Page 240 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes Working Note
As per Sinking Fund Table there should be annual investment of 0.23549 to get 1 at the end of
4 years @4% p.a.

Thus the amount investment should be = 0.23549 × 1,00,000 = 23,549.
10.3.5 Insurance Policy Method

The method is similar to the sinking fund method. Under this method to replace the assets, an
insurance policy is taken by the firm. Amount of premium is paid by the annual amount of
depreciation while under the sinking fund method, some securities were bought by the firm.
The amount of premium with interest accumulates with the insurance company. On the expiry
of the useful life of the assets, the insurance policy matures. On maturity the amount is made
available by the insurance company which is used for the purchase of new assets. Thus this
method provides more safety and liquidity to the funds. Under this method the following
journal entries are passed.
1. When depreciation is charged:

P&L Account Dr.
To Depreciation Fund Account
2. When amount of premium is paid

Depreciation Fund Policy Account Dr.
To Bank Account
3. When amount of policy is received from insurance company on maturity
Bank Account Dr.
To Depreciation Fund Policy Account

4. There may be profit or loss on the policy that is transferred to the depreciation fund
account. Then following entry is passed for profit
For Profit:

Depreciation Fund Policy Account Dr.
To Depreciation Fund Account
For Loss:

Depreciation Fund Account Dr.
To Depreciation Fund Policy Account
5. When new assets are acquired:
Assets Account Dr.
To Bank Account

Illustration 8: Insurance Policy Method
ABC Company Ltd. took a lease which is to be replaced after 3 years for 4,00,000 on 1st April,
2005 and decided to provide for its replacement by means of an insurance policy for 4,00,000.
The annual premium is 1,19,333.33. On 1st April, 2008 the lease is renewed for 4,80,000.
Show necessary accounts in the books of the company.

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