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Insurance Policy Method of Depreciation:

Contents:

Definition and Explanation:

Insurance policy method of depreciation is somewhat  alike the depreciation or sinking fund method. The only difference is that the annual depreciation instead of investing in government papers or gilt-edged securities is paid as as premium to an insurance company, who issues an insurance policy equivalent to cost of asset. At the end of the life of asset, insurance company pays money covered by the policy and a new asset is purchased with it.

Journal Entries:

    $ $
When premium is paid at the end of the year:      
Insurance policy a/c Dr. XXXX  
     Cash a/c     XXXX
       
When depreciation is charged (equal to premium):      
Profit and loss a/c Dr. XXXX  
     Depreciation fund a/c     XXXX
       
When policy money is received on maturity:      
Cash a/c Dr. XXXX  
     Insurance policy a/c     XXXX
       
To transfer the excess amount received over premium:      
Insurance policy Dr. XXXX  
     Depreciation fund a/c     XXXX
       
When asset is retired:      
Depreciation fund a/c Dr. XXXX  
     Asset a/c     XXXX
       
When scrap is sold:      
Cash a/c Dr. XXXX  
     Asset a/c     XXXX

Example:

On 1st January 2003 a business purchased a three years lease of premises for $10,000 and it was decided provision for replacement of the lease by means of an insurance policy purchased for an annual premium of $3,200.

Required: Prepare journal entries.

Solution:

Year 2003     $ $
Jan. 1 Leasehold a/c Dr. 10,000  
       Bank a/c     10,000
  (For lease purchased for three years)      
 
     
Jan. 1 Depreciation fund policy a/c   3,200  
       Bank a/c     3,200
  (For lease policy taken for replacement)      
 
     
Dec. 31 Profit and loss a/c   3,200  
       Depreciation fund a/c     3,200
  (For charge of premium against profits)      
 
     
Year 2004        
Jan. 1 Depreciation fund policy a/c   3,200  
       Bank a/c     3,200
  (For premium paid on lease policy)      
 
     
Dec. 31 Profit and loss a/c   3,200  
       Depreciation fund a/c     3,200
  (For charge of premium against profits)      
 
     
Year 2005        
Jan. 1 Depreciation fund policy a/c   3,200  
       Bank a/c     3,200
  (For premium paid on lease policy)      
 
     
Dec. 31 Profit and loss a/c   3,200  
       Depreciation fund a/c     3,200
  (For charge of premium against profits)      
 
     
Dec. 31 Depreciation fund a/c   10,000  
       Leasehold a/c     10,000
  (For lease property retired)      
 
     
Dec. 31 Bank a/c   10,000  
       Depreciation fund policy a/c     10,000
  (For policy money received on maturity)      
 
     
Dec. 31 Depreciation fund policy a/c   400  
       Depreciation fund a/c     400
  (Being transfer of policy account to depreciation fund account)      
 

More study material from this topic:

Definition, explanation and causes of depreciation
Depreciation is not a matter of valuation but a means of cost allocation
Activity method of depreciation
Straight line method of depreciation
Sum of the years' digits method of depreciation
Reducing balance method
Annuity method
Depreciation fund method or sinking fund method
Insurance policy method
Revaluation method
Depletion method
Machine hour rate, mileage, and global method
Methods of recording depreciation
Reserves
Difference between general reserve and specific reserve
Difference between capital reserve and general reserve
Difference between reserve and reserve fund
Difference between provision and reserve

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
----------------------------------------------------------------------------
  Analysis of Business Transactions
----------------------------------------------------------------------------
  Journal, Ledger and Trial Balance
----------------------------------------------------------------------------
  Accounting for Bills of Exchange
----------------------------------------------------------------------------
  Special Journals
----------------------------------------------------------------------------
  Cash Book
----------------------------------------------------------------------------
Bank Reconciliation Statement
----------------------------------------------------------------------------
  Final Accounts
----------------------------------------------------------------------------
  Work Sheet
----------------------------------------------------------------------------
  Capital and Revenue Items
----------------------------------------------------------------------------
  Valuation of Inventories
----------------------------------------------------------------------------
  Accounts of Non-profit Making Organizations
----------------------------------------------------------------------------
  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
----------------------------------------------------------------------------
  Depreciation, Provisions and Reserves
----------------------------------------------------------------------------
  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
----------------------------------------------------------------------------
  Cost Volume Profit Relationship
----------------------------------------------------------------------------
  Variable Costing System
----------------------------------------------------------------------------
  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 
 

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