Insurance Policy Method of Depreciation:

Learning Objectives:

1. Define and explain the insurance policy method of depreciation.

Definition and Explanation:

Insurance policy method is a slight modification of the depreciation fund method or sinking fund method. Under this method the amount represented by the depreciation fund, instead of being used to buy securities, is paid to an insurance company as premium. The insurance company issues a policy promising to pay a lump sum at the end of the working life of the asset for its replacement.

The advantage of insurance policy method is that risk of loss on the sale of investment and the trouble and expense of buying investment are avoided, while disadvantage lies that the interest received on the premiums paid is comparatively very low.

When insurance policy method is employed the policy account will take the place of the depreciation fund investment account and no interest will be received at the end of each year, but the total interest on the premiums will be received when the policy matures.

Entries:

Every years two entries will be made:

1.	In the beginning:
	Depreciation insurance policy account
	To Cash account
	(Being the payment of premium on depreciation policy)
2.	At the end of the year:
	Profit and loss account
	To Depreciation fund account
	(Being the amount of depreciation charged to profit and loss account)
When the policy will mature i.e., to say the amount of the policy will be received. The entry is:
3.	Cash account
	To Depreciation insurance policy account
	(Being the policy amount realized)
The depreciation insurance policy account will show some profit. This will be transferred to depreciation fund account, the entry being.
4.	Depreciation insurance policy account
	To Depreciation fund account
	(Being the policy amount realized)
The asset account will have been shown throughout at its original cost. It now be written off by transfer to depreciation fund account. The entry is:
5.	Depreciation fund account
	To Asset account

Insurance Policy Method Example:

On 1st January, 1990 a business purchases a three year lease of premises for $20,000 and it is decided to make a provision for replacement of the lease by means o an insurance policy purchased for annual premium.

Show the ledger accounts dealing with this matter.

Solution:

Leasehold Account

Dr. Side				Cr. Side
1990				1990
Jan. 1	To Cash	20,000		Dec. 31	By Depreciation fund	20,000

Depreciation Fund Account

Dr. Side				Cr. Side
1990				1990
Dec. 31	To Balance c/d	6,400		Dec. 31	By Profit and loss a/c	6,400
1991
Dec. 31	To Balance c/d	12,800		Jan. 1	By Balance b/d	6,400
				Dec. 31	By Profit and loss a/c	6,400
		12,800				12,800
1992				1992
Dec. 31	To Leasehold Property	20,000		Jan. 1	By Balance b/d	12,800
				Dec. 31	By Profit and loss a/c	6,400
				"	By Leasehold	800
		20,000				20,000
Leasehold Policy Account
Dr. Side				Cr. Side
1990				1990
Dec. 31	To Cash	6,400		Dec. 31	By Balance c/d	6,400
1991				1991
Jan. 1	To Balance b/d	6,400		Dec. 31	By Balance c/d	12,800
Dec. 31	To Cash	6,400
		12,800				12,800
	To Balance b/d	12,800			By Cash	20,000
	To Cash	6,400
		800
		20,000				20,000