period + Insured Standing Charges.
	2. In case of existence of Net loss
	GP  = Insured standing charges - [Net Loss * (Insured Standing Charges/All Standing Charges)]
Step 2	Determination of GP rate
	GP rate = GP/Sales * 100
Step 3	Calculate Short Sales
	Short Sales = Standard Turnover – Actual Turnover for Indemnity Period.
Step 4	Calculate GP Lost on Short Sales:
	GP Lost = Short Sale × GP rate
Step 5	Determine admissible additional expenses for insurance claim:
	i. Actual additional expenses
	ii. Sales due to additional expenses  × GP rate
	iii. Actual additional expenses × (Net Profit + Insured Standing Charges/Net Profit + All Standing Charges)
Step 6	Calculation of Gross Claim
	Gross claim = GP lost + Admissible Expenses for Insurance Claim – Saving in Standing Chages.
Step 7	Insurable value = Adjusted Annual Turnover × GP rate
Step 8	Claim to be lodged
	Situation 1: When average clause is applicable(insurable value < policy value)
	Net Claim = Policy Value/Insurable Value * Gross Claim
	Situation 2: When average clause is Not applicable (insurable value is >policy value)
	Net Claim = Gross Claim

NB: Some of the important points relating to the variables are as under:

• If additional Sales due to additional expenses is not given, assume that entire sale has been attained due to additional expenses.
• All standing charges = insured standing charges + uninsured standing charges.
• In absence of specific information assume that all standing charges are insured.
• If  sales for past years is given we need to determine the trend of sales.

Illustration 8

On account of fire on June 15, 2021, in business house of a company, the working remained disturbed up to December 15, 2021 as a result of which it was not possible to affect any sales. The company had taken out an insurance policy with an average clause against consequential losses for ₹  1,40,000 and a period of 7 months has been agreed upon as indemnity period. An increase of 25% was marked in the current year’s sales as compared to last year. The company incurred an additional expenditure of ₹  12,000 to make sales possible and made a saving of ₹  2,000 in insured standing charges.

Ascertain the claim under the consequential loss policy keeping the following additional information in view:

Particulars	(₹)	Particulars	(₹)
Actual sales from 15.6.21 to 15.12.21	70,000	Total standing charges for last financial year	1,20,000
Sales from 15.6.20 to 15.12.20	2,40,000	Turnover for last financial year	6,00,000
Net profit for the financial year	80,000	Turnover from 16.6.20 to 15.6.21	5,60,000
Insured standing charges for last financial year	70,000

Solution:

GP for previous accounting period  = Net profit for previous accounting period + Insured standing charges.  = ₹ 80,000 + ₹ 70,000 = ₹ 1,50,000

GP rate = GP/Sales * 100 = ₹1,50,000/₹6,00,000 * 100 = 25%

Short Sale - standard turnover - actual turnover for tindemnity period.  =₹(2,40,000 * 125%) - ₹ 70,000 = ₹ 2,30,000

Admissible additional expenses for insurance claim  Least of the following:    (₹)   i. Actual additional exp   12,000  ii. Sales due to additional expenses  × GP rate (₹ 70,000 × 25%)    17,500  iii. Actual additional expenses × (Net Profit + Insured standing charges / Net Profit + All standing charges)  ₹(12,000 * (80,000+70,000 / 8,00,000+1,20,000))     9,000 Admissible additional expenses     9,000

Gross claim = GP lost + admissible expenses for insurance claim – Saving in standing charges.  = ₹  (57,500 + 9,000 – 2,000) = ₹ 64,500

Insurable value = adjusted annual turnover × GP rate  = (₹ 56,00,000 × 125%) × 25% = ₹  1,75,000

Net Claim = Policy Value/Insurable Value * Gross claim = ₹1,40,000/₹1,70,000 * ₹64,500 = ₹ 53,118

 Illustration 9

From following details, calculate consequential loss claim:

● Date of fire: Sept. 1

● Indemnity period: 6 months

● Period of disruption September  1 to February 1

● Sum insured ₹  1,08,900

● Sales were ₹  6,00,000 for preceding financial year ended 31st march.

● Net profit for preceding financial year ₹  36,000 plus insured standing charges ₹  72,000

● Rate of gross profit 18%

● Turnover during disruption period ₹  67,500

● Annual turnover for 12 months immediately preceding the date of fire ₹  6,6,0000

● Standard turnover i.e. for corresponding months in the year preceding the date of fire ₹  2,25,000

● Increase in the cost of working capital ₹  12,000 with a saving of insured standing charges ₹  4,500 during the disruption period;

● Reduced turnover avoided through increase in working capital ₹  30,000

● A special clause stipulated:

• Increase in rate of GP by 2%
• Increase in turnover (standard and annual) 10%

Solution:

GP rate = 18% + 2% = 20%

Short sale = standard turnover – actual turnover for indemnity period.  = (₹ 2,25,000 × 110%) – ₹ 67,500 = ₹ 1,80,000

GP Lost = Short sale × GP rate  = ₹ 1,80,000 × 20% = ₹ 36,000

Admissible additional expenses for insurance claim  Least of the following:     (₹)  i. Actual additional exp.   12,000  ii. Sales due to additional expenses  × GP rate (₹ 30,000 × 20%)       6,000  iii. Actual additional expenses × (Net Profit + Insured standing charges / Net Profit + All standing charges) ₹(12,000 * (36,000+72,000/ 3,60,000+(72,000+6,000)))     11,368  Admissible additional expenses     6,000

Gross claim = GP lost + admissible expenses for insurance claim – saving in standing charges =   ₹  (36,000 + 6,000 – 4,500) =  ₹  37,500

Insurable value = adjusted annual turnover × GP rate  = (₹  6,60,000 × 110%) × 20% = ₹  1,45,200

Net Claim = Policy Value/Insurable Value * Gross claim = ₹1,08,900/₹1,45,200 * 37,500 = ₹ 28,125

Illustration 10

A fire occurred on Mar. 15, 2021 in the premises of Omega Ltd. A Loss of Profit policy was taken by Omega Ltd. for ₹ 80,000. The indemnity period was for 3 months. Net Profit for the year ending Dec. 31, 2020 was ₹ 56,000 and standing charges (all insured) amounted to ₹ 49,600. Determine insurance claim from the following details available from quarterly sales tax returns:

Sales	2018(₹)	2019(₹)	2020(₹)	2021(₹)
From Jan.1 to Mar.31	1,20,000	1,30,000	1,42,000	1,30,000
From Apr.1 to June 30	80,000	90,000	1,00,000	40,000
From July 1 to Sept.30	1,00,000	1,10,000	1,20,000	1,00,000
From Oct.1 to Dec.31	1,36,000	1,50,000	1,66,000	1,60,000

 

Sales	2018(₹)
Sales from 16.3.2020 to 31.3.2020	28,000
Sales from 16.3.2021 to 31.3.2021	Nil
Sales from 16.6.2020 to 30.6.2020	24,000
Sales from 16.6.2021 to 30.6.2021	6,000

Solution: 

Statement of Claim for Loss of Profit

Particulars	(₹)
GP lost on Short Sales [WN: 4]	16,080
Less: Savings in Standing Charges	Nil
∴ Gross Claim	16,080

 ∴ Net Claim (under “Average clause”) =  Gross Claim * Policy Value/Insurable Value 

 =  ₹ 16,080  ×  80,000/1,19,680

 =  ₹ 10,749 (Approx.)

Working Notes:

WN: 1 Trend of Turnover of last few years

Sales of: 2018 = ₹ (1,20,000 + 80,000 + 1,00,000 + 1,36,400) =  ₹ 4,36,400

2019 = ₹ (1,30,000 + 90,000 + 1,10,000 + 1,50,000) =  ₹ 4,80,000

2020 = ₹ (1,42,000 + 1,00,000 + 1,20,000 + 1,66,000) =  ₹ 5,28,000 

Rate of Turnover change = (Turnover of the current year – Turnover of the previous year)/Turnover of the previous year × 100 

For 2020 =  (5,28,000 –  4,80,000)/4,80,000 × 100 = 10%

For 2019=  (4,80,000 –  4,36,400)/4,36,400× 100 = 10%(approx.)

Thus, we observe a 10% upward trend in turnover over the last few years.

 2. Calculation of GP Rate

Particulars	(₹)
Net Profit of 2020	56,000
Add: Insured Standing Charges	49,600
∴ Insured Gross Profit	1,05,600

 Sales of 2020 = ₹ 5,28,000 (as computed above) 

 ∴ Rate of Gross Profit in 2020 = Gross Profit/Sales × 100 

     = 1,05,600/5,28,000 × 100

     = 20 %

 3. Calculation of Short Sales

Particulars	(₹)	(₹)
Standard Turnover (from March 15, 2021 to June 15, 2021):
Turnover from April 1, 2020 to June 30, 2020	1,00,000
Add: Turnover from March 16, 2020 to March 31, 2020	28,000
	1,28,000
Less: Turnover from June 16, 2020 to June 30, 2020	24,000	1,04,000
Add: Upward trend @ 10% [WN: 1]		10,400
		1,14,400
Less: Actual Turnover (from March 15, 2021 to June 15, 2021)
Turnover from April 1, 2021 to June 30, 2021	40,000
Add: Turnover from March 16, 2021 to March 31, 2021	Nil
	40,000
Less: Turnover from June 16, 2021 to June 30, 2021	6,000	34,000
∴ Short Sales		80,400

 4. GP lost on Short Sales

 Short sales × Rate of GP = ₹ 80,400 × 20% = ₹ 16,080 

 5. Annual Turnover i.e. Sale for the year ending March 15, 2021

Particulars	(₹)
From March 16, 2020 to March 30, 2020	28,000
From April 1, 2020 to June 30,2020	1,00,000
From July 1, 2020 to September 31,2020	1,20,000
From October 1, 2010 to December 31, 2010	1,66,000
From January 1, 2021 to March 31, 2021	1,30,000
	5,44,000
Less: March 16, 2021 to March 31, 2021	Nil
	5,44,000

6. Applicability of Average Clause

 Insurable Value = Adjusted Annual Turnover × GP Rate = (₹ 5,44,000 × 110%) × 20% = ₹ 1,19,680

 Policy Value = ₹ 80,000 (Given)

 In this case, as Policy Value < Insurable Value, there is ‘under insurance’ and so Average Clause is applicable.

Exercise

Numerical Questions

CMA book unsolved questions solution

1. From the following information, calculate the amount of claim for loss of stock with Insurance Company C Ltd:

Particular	Amount (Rs.)
Purchase for the year 2021	9,15,000
Sales for the year 2021	12,00,000
Purchase from 1.1.2022 to 30.6.2022	8,00,0000
Sales from 1.1.2022 to 30.6.2022	9,90,000
Stock on 1.1.2021	1,35,000
Stock on 1.1.2022	1,50,000

You are informed that:

(i) In 2022 the purchase prices raised by 20% above the level prevailing in 2021.

(ii) In 2022 the selling prices hiked by 10% over the level prevailing in 2021.

(iii) Salvaged value of stock 20000.

(iv) Fire insurance policy for 148750 to cover the loss of stock by fire.

Solution:

In the books of C Ltd.

Trading Account for the year ended 31.12.2021

Dr.			Cr.
Particulars	Amount (₹)	Particulars	Amount (₹)
To Opening Stock	1,35,000	By Sales	12,00,000
To Purchase	9,15,000	By Closing Stock	1,50,000
To Gross profit	3,00,000
	1420000		14,20,000

Estimated Trading Account for the period from 1.1. 22 to 30.06. 22

Dr.					Cr.
Particulars		Amount(₹)	Particulars		Amount(₹)
To Opening Stock	1,50,000	1,50,000	By Sales	9,90,000	9,00,000
To Purchase	8,00,000	6,66,667	By Closing Stock	1,70,000	1,41,667
To Gross profit	2,10,000	2,25,000
	1,16,000	10,41,667		1,16,000	10,41,667

Statement of Claim for Loss of Stock

Particulars
Estimated value of stock on the date of fire on 30.06. 22 (-) value of stock salvaged	17,000
Actual stock lost by fire	20,000
	1,50,000

The Policy value of the insured stock is 148750

The claim to be made after applying Average Clause= Actual Loss*Sum Insured/Value of Stock

= 150000*148750/170000 = 131250.

Workings:

1. Rate of Gross profit for the year 2021-22: 300000/1200000*100=25%. It is assumed that this rate has not changed in 2022 though purchase and selling price have risen.
2. Purchase in 2022 at the price level of 2021 = 800000*100/120 = 666667.
3. Sales in 2022 at the price level of 2021 = 990000*100/110 = 900000.
4. Gross profit between 1.1. 22 and 30.6. 22 at last year’s rate = 25% of 900000 = 225000.
5. Closing stock for this period at last year’s rate 141667 (balancing figure). Stock on that date at current price = 141667 + 20% there of = 170000.

2. X &Co. suffered a loss of stock due to fire on 31.3.20X3. From the following information prepare a statement showing the claim for the loss to be submitted:

Particulars	Amount (Rs.)
Purchase for the year 2022	3,20,000
Sales for the year 2022	4,05,200
Purchase from 1.1.20X3 to 31.3.20X3	1,08,000
Sales from 1.1.20X3 to 31.3.20X3	1,22,800
Stock on 1.1.2022	76,800
Stock on 1.1.20X3	63,600

An item of goods purchased in 2021 at a cost of 20000 was valued at 12000 on 31.12.21. Half of these goods were sold during 2022 for 5200 and the remaining stock was valued at 4800 on 31.12.22. ¼th of the original stock was sold for 2800 in February’07 and the remaining stock was valued at 60% of the original cost. With the exception of this item, the rate of gross profit remained fixed. The stock salvaged was estimated at 24000. The insurance policy value was for 300000.

Solution:

In the books of X & Co.

Trading Account for the year ended 31.12.2022

Dr.					Cr.
Particulars	Amount (Rs.)	Amount (Rs.)	Particulars	Amount (Rs.)	Amount (Rs.)
To Opening Stock	76800		By Sales	405200	4,00,000
(-) Value of Abnormal item	12000	64800	(-) Sale of Abnormal item	5200
To Purchase		32,00,000	By Closing Stock	63,600
To Gross profit		74,000	(-) Value of Abnormal item	4800	58,800
		1,42,000			1,42,000

Rate of gross profit for the year 2022: 74000/400000*100=18.5%.

Estimated Trading Account for the period from 1.1. X3 to 31.3. X3

Dr.				Cr.
Particulars	Amount (Rs.)	Particulars	Amount(Rs)	Amount(Rs.)
To Opening Stock	58800	By Sales	122800
To Purchase	108000	(-) Sale of Abnormal Item	2800	120000
To Gross profit(120000*18.5%)	22200	By Closing Stock (balancing figure)		69000
	1041667		1160000	1041667

Statement showing Claim for Loss of Stock

Particulars	Amount (Rs.)
Estimated value of stock on the date of fire on 31.3.X3	69000
(+) Estimated value of abnormal item of stock	3000
	72000
1-1/2-1/4)= 1/4*20000= 5000*60% (-) value of stock salvaged	24000
Actual stock lost by fire	48000

The Policy value of the insured stock is 3,00,000. There is over insurance. The amount of claim is 48000.

3. A fire occurred on 1st February, 2022, in the premises of Pioneer Ltd., a retail store and business was partially disorganized up to 30th June, 2022. The company was insured under a loss of profits for ₹ 1,25,000 with a six months period indemnity.

	₹
Actual turnover from 1st February to 30th June, 2022	80,000
Turnover from 1st February to 30th June, 2021	2,00,000
Turnover from 1st February, 2021 to 31st January, 2022	4,50,000
Net Profit for last financial year	70,000
Insured standing charges for last financial year	56,000
Total standing charges for last financial year	64,000
Turnover for the last financial year	4,20,000

The company incurred additional expenses amounting to ₹ 6,700 which reduced the loss in turnover. There was also a saving during the indemnity period of ₹ 2,450 in the insured standing charges as a result of the fire.

There had been a considerable increase in trade since the date of the last annual accounts, and it has been agreed that an adjustment of 15% be made in respect of the upward trend in turnover.

Solution:

Computation of the amount of claim for the loss of profit

Reduction in turnover		₹
Turnover from 1st Feb. 2021 to 30th June, 2021		2,00,000
Add: 15% expected increase		30,000
Adjusted Standard Turnover		2,30,000
Less: Actual Turnover from 1st Feb., 2022 to 30th June, 2022		(80,000)
Short Sales		1,50,000
Gross Profit on reduction in turnover @ 30% on ₹ 1,50,000 (see working note 1)		45,000
Add: Claim for Additional Expenses being Lower of
(i) Actual = ₹ 6,700	6,700
(ii) Additional Exp. X
6,700 x (1,55,250/1,63,250) = 6,372	6,372
(iii) G.P. on sales generated by additional expenses - 80,000 x 30%	24,000
Therefore, lower of above is		6,372
		51,372
Less: Saving in Insured Standing Charges		(2,450)
Amount of claim before Application of Average Clause		48,922
Application of Average Clause:
=		39,390
Amount of claim under the policy		₹39,390

Working Notes:

(i) Rate of Gross Profit for last Financial Year:

Gross Profit:	₹
Net Profit	70,000
Add: Insured Standing Charges	56,000
	1,26,000
Turnover for the last financial year	4,20,000
Rate of gross profit = (1,26,000 / 4,20,000) x 100 = 30%

(ii) Annual Turnover (adjusted):

Turnover from 1st Feb., 2021 to 31st January, 2022	4,50,000
Add: 15% expected increase	67,500
	5,17,500
Gross profit on ₹ 5,17,500 @ 30%	1,55,250
Standing changes not insured (64,000 - 56,000)	8,000
Gross profit plus non-insured standing changes	1,63,250