Insurance Policy

A business enterprise may suffer loss caused by fire, flood, earthquake and other natural calamities which affects the normal capacity of business for some times. To mitigate such uncertain loss, the concern undertakes insurance policy.

Insurance contract is a contract of indemnity under which an insurance company indemnifies the loss of property due to specified risks. When an accident occurs, business organization has to estimate in respect of the following loss and lodge claim with insurance company.

• Loss of Stock-in-Trade.
• Loss of Profits or Consequential Loss.

Loss of Stock-in-Trade

When a fire occurs, it destroys a number of assets of a business. The books of account normally contain accounts of all the assets except (usually) stock-in-trade. The value of stock on hand on the date of fire, therefore, has to be estimated.

• When stock records are maintained and records are not destroyed : In such case, the value of stock can be known from the stock register. Out of this stock, the value of stock saved is deducted. Remaining value will be the amount of loss for which claim will be lodged.

Ex.: Value of stock as per stock register on the date of fire Rs.40,000; value of stock saved Rs.10,000. In this case, amount of loss and claim will be (40,000 – 10,000) Rs.30,000.

• When stock records have been destroyed or when stock records are not maintained : In such case, it may not be possible to find out the accurate value of the stock, but stock value may be estimated through procedure explained below:

Computation of Insurance Claim

Step 1: Preparation of Trading Account for last accounting year:

Trading Account

Particulars	Dr	Particulars	Cr
To Opening Stock [Note 1]	x	By Sales (less return) [Note 1]	x
To Purchase (less return) [Note 1]	x	By Drawings [Note 3]	x
To Direct Expenses [Note 2]	x	By Closing Stock[Note 1]	x
To Gross Profit	x
	xx		xx

Note:

1: If Opening Stock, Purchase, Sales, Closing Stock include abnormal/poor selling line goods, it will be deducted from them.

2: Direct Expenses include wages, carriage, freight etc.

3: For manufacturing concern, the Journal Entry will be for drawing of goods;

    Drawing A/c                      Dr.

To Trading A/c

For trading concern;

Drawing A/c                      Dr.

To Purchase A/c

Step 2: Calculation of Gross Profit Ratio:

GP Ratio= [(G.P of last accounting year /Sales of the last accounting year) X 100]

Note: Rate of normal GP & normal sale should be arrived after adjustment for increasing/decreasing sales trend, if any.

Step 3: Memorandum Trading Account: It should be prepared for the period beginning from the accounting year to the date of accident.

Memorandum Trading Account

Particulars	Dr	Particulars	Cr
To Opening Stock	x	By Sales (less return)	x
To Purchase (less return)	x	By Drawings [Note 3]	x
To Direct Expenses	x	By Closing Stock [Balancing Figure]	x
To Gross Profit	x	(stock on date of accident)
	xx		xx

Note: Abnormal/poor selling line goods will be deducted as discussed above (if any).

Step 4: Statement of Settlement Claim: The claim with the insurer (insurance company), in respect of loss of stock, should be computed as follows:

Particulars	Rs.
Estimated value of the stock on the date of fire.[as per Memorandum Trading A/c]	x
Less: Salvaged Stock (if any)	x
Value of Stock destroyed by fire and claim to be lodged=	x

Different Situation for Valuation of Stock on Date of Accident

Different situations may arise for valuation of Stock on date of accident as discussed below:

1. When there is no increasing or decreasing trend in Sales price.
2. When there is increasing or decreasing trend in Sales price.
3. When stock is valued below or above cost.
4. When amount of sale or purchase is not given.

When there is no increasing or decreasing trend in Sales Price

Ex. Date of fire in godown on 20.5.2010, Accounting year Jan-Dec.	Rs.
Stock as on 1.1.2010	40,000
Purchases from 1.1.2010 to 20.5.2010	7,00,000
Sales from 1.1.2010 to 20.5.2010	9,00,000
Gross profit Rate in 2009	30%
Salvage Value	10,000

Solution:

Memorandum Trading Account for the period from 1.1.2010 to 20.5.2010

Particulars	Rs.	Particulars	Rs.
To Opening Stock	40,000	By Sales	9,00,000
To Purchases	7,00,000	By Stock (on 20.5.2008)  [Balancing figure]	1,10,000
To Gross Profit (30% of Rs.9,00,000)	2,70,000
10,10,000	10,10,000

Value of Stock on 20.5.2010	1,10,000
Less: Salvage value	10,000
Value of Stock lost by fire	1,00,000

When there is increasing or decreasing trend in Sales Price

In case of current year’s sales price or cost shows increasing or decreasing trend compared to previous year, Gross Profit rate of the current year will change. In such case, adjusted G.P. rate and value of stock will be calculated on the basis of revised G.P. rate.

Ex. Gross Profit Ratio of Previous Year….20%.

Sales Price during the current year has increased by 10%.

Calculate new G.P. Rate.

Solution:

	Selling Price	Cost Price	Gross Profit
Previous year	100	80	20
Current Year	110	80	30
Therefore, G.P. Rate for current year will be 30 x 100/110 = 27.27%.

Ex. Gross profit rate of previous year….20%.

Cost per unit has increased by 10% during the current year. Calculate G.P. Rate for current year.

Solution:

	Selling Price	Cost Price	Gross Profit
Previous Year	100	80	20
Current year	100	(80+80×10%)=88	12
Therefore, G.P. Rate for Current Year will be 12×100/100 =12%

So, in this case, G.P on the sale of opening stock will be @ 20% and sale out of current year’s purchases will earn 12%.          

Valuation of stock at below or above cost

If business maintains stock value at a price which is below or above cost, Trading Account will be prepared to compute the value of stock at Cost price.

When amount of sale or purchase is not given

If amount of sales or purchases is not given, amount of sales and purchases will be calculated by preparing Total Debtors and Total Creditors Accounts. Cash sales and cash purchases will be added to these figures to find out total sales and total purchases.

Ex. A fire occurred on 1.4.2010. The following figures were available:

Sundry debtors as on 1.1.2009 Rs.27,000;

Cash received from debtors during 2009 Rs.65,000;

Sundry debtors as on 31.12.2009 Rs.20,000;

Discount allowed to debtors during 2009 Rs.3,000;

Bad Debts written off during 2009 Rs.4,000;

Cash sales during 2009 Rs.30,000.

Sundry creditors as on 1.1.2009 Rs.30,000;

Cash paid to creditors during 2009 Rs.80,000;

Sundry creditors as on 31.12.2009 Rs.32,000;

Discount received from creditors during 2009 Rs.3,000;

Purchases returns Rs.4,000; Cash purchases Rs.25,000;

Find out total sales and purchase during the year.

Solution:

Calculation of Total Sales:

Total Debtors Account

Dr.					Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
1.1.09	To Balance b/ f	27,000	31.12.09	By Cash	65,000
31.12.09	To Credit Sales (Balancing fig.)	65,000	31.12.09	By Discount	3,000
			31.12.09	By Bad Debts	4,000
	31.12.09	By Balance c/d	20,000
	92,000		92,000

	Rs.
Credit Sales	65,000
Add: Cash Sales	30,000
Total Sales	95,000

Calculation of Total Purchase:

Total Creditors Account

Date	Particulars	Dr	Date	Particulars	Cr.
31.12.09	To Cash	80,000	1.1.09	By Balance b/f	30,000
“	To Discount	3,000	31.12.09	By Credit Purchases (Bal. fig.)	89,000
“	To Purchases Return	4,000
31.12.09	To Balance c/d	32,000
		1,19,000			1,19,000

Credit Purchases Less: Purchase Return   Add: Cash Purchases	89,000 4,000
85,000 25,000
Total Purchases	1,10,000

Average Clause

If the amount of policy is less than the estimated value of stock destroyed, then the insurance co. will settle the claim on applying average clause as per the following formula:

Claim= Loss Suffered (net claim) X Insurance Policy Value / Value of stock on the date of fire

Average Clause is applied after the deduction of salvage stock. Objective of Average Clause is to discourage under-insurance.

Ex. Amount of policy 70,000; Amount of total stock in godown at the time of accident Rs.90,000; value of salvage Rs.20,000. Calculate claim.

Solution:

Total Stock in godown                                                  Less: Salvage value	90,000 20,000
Stock Lost	70,000
Applying average clause, claim       =	[(Amount of policy x Loss of stock) /Total stock on the date of fire]
=	(70,000 x 70,000) / 90,000 = Rs.54,444

Self – insurance and Co-insurance

A firm can build up its own fire insurance reserves by debiting the Profit and Loss Account every year and crediting a Fire Insurance Provision Account. Actual loss, if any, would then be debited to this Provision Account.

• Self-insurance : Self – insurance works where:
• There are many properties.
• Properties are located at different geographic centres.
• A big provision has been built before loss occurs.

Self-insurance assumes full risk, through a systematic creation of the fire insurance provision.

• Co-insurance : It means assumption of a part of the risk by the owner himself.

Ex. a property costing Rs.4lakh is insured with a 75% co-insurance clause. The loss is Rs.3 Lakh and the amount of the policy is Rs. 3 lakh 25 thousand. The insurer will pay Rs.3 lakh.

If, however, the amount of policy is Rs.2 lakh and there is a salvage of Rs.25 thousand so that the loss is Rs.2 lakh 25 thousand, the claim will be Rs.1,50,000, i.e., [Rs.2,25,000 x 2,00,000 / 3,00,000] (Without the co-insurance clause, the claim would have been Rs.1,12,500 i.e. 2,25,000 x 2,00,000 / 4,00,000).

In no case will the insurer be liable for more than the amount of the policy.

Poor Selling Goods / Sale at Loss

Sometime some poor selling goods remain in the stock. These goods are normally valued at below cost which reduces Gross Profit. To determine the normal rate of Gross Profit, the stock and sales proceeds of these goods are eliminated from the total sales and stock. Alternatively, separate figures may be compiled for normal items and abnormal items.

Accounting Entries in the Books of Insured

	Particulars		Dr. (Rs.)	Cr. (Rs.)
	For estimated value of stock ascertained as on the date of fire Insurance claim A/c To Stock lost by fire A/c (Value of stock on the date of fire)	Dr.
	For the stocks salvaged Stock A/c To Insurance Claim A/c (Value of stock salvaged)	Dr.
	For claims admitted by the insurance company Insurance company A/c (claim admitted) Profit & Loss A/c (Amount of claim not admitted) To Insurance Claim A/c	Dr. Dr.
	For claim amount admitted by insurance co. received Bank A/c To Insurance Company A/c	Dr.
	For stock lost by fire transferred to trading account Stock by fire A/c (cost of goods lost) To Trading A/c	Dr.

Claim for Loss of Profit (Consequential Loss)

When a fire occurs, it destroys assets or stock etc. of the firm. Apart from that, it may also seriously affect the production and sales of the business. Thus, the loss is due to: (i) non – recovery of constant expenses, and (ii) the loss of profit that would have been earned. Further, there may be increased cost of working (e.g. renting premises temporarily). The loss is called “consequential loss”, which may be covered by a separate policy. The amount of the consequential loss may not depend on the value of the property destroyed – a small damage may give rise to a rather big consequential loss if the dislocation of the business is serious.

• Period of Indemnity: The period for which loss is to be calculated is called period of indemnity, which is lower of: (1) Actual period of dislocation; and (2) Period covered by the policy.
• Period of Dislocation: Period of dislocation means the period from the date of occurrence of fire etc.to the date, the firm attains its normal operating capacity.

Computation of G.P. Rate in case of Profit

To calculate loss of profit, rate of profit on sales is calculated as follows:

G.P.Ratio = [{(Net profit + Insured Standing Charges) x 100} / Sales of the last accounting year]

The figures relate to the accounting year which has ended before the date of fire. For example if firm’s accounting year is from1st April 2009 to 31^st March 2010 and date of fire is on 1.8.2010, the above figure will be for the period from 1^st April, 2009 – 31^st March, 2010. In case of dislocation of business, there is loss of net profit. In addition, fixed expenses (standing charges) will have to be incurred during the indemnity period. But while calculating the rate of profit, standing charges, which have not been insured, should be excluded.

G.P.Rate of the previous year has to be adjusted for changes in the business activity during the current year.

Ex. Date of fire :10^th March, 2010 Accounting year of the business: 1^st Jan – 31^st Dec.; Sales for 2009 Rs.5,00,000; Net profit for 2009 Rs.60,000; Standing charges (fixed expenses) for 2009 Rs.45,000.

Standing charges to the extent of Rs.5,000 are not insured. During 2010, a new machine has been introduced. Consequently profit is expected to increase by 2%. Calculate G.P.Rate.

Solution:  

Gross Profit Rate  = [(Net profit + Insured Standing Charges) x 100] / Sales
= (60,000+40,000)x100/5,00,000) =	20%
Add: Expected increase in profit	2%
Applicable G.P. Rate	22%

Computation of G.P. Rate in case of loss: In case of Net Loss, the formula for calculatingG.P. Rate will be as under:   

G.P. Ratio = [{(Insured Standing Charges – Adjusted Net loss) x 100} / Sales]

If all standing charges are not insured, amount of net loss will be reduced in proportion to insured standing charges. Adjusted net loss will be calculated as under:

Adjusted Net Loss = [(Net Loss x Insured Standing Charges)/ All Standing Charges]

Ex. Date of fire: 16^th June 2008, Particular for the year ended 31^st March 2007 are : Sales :Rs.3,00,000; Standing charges: Rs.90,000; Net Loss:Rs.60,000.

Calculate G.P.rate (i) if all standing and (ii) if standing charges to the extent of Rs.20,000 are not insured.

Solution: If all standing charges are insured: G.P. Rate = [(90,000 – 60,000)/ 3,00,000] x 100 = 10%

If all standing charges are not insured: Adjusted Net Loss = (60,000 x 70,000*) / 90,000 = Rs.46,667                             

G.P. Rate = [(70,000 – 46,667)/3,00,000] x 100 = [(23,333/3,00,000) X 100] = 7.8%

*Insured Standing charges = (90,000-20,000) = Rs.70,000.

Short Sales or Reduction in Turnover during the period of dislocation: To calculate loss of profit, loss due on reduction in sales during indemnity period arising due to the business dislocation is to be calculated. Reduction in turnover (or Short Sale) is calculated by comparing sales in previous year during the period corresponding to the period of indemnity with the actual sales, if any, during indemnity period. Such sale of the previous year is called ‘Standard Turnover’. If sales of the current year are expected to increase or decrease, standard sales will be adjusted accordingly.

Short sales is calculated as under:

Adjusted standard sales	X
Less: actual sales during Indemnity Period	X
Short Sales =	x

Ex. A fire occurred on 1^st July, 2010 Indemnity period: 3 months; Sales for the period from 1^st July, 2009 to 30^th Sept. 2009 Rs.1,00,000; Sales during indemnity period; Rs.30,000. Sales are expected to increase by 10% during 2010. Calculate short sales. 

Solution:

		Rs.
Standard turnover	1,00,000
Add: expect increase (10% on 1,00,000)	10,000
Adjusted standard turnover	1,10,000
Less: Sales during indemnity period	30,000
Short Sales	80,000

Loss of Profit: Amount of loss of profit can be calculated by following formula:

Loss of Profit = Short Sales x G.P. Rate.

Additional Expenses or Extra Cost of Working: If insured has incurred some expenses to effect sales during indemnity period, the insurance company may pay the least of the following amounts against additional expenses or extra cost of working:

• Actual amount spent by insured during the indemnity period;
• Gross Profit on sales generated through additional expenses;
• Amount to be paid as per following formula:

[Additional Expenses x Coverage Required / (Coverage Required + Uninsured Standing Charges)]

or Alternatively

[{Actual Additional Expenses x (Net Profit + Insured Standing Charges)}/(Net Profit + All Standing Charges)]

Out of the above additional expenses, savings in standing charges, if any, should be deducted.

Coverage Required and Application of Average Clause:  The amount of policy should be adequate and should not be less than ‘Coverage Required’. Coverage Required is calculated as under:

• Coverage Required = Adjusted Annual Turnover x G.P. Rate
• Annual Turnover = Sales for the period of 12 months immediately preceding the date of fire.
• If sales are expected to increase or decrease, annual sales will be adjusted accordingly.
• If amount of policy is less than coverage required, average clause will be applicable and claim amount will be reduced proportionately.

Net Claim = [(Gross Claim x Amt. of Policy) / Coverage Required]

Where, Gross Claim = Loss of Profit + Additional Cost of Working – Savings in Expenses.

Loss of Stock (with application of Average Clause

Ex. On 2.6.2007 the stock of Mr. Black was destroyed by fire. Following particulars were found from record saved:

	Rs.
Stock at cost on 1.4.2006	1,35,000
Stock at 90% of cost on 31.3.2007	1,62,000
Purchases for the year ended 31.3.2007	6,45,000
Sales for the year ended 31.3.2007	9,00,000
Purchases from 1.4.2007 to 2.6.2007	2,25,000
Sales from 1.4.2007 to 2.6.2007	4,80,000

Sales upto 2.6.2007 including Rs. 75,000 for goods not dispatched to the customers. Sales invoice price is Rs.75,000.

Purchases upto 2.6.2007 includes a machinery acquired for Rs.15,000.

Purchases upto 2.6.2007 does not include goods worth Rs.30,000 received from suppliers, as invoice not received upto the date of fire. These goods have remained in the godown at the time of fire. Value of stock salvaged from fire Rs.22,500 and this has been handed over to the insurance company.

The insurance policy is for Rs.1,20,000 and it is subject to average clause. Ascertain the amount of claim for loss of stock.

Solutions: Step involved in solving the above problems-

• Preparation of Trading Account.
• Calculation of Gross Profit Ratio.
• Calculation of Amount of Gross Profit.
• Preparation of Memorandum Trading A/c.
• Computation of Insurance Claim.

Working Details:

1. In the books of Mr. Black

Trading Account for the year ended 31.3.2007

Particulars	Rs
	Dr.	Cr.
To Opening Stock	1,35,000
To Purchases	6,45,000
By Sales		9,00,000
By Closing Stock at cost (1,62,000 x 100 / 90)		1,80,000
To Gross Profit (Balancing Fig.)	3,00,000
	10,80,000	10,80,000

• Calculation of Gross Profit Ratio

G. P ratio = (3,00,000 / 9,00,000) x 100 = 33 1/3 %

• Calculation of Amount of Gross Profit from 1.4.07 to 2.6.07

	Rs.
Sales from 1.4.2007 to 2.6.2007	4,80,000
Less: goods not dispatched to the customers during the period	75,000
	4,05,000
Amount of Gross Profit = (4,05,000 x 33 1/3 %)	1,35,000

4. Memorandum Trading A/c for the period from 1.4.2007 to 02.06.2007

Particulars		Rs.
		Dr.	Cr.
To Opening Stock at cost		1,80,000
To Purchases       Add: Goods received but Invoice not received	2,25,000 30,000
Less:- Machinery	2,55,000 15,000	2,40,000
By Sales [Wn.3]			4,05,000
By Closing stock destroyed by fire (Balancing figure)			1,50,000
To Gross Profit [Wn.3]		1,35,000
		5,55,000	5,55,000

• Computation of Insurance Claim

After applying Average clause, claim will be = Actual loss of stock (Net claim) x ( Amount of Policy / Value of stock on the date of fire) = 1,50,000 x (1,20,000 / 1,50,000) = Rs. 1,20,000

Note:- Salvaged stock amounting Rs.22,500 handed over to the insurance company is also treated as loss to Mr. Black.

Loss of Stock (Normal & Abnormal)

Ex. On 11.11.2007 the premises of Rocky Ltd. was destroyed by fire. The following information is made available:

	Rs.
Stock as on 1.4.2006	3,75,000
Purchases from 1.4.2006 to 31.3.2007	5,20,000
Sales from 1.4.2006 to 31.3.2007	8,55,000
Stock as on 31.3.2007	2,00,000
Purchase from 1.4.2007 to 11.11.2007	3,41,000
Sales from 1.4.2007 to 11.11.2007	4,35,500

In valuing the stock on 31.3.2007, due to damage 50% of the value of the stock which originally cost Rs. 22,000 was written off.

In June, 2007 about 50% of this stock was sold for Rs.5,500 and the balance of obsolete stock is expected to realise the same price (i.e. 50% of the original cost).

The gross profit ratio is to be assumed as uniform in respect of other sales.

Stock salvaged from fire amounts to Rs.11,500.

Compute the value of stock lost in fire.

Solutions:

Steps involved in solving the above problem-

• Preparation of Trading Account.
• Calculation of Gross Profit Rate.
• Preparation of Memorandum Trading A/c.
• Calculation of Loss of Stock.

Working Details:

1. Trading Account for the year ended 31.3.2007

Dr.			Cr.
Particulars	Rs.	Particulars	Rs.
To opening Stock	3,75,000	By Sales	8,55,000
To Purchase	5,20,000	By Closing Stock (1,89,000 + 22,000)	2,11,000
To Gross Profit [Bal. Fig.]	1,71,000
	10,66,000		10,66,000

• Calculation of Gross Profit Rate

G.P. Ratio = (Normal G.P./Normal Sale) x 100 = (1,71,000 / 8,55,000) x 100 = 20%.

3. Memorandum Trading Account for the period from 1.4.07 to 11.11.07

Dr.					Cr.
Particulars	Rs.	Rs.	Particulars	Rs.	Rs.
To Opening Stock	2,11,000		By Sales	4,35,500
Less: Abnormal Stock To Purchase To Gross Profit (20% on	22,000	1,89,000 3,41,000	Less: Abnormal Stock                 (50% of 22,000 sold                  for 5,500)	5,500	4,30,000
Normal sale)		86,000	By Closing stock (destroyed       by fire) [Bal. Fig]		1,86,000
		6,16,000			6,16,000

• Calculation of Loss of Stock

	Rs.
Closing stock on the date of fire	1,86,000
Add: Value of abnormal stocks [Note]	5,500
Total value of stock	1,91,500
Less: Salvage value of stock	11,500
Loss of stocks	1,80,000

Note: (on abnormal stock)

50% of 22,000	11,000
Less: Sale price	5,500
Abnormal Stock (Rs.)	5,500

Loss of Profit (with application of Average Clause)

Ex. On account of a fire on 15 June, 2002 in the business house of a company, the working remained disturbed upto 15 Dec., 2002 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 Rs.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 Rs.12,000 to make sales possible and made a saving of Rs.2,000 in the insured standing charges.

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

	Rs.
Actual sales from 15 June, 2002 to 15 Dec., 2002	70,000
Sales from 15 June, 2001 to 15 Dec., 2001	2,40,000
Net profit for last Financial year	80,000
Insured standing charges for the last Financial year	70,000
Total standing charges for the last Financial year	1,20,000
Turnover for the last Financial year	6,00,000
Turnover for one year : 16 june, 2001 to 15 June,2002	5,60,000

Solution: Steps involved in solving the above problem-

• Calculation of Amount of Short Sales.
• Calculation of Gross Profit Ratio.
• Calculation of Amount of Loss of Profit.
• Calculation of Adjusted Sales.
• Calculation of Adjusted Additional Cost of working least.
• Calculation of Amount of Net Claim.
• Application of Average Clause.

Working Details:

1. Calculation of Amount of Short Sales:

	Rs.
Sale of dislocation period of Previous Year	2,40,000
Add: Increase (25%)	60,000
Less : Actual sale of dislocation period	(70,000)
Amount of Short sales	2,30,000

• Calculation of Gross Profit Ratio:

[{(Net Profit + Insured standing charges) / Turnover for financial year} x 100] = [{(80,000 + 70,000) / 6,00,000} x100]  = 25 %.

• Calculation of Amount of Loss of Profit:

 Loss of Profit = (Short sales x G / P Ratio) = [2,30,000 (Wn.1) x 25% (Wn.2)]  = 57,500

• Calculation of Adjusted Additional Sales:

	Rs.
Turnover for 12 months preceding date of fire	5,60,000
Add: –   Increase (25%)	1,40,000
	7,00,000
Total Insurable value (7,00,000 x 25 / 100) =	1,75,000

• Calculation of Adjusted Additional cost of working:

        Least of following:

(a) Actual Expenses	Rs.12,000
(b)  [{Actual Additional Exp. x (Net profit + Insured  standing charges )} / ( Net profit  + All standing                charges)] [{12,000 x (80,000+70,000)} / (80,000+1,20,000)]	Rs.9,000
So, Rs.9,000 will be cost of working.

• Calculation of Amount of Net Claim:

	Rs.
Loss of profit (Wn.3)	57,500
Add : Adjusted Additional Cost of Working ( Wn.5)	9,000
	66,500
Less: Saving in Exp.	2,000
Amount of net claim	64,500

• Application of Average Clause:

(Amount of policy / G.P. on adjusted annual turnover) x Net claim = (1,40,000 / 1,75,000) x 64,500 = Rs.51,600.

Loss of Profit (with application of Average Clause and stipulation of special clause

Ex. From the following details, calculate consequential loss claim:

1. Date of fire: 1st September following;
2. Indemnity period: 6 months;
3. Period of disruption: 1st September to 1st February;
4. Sum insured: Rs.1,08,900;
5. Sales were Rs.6,00,000 for preceding financial year ended on 31st March.
6. Net profit for preceding financial year Rs.36,000 plus insured standing charges Rs.72,000;
7. Rate of Gross profit 18%;
8. Uninsured standing charges Rs.6,000;
9. Turnover during the disruption period Rs.67,500;
10. Annual turnover for 12 months immediately preceding the date of fire Rs. 6,60,000;
11. Standard turnover i.e. for corresponding months (1st September to 1^st February) in the year preceding the date of fire Rs.2,25,000;
12. Increase in the cost of Working capital Rs.12,000 with a saving of insured standing charges Rs.4,500 during the disruption period;
13. Reduced turnover avoided through increase in Working capital Rs.30,000;
14. Special clause stipulated:

(a) Increase in rate of G.P. 2%

(b) Increase in turnover (Standard and Annual) 10%.

Solutions:

Step involves in solving the above problem-

• Computation of amount of claim.
• Calculation of Gross Profit Ratio.
• Calculation of Loss of Profit during the dislocation period.
• Calculation of Increased working cost.
• Saving in incurred standing charges.
• Statement of Gross Claim.
• Application of Average Clause.

Working Details:

1. Computation of Amount of Claim

Period of indemnity = 5 months.

Loss of turnover in the dislocation period:

	Rs.
Standard turnover in the same period of last year	2,25,000
Add:   10% upward trend	22,500
	2,47,500
Less:    Actual turnover in the dislocation period	67,500
Loss of turnover in dislocation period =	1,80,000

• Calculation of Gross Profit ratio based on last accounting year

G.P. Ratio	= (Net Profit + Insured standing charges ) / Turnover
	= [(36,000 + 72,000) / 6, 00,000] x 100
	= 18%
Add: increasing trend	=   2%
	= 20%

• Calculation of Loss of Profit during the dislocation period

Loss of Profit	= Loss of Turnover x G. P. Ratio.
	= (1,80,000 x 20%) = Rs.36,000

• Calculation Increased Working Cost

Increased working Cost = Rs.12,000

Amount of Claim is restricted to the minimum of the following two alternatives:

• (Increased working Cost x Coverage required) / (Coverage required + Uninsured standing charges)

= (12,000 x 1, 45,200) / (1,45,200 + 6,000)

= Rs.11,524

• Proportionate working cost
  • Maximum saving of liability of the insurer:

Amount of reduction in turnover avoided through increased working cost x G.P. Ratio

 = (Rs.30,000 x 20%) = Rs.6,000

Alternatively, this may be calculated as

= (Rs.67, 500 x 20%) = Rs.13, 500.

So, the claim of loss will be restricted to Rs.6,000.

• Saving in incurred standing charges = Rs.4,500
• Statement of Gross Claim:

	Rs.
Claim for loss of Profit as per (3) above	36,000
Add:  Claim for loss on account of increased working cost	6,000
	42,000
Less: Saving in increased Standing Charges	4,500
Amount of Gross Claim	37,500

• Application of Average Clause:

	Rs.
Annual turnover preceding the date of fire	6,60,000
Add: Expected increase @ 10%	66,000
Adjusted Annual Turnover	7,26,000
G.P. on adjusted annual Turnover (coverage required)
= (7,26,000 x 20%)
= Rs.1,45,200
But the amount of policy is Rs.1,08,900
Hence average clause will be applied
Hence, admissible amount : [(Gross claim x Amount of Policy) / Coverage required] = [(37,500 x 1,08,900) / 1,45,200] = Rs.28,125

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