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Unit 8: Methods of Redemption–I

Profit and Loss Account (2004) Notes
To Sinking Fund Investments A/c (loss) 96 By Interest on Sinking Fund Investments 2,364
Profit and Loss Account (2005)
By Interest on Sinking Fund Investments 3,648

8.3 Insurance Policy Method

In this method too, a part of profit is set aside and is transferred to the Debenture Redemption
Fund Account. Like the method of sinking fund, appropriated profits are not invested in safe or
marketable securities. Instead, an insurance policy is taken by the company to get the money for
redemption of debentures after a specified period of time. The premium of this insurance policy
equals to profit set aside annually. At the time of redemption of debentures or on the date of
maturity of policy, the amount is received from insurance company and from this amount
debentures are redeemed. The period of insurance policy will be equal to the period of issue of
debentures. The main differences between Sinking Fund Method and Insurance Policy Method
are as below:

1. In sinking fund method profits are invested at the end of the year while premium is paid
in the beginning of the year in the case of insurance policy method.
2. In last year no investment is made in sinking fund method, while in the insurance policy
method, the amount of premium is paid in the beginning of the last year.
3. When money is invested in marketable securities in sinking fund method, there will be no
certainty about the amount to be received from the sale of securities, due to market
fluctuations. In the case of insurance policy method, there is certainty about the receipt of
a fixed sum at maturity.

Notes At the time of redemption of debentures or on the date of maturity of policy, the
amount is received from insurance company and from this amount debentures are
redeemed.
4. Annual interest on investment is received in the case of sinking fund method, while no
such annual income is received in the case of insurance policy method. But many accountants
like to record the amount of interest every year which is based on expected rate of interest
and they pass the following journal entry:

Debenture Redemption Fund Policy Account Dr.
To Debenture Redemption Fund Account
Accounting treatment: The following entries are passed in the insurance policy method—
(a) For all years (including last year) following entries are passed:
(i) When the amount of premium is paid—
Debenture Redemption Fund Policy Account Dr.
To Bank Account

(ii) When profit is set aside at the end of the year—
Profit and Loss Appropriation Account Dr.
To Debenture Redemption Fund Account

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