Professional Documents
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FINANCE
AB
WWW.AMBITIOUSBABA.COM
1/5/2019
IC-26
IC-26
The course is purely meant for the purpose of study of the subject by students
appearing for the examinations of Insurance Institute of India and is based on
prevailing best industry practices. It is not intended to give interpretations or
solutions in case of disputes or matters involving legal arguments.
This course is designed for the use of candidates appearing for the Associateship
Examination (Life Branch) of Insurance Institute of India.
The course primarily deals with the Principles of Accounts, Life Insurance
Accounting procedures, budgetary control and Application of financial
management and financial analysis for life insurance business. . During last one
decade insurance sector has been liberalized and around two dozen private life
insurance companies are operating in market. To regulate these life insurance
companies Central govt. has appointed IRDA as regulator. For bringing
uniformity among all insurers including govt. run LIC, IRDA has prescribed
uniform accounting system and regulation of investment and other financial
aspect. This study material has been revised after considering IRDA’s regulation
on accounts, investment and other financial matters which is equally applicable
on all life insurance companies, be private or govt. run. In addition to these
global changes has also been considered wherever considered necessary.
The earlier part of this course deals with Principles of Elementary Book-Keeping,
Principles relating to Life Insurance Account such as Accounting of Premium,
Accounting of Policy Payments and Expenses of Management- leading to
Finalization of Accounts and other relevant Topics namely Audit and Budget
with special reference to accounting in LIC of India.
The latter portion of the course deals with important aspects of Accounts and
Finance and the emerging trends with which the candidates should be familiar
viz., New concepts in Accounting like Human Resource Accounting,
Significance of Accounting standards, Techniques of Financial Analysis and
Application of Financial Management concepts and Accounting Standard
applicable on life insurance industry.. The course also introduces candidates to
Income Tax., Antimony laundering act and compliance with IFRS.
Although the course covers the syllabus prescribed for the examination, it is
desirable that candidates should read additional material such as Accounting &
Financial Text Books, office manuals and operating instructions, insurance
magazines, law journals etc. This will enrich their knowledge of the subject.
The candidates are recommended to collect and study specimen forms used in
offices (e.g. proposal, policy claim forms etc. and other forms relevant to the
subject). This will provide a practical basis for their studies.
The candidates may also avail of Oral Tuition service whenever arranged by the
Associated Institutes and the Postal Tuition Service provided by the Institute.
These supplementary aids will help the students to improve their performance in
the examination.
The course should also prove useful to the general reader who desires to have
knowledge of the subject covered.
To enhance the learning and to make it rich, each chapter in the study text has
specific learning outcomes listed at the beginning of the chapter and a summary
at the end of the chapter followed by self-test questions and answers. Within the
study text there are a number of features like case studies, extensive use of
examples, diagrams, tables, MCQs, tips etc. to add life to learning and to make it
interesting for the candidate.
To supplement the study text, key notes have been provided. Key notes include
topics presented in the same order as the study text and aid revision by giving
clear, visual emphasis to key points. Key notes are quite handy as they are
portable and concise, ideal for last minute revision on the move.
CONTENTS
CHAPTER 1
Book keeping has been defined as “the art of recording business transactions with
a view to having a permanent record of them and of showing their effect on
wealth”. It is a science which records pecuniary transactions (i.e. transactions in
money or money’s worth) in such a manner that a trader is able to ascertain:
1. The nature and value of his assets, including the amount owing to him by
sundry debtors.
2. The amount of his liabilities including the amount owing by him to his
creditors.
3. Whether he has made a profit or loss during a given period and how the
amount he has gained or lost is made up.
4. Whether he is solvent or insolvent and the amount of his capital or
deficiency.
This chapter will give you an insight into the various stages of the accounting
process.
2
During the accounting process, accountants identify record and analyse the
financial dealings of a company. At the end of each period, accountants use the
information they have collected to prepare financial statements. Thus financial
reporting is the process of preparing and presenting the financial statements.
John purchased a car. The evidence of this transaction is an invoice issued by the
car dealer. An invoice contains the seller’s name, description of goods, buyer’s
name and date and amount of transaction. For the above transaction, the invoice
issued by the car dealer is a data source.
For every transaction of an entity, there has to be some kind of proof or data
source. This is the first step in the accounting process i.e. identifying
transactions.
Which of the following pairs do not show the transaction and its related source
document on the basis of which the transaction is recorded in the books of
accounts?
Accountants often say ‘every debit entry has a corresponding credit entry’.
Under the double-entry book-keeping system, all transactions are recorded by
giving two accounting effects - debit and credit. Debit is traditionally shown as
a positive figure and credit as a negative figure.
The above mentioned rules are to be rigidly followed under all circumstances.
The following examples will facilitate your understanding of the above concepts
and rules:
1. Capital
2. Purchases
3. Sales
4. Drawings
5. Rent paid
6. Grand Insurers
7. Bank of India
8. Cash
9. Bank balance
10. Outstanding salary
11. Commission received
12. Furniture and fixtures
13. Sushant
14. Jaycee
Answer
a) Grand Insurers purchased a motor car for Rs.600, 000 on credit from
Mr. Shaan.
b) Paid Cash to Mr. Shaan Rs. 600,000 (from whom the motor car was
purchased on credit earlier)
Credit: Seller’s account with like Credit: Sales (Car) account with
amount (the value of the car). Rs.600,000
If the payment is made at the time of sale, it would not be necessary to open
personal accounts in either the purchaser’s or vendor’s books and the transactions
would be recorded by entries in the Car and Cash Accounts as under:
Debit: Car account with Rs.600,000 Debit: Cash account with Rs.600,000
Credit: Cash account with Credit: Sales account (Car A/c.) with
Rs.600,000 Rs.600,000
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Selva Stores sold its computer for Rs. 25,000 on credit to Ganesh.
The entries are arranged so as to indicate clearly the respective accounts debited
and credited. The rectification entries as well as the closing entries are passed
through the journal.
In the journal entry given above, why is the car account debited and not the
cash account? This is because all journal entries have to follow the principles
of double-entry book-keeping (which are explained earlier).
a) The names of the two principal ledger heads of accounts affected. i.e.
the account head which is to be debited is entered on the left hand side.
This is succeeded by the abbreviation Dr at the right hand corner of this
line (in the particulars column)
the line below will have to be indented and begins with the word ‘To’
followed a few spaces away by the account head which is to be credited
3. Remember that each journal entry will contain items which are to be debited
and items which are to be credited. The total of the debit items should always
be equal to the total of the credit items.
The following transactions took place during the month of September 2011:
Answer
Lal Bros Dr
14.9.2011 To Sales 20,000
(Being goods sold on credit) 20,000
The following balances appeared in the books of Chetna Book Stall as on 1st
January 2004:
Bank Rs.77, 000, Stock Rs. 80,000, Furniture Rs. 10,000, Debtors Rs. 33,000 and
Creditors Rs. 90,000.
It is the principal book as well as the book of final entries. It contains, in a series
of classified and summarized accounts, a permanent record of all the trader’s
transactions under various Heads of Accounts.
1. Format of a ledger
Name of account
Dr Cr
Date Particulars Folio Amount Date Particulars Folio Amount
(Rs.) (Rs.)
To (name XXX By (name XXX
of account of account
credited in debited in
journal) journal)
a) Name of account:
The left hand side is called the debit side and the right hand side is called the
credit side.
15
b) Date column:
This column will contain the names of accounts which are credited in the journal.
Each account name will be preceded by the word ‘To’.
This column will contain the names of accounts which are debited in the journal.
Each account name will be preceded by the word ‘By’.
In this column, the page number of the journal (or any other subsidiary book like
cash book) from where the entry is transferred, is entered.
f) Amount:
The amount relating to the item debited / credited will be recorded in this
column.
Let us take up the above stated example to understand how entries are made
in the ledger.
16
1.4.2011 Goods purchased on credit from Ibrahim and Sons Rs. 8,000
To record the above entry, Lead Way has to open two ledger accounts:
Purchase account
Dr Cr
Date Particulars Folio Amt Date Particulars Folio Amt
(Rs.) (Rs.)
To Ibrahim 8,000
1.4.2011 and Sons
Journal entries are to be posted to the Principal Ledger twice. The amount
appearing against the account head in the Debit column of the journal is posted to
the debit side of the account in Principal Ledger and amount appearing against
the account head in the credit column of the journal is posted to the credit side of
the account in the Principal Ledger.
17
By maintaining a ledger account you have all the transactions with the same
person or purpose in one place. This is an easy form that can be used to answer
day-to-day queries such as the amount of sales made to a customer in a month or
the balance outstanding from any customer etc.
The cash book is a book of prime entry of a special kind as it is also a part of the
ledger system. The cash book is meant to record all cash transactions, whatever
may be their nature.
Cash or bank columns serve the purpose of cash or bank accounts, often in a
ledger account. There is no need to post the transactions again in cash or bank
accounts. These columns are balanced just like a ledger account and the closing
balances are taken to the trial balance. The steps to record transactions in the cash
book are as follows:
The receipts side of the cash book is used to record entries which debit the
cash account or the bank account;
The payments side is used to record entries which credit either the cash
account or the bank account;
However, once the transaction is entered into the cash book, the second
effect to the respective ledger account is also given.
In a modern business, transactions with or through the bank are even more
numerous than strictly cash transactions. Therefore, each side has two columns –
one to record cash transactions and the other to record bank transactions –
payments into the bank being entered on the left hand side and payments out of
the bank being entered on the right hand side.
Sometimes cash may be deposited in the bank and at other times, cash may be
withdrawn for use in the office. In this case, entries for both the transactions will
appear in the cash book itself, in the appropriate columns. These are called
contra transactions.
Cash deposited Cash withdrawn
Cash deposited into the bank is Cash withdrawn from the bank is
recorded as a payment in the cash recorded as a payment in the bank
column, and as a receipt in the bank column and as a receipt in the cash
column. column.
Bank account Dr X Cash account Dr X
To Cash account To Cr Bank account X
X
These contra transactions do not have to be posted into any ledger accounts since
both debit (receipt) and credit (payment) effects have already been given in the
cash and bank columns of the cash book, which itself is also a ledger account.
Proforma of the cash book is given below:
Analytical columns
Certain additional analytical columns are drawn on either side of a cash book
according to the accounting and reporting needs of each entity. These columns
are totalled, and not balanced. The totals are used for the purpose of summary
postings into ledger accounts e.g. discount allowed, discount received, etc.
Cash discount usually arises when payment is made before a specified date, e.g.
the supplier may offer a discount of 2% if the payment is made within a month.
19
Sometimes, cash discount is received from creditors also. These are therefore
shown in a columnar cash book for convenience.
Discount allowed by a trader to a customer on the receipt of cash represents a
loss. Discount received by a trader on payment represents a gain.
If analytical columns are maintained, instead of individual entries, only the totals
are recorded to the respective ledger accounts. For example, if columns are
maintained for discount allowed, the totals of these columns will be recorded in
the accounts receivable and cash sales ledger account. Individual transactions of
accounts receivable are posted in the personal ledgers, which are not part of the
double entry system.
It may be noted that the cash book is a subsidiary book, and at the same time,
serves as a ledger in respect of cash and bank transactions. Hence, no separate
Cash/Bank Accounts are kept in the ledger. But even in cash/bank transactions,
there must be another aspect (usually one that does not involve cash or bank).
Ledger posting should be made in respect of these other aspects of accounts. No
ledger posting would be necessary for the cash/bank aspects. The rule for posting
non-cash/non-bank transactions is that the entry appearing on the debit side of the
cash / bank account is posted to the credit side of the Principal Ledger account
and vice versa.
It can be seen that only the bank and cash columns are balanced in order to arrive
at a balance which is to be incorporated into the trial balance. These accounts
serve the purpose of being ledger accounts. Other analytical columns do not
function as ledger accounts. They simply give totals which can be posted to the
individual ledger accounts.
Cash Book
Discount Discount
Date Receipts LF Cash Bank Date Payments LF Cash Bank
allowed received
Rs. Rs. Rs. Rs. Rs. Rs.
Bank
Balance
1 Nov 1 Nov account c 5,000
b/f
(contra)
Cash
Trade
1 Nov account 5,000 2,000 200
7 Nov payable
(contra) c
Cash Bank
8 Nov account 1,000 account 1,000
8 Nov
(contra) c (contra) c
Cash
Trade
14 Nov 2,000 200 24 Nov account 2,000
receivable c
(contra)
Trade
16 Nov 7,000 700
receivable
Bank
Balance
24 Nov account 2,000 3,000 4,000
c/f
(contra) c
9,000 8,000 *900 9,000 8,000 *200
Balance
3,000 4,000
b/f
21
They are only to be totalled and posted to the respective ledger accounts.
Answer to illustration
The transactions recorded in the Journal, Cash Book and Principal Ledger are set
out below.
22
Journal
Cash Book
Dr Cr
L. Amount L. Amount
Date Particulars Date Particulars
F. (Rs.) F. (Rs.)
1-1-11 To Kapur’s 5,000.00 6-1-11 By India 1,200.00
Capital A/c. Cements
A/c.
Principal Ledger
Capital Account
Dr Cr
Date Particulars Amount Date Particulars Amount
(Rs.) (Rs.)
31-1-11 To Balance 5,000.00 1-1-11 By Cash 5,000.00
c/d
Purchase Account
Sales Account
India Cements Co
Pal Construction Co
Which of the following options contains the journal entry for the following
transaction?
A trial balance is the summary of all the ledger account balances at a particular
point in time.
Under the double entry system of accounting, every debit has a corresponding
credit and vice-versa. This means that the total of the debit balances of all
accounts in the ledger must be equal to the total of all credit balances.
The trial balance is simply a list of all the ledger accounts and their respective
balances as at a specified point of time e.g. as at 31 December 2009.
Trial balance as at
Debit Credit
Rs. Rs.
Cash X
Inventory X
Payables X
Share capital X
Retained earnings X
Other accounts X
Total X X
Although it has debit and credit columns, the trial balance is a statement, not a
ledger account. It is prepared periodically, usually at the end of every reporting
period. Note that the trial balance is not a part of the financial statements.
27
After preparing all the required ledger accounts, a trial balance is prepared to
list, at one place, the balances of all the ledger accounts. This helps the
accountant to check the arithmetic accuracy of accounting.
When preparing a trial balance, the debit and credit balances for each ledger
account are totalled. If the totals of the debit column and the credit column of the
trial balance do not tally, we know at once that there is some error in the ledger
balance.
The fact that the trial balance agrees is a preliminary assurance that there are no
mathematical / arithmetic errors in the preparation of the accounts.
2. Calculate the totals of the balances in the debtors and creditors ledger
accounts. (A single consolidated figure will be taken for total debtors /
creditors in the trial balance - not all individual ledger accounts).
1. Transactions are identified and recorded in day books (journal, sales book,
purchase book, cash book, etc.).
Ledger balances that affect the Profit and loss account – balance of
expense accounts and income accounts
Ledger balances that affect the Balance Sheet– balance of asset accounts
and liability accounts
29
5. Balances that affect the profit and loss account are recorded in it and profit
earned or loss incurred during the period is determined.
6. Balances that affect the Balance Sheet along with the profit or loss
determined by the Profit and loss account are recorded in it.
7. The asset and liability side of the Balance Sheet is totaled. The total of the
assets side should be equal to the total of the liabilities side.
Rs. Rs.
Sales 50,000 Accrued expenses 6,300
Purchases 30,000 Expenses 12,000
Bad debts 2,000 Discount received 600
Depreciation 3,500 Inventory: 01/01/2009 6,000
Accumulated depreciation 10,500 Loss on sale of asset 500
Amortisation of intangible
Rent received 3,500 asset 300
Petty cash 500 Intangible assets 3,000
Cash at bank 35,000 Share premium account 6,000
Provision for bad debts
Share capital 12,900 01/01/2009 3,000
Provision for bad debts
Inventory:31/12/2009 7,000 31/12/2009 4,000
30
On the same day he bought glass worth Rs.15,000 and a shop for Rs.30,000. All
the glass was sold during the same month for Rs.20,000.
Table 1
Purchases Sales
Sr. Cash Capital Shop Debit Credit
Transaction account account
no. Rs. Rs. Rs. Rs. Rs. Rs. Rs.
John
Cash Capital
1 introduced 50,000 (50,000)
(↑asset) (↑liability)
capital
John Purchases
Cash
2 purchased (15,000) 15,000 account
(↓asset)
glasses (↑expenses)
John
Shop Cash
3 purchased (30,000) 30,000
(↑asset) (↓asset)
shop
John sold Cash Sales
4 20,000
glasses (20,000) (↑asset) (↑income)
Balance 25,000 (50,000) 30,000 15,000 (20,000)
32
Debits = Credits
(25,000 + 30,000+15,000) = (50,000 + 20,000) (figures in brackets)
Rs.70,000 = Rs.70,000
Note:
The steps related to recording the transactions and preparation of a trial balance,
Profit and loss account and BALANCE SHEET are explained in greater detail
later in this book. Here, a simple example is given to explain the accounting
equation.
Rs. Rs.
Total 55,000
Total 55,000
Debits = Credits
The assets have a debit balance and liabilities have a credit balance. The total
debits are always equal to total credits hence; in the balance sheet, total assets
are equal to total liabilities (owed to outsiders and to owners). Therefore, the
two sides of the balance sheet always balance.
Profit is the net result of all incomes and expenses and is added to capital.
Incomes / expenses are not considered individually in the accounting
All are mathematically the same. The most commonly used presentation is:
The liabilities of a business are Rs. 30,000, and the capital of the proprietor is
Rs.70, 000. The total assets are:
A Rs.70,000
B Rs. 100,000
C Rs. 40,000
D Rs. 30,000
35
This account helps to determine the amount of profit or loss made during the
year. This statement shows the transactions of a business for a period of time (say
one year).
This statement helps to determine the financial position of the entity i.e. the
position of assets and liabilities as at the end of a period. It is a statement of the
amount owed and owned by the entity.
7.3 Steps for preparing the trading and profit and loss account and
balance sheet
Step 2: Transfer the balances of nominal accounts from the ledger to the
“Trading and Profit and Loss” account or ‘Income and Expenditure account or
Revenue account. For this:
Step 3: Transfer the net profit / loss (arrived at in step 2) to the balance sheet. If
the P/L account shows a loss, then it is shown on the asset side. If, on the other
hand, the P/L account shows a profit, then it is shown on the liability side.
Step 4: Transfer the balances of other accounts (personal and real) that are not
closed from the trial balance to the Balance Sheet. For this, the credit balances of
the accounts should be shown on the left hand side of the Balance Sheet (i.e. the
side known as capital and liabilities) and the debit balances should be shown on
the right hand side (which is known as property and assets).
36
Step 5: The two sides of the Balance Sheet are totalled and tallied.
P/L- Profit and Loss account
B/S- Balance Sheet
1. Casting error
The term casting means adding up. This error affects the agreement of a trial
balance. This error can be an error of overcasting or an error of undercasting.
Overcasting means summing (i.e. arithmetically adding) the totals to more than
what they are and undercasting means summing (i.e. arithmetically adding) the
total to less than what they are.
2. Posting error
This error occurs while posting a transaction from the books of prime entry to the
ledgers. This can be:
Here, the posting of the journal entry should have been Rs.500, but was
incorrectly posted as Rs.200.
38
Here, the posting of the journal entry should have been Rs.500, but was
incorrectly posted as Rs.200.
ICC Ltd
Dr Bad debts account Cr
Date Rs. Date Rs.
31-Dec AAL account 200
Profit and loss
31-Dec account 200
Total 200 Total 200
Receivables ledger
Dr AAL account Cr
Date Rs. Date Rs.
1-Dec Balance b/f 5,000 31-Dec Bad debts 500
31-Dec Balance c/f 4,500
Total 5,000 Total 5,000
The most common form for posting the wrong amount is a transposition error.
39
Let us see how the posting of the following journal is wrongly omitted.
The ledger should have been posted with Rs.500. An error was made, and
this amount was omitted and posted with zero.
Dr AAL account Cr
Date Rs. Date Rs.
1/12/2009 Balance b/f 5,000 31/12/2009 Bad debts 500
31/12/2009 Balance c/f 4,500
Total 5,000 Total 5,000
Let us see how the posting of the following journal is made to the wrong side
of the correct account.
The AAL account should have been on the debit side, and not on the credit
side.
40
Dr AAL account Cr
Date Rs. Date Rs.
1 Dec Balance b/f 5,000 31 Dec Bad debts 500
31 Dec Balance c/f 4,500
Total 5,000 Total 5,000
The bad debt account is correctly posted from the journal with Rs.500. While
taking the balance of the bad debt accounts to the trial balance, it is incorrectly
carried over from Rs.500 to Rs.900.
Transposition error
Samuel purchased raw materials from Sam for Rs.5,200. He debited the purchase
account with Rs.2,500 and credited Sam’s account with Rs.5,200.
Has any error been committed by Samuel? If yes, what is the error?
The main purpose of the trial balance is to ensure that double entry book keeping
has been followed correctly and that debits = credits. If using a manual system, it
is possible to post just one side of the entry or even to write in an incorrect
amount. The trial balance will highlight this if it occurs, as debits ≠ credits.
While it is simple to identify that an error has been made, there is often a long
and difficult task of cross checking balances to find out where the error is! We
will discuss this in more detail in the next Learning Outcome.
When the totals of debits and credits are equal in a trial balance, this does not
assure the correctness of accounting. There may still be errors, which do not
create a difference in the debit and credit totals of a trial balance. These errors
distort the financial statements, but the trial balance total of debits and credits is
equal. These errors are difficult to detect compared to those errors that affect the
agreement of the trial balance.
ICC Ltd sold goods to Alan for Rs.1,200 but omitted to record the transaction in
both the sales day book and the debtors ledger. Since both the accounting effects
(i.e. the credit in the sales account and the debit in the debtors ledger) of the
transaction are not recorded there cannot be a difference in the trial balance.
2. Error of commission
These are basically the clerical errors committed at the time of recording and / or
posting the transactions. This includes errors such as the recording of a
transaction to the wrong account or recording a transaction with the wrong
amount.
43
ICC Ltd sold goods to Alan for Rs.1,200 and recorded this in the sales day book.
However instead of debiting the amount to Alan’s account, it was debited to
Peter’s account. This error will not affect the agreement of the trial balance
because whether Alan’s account is debited or Peter’s account is debited – the
posting has gone to the debit side of the account. The credit effect has been
correctly taken and so the trial balance will agree.
3. Error of principle
As a result, the company’s profits and assets will be reported with a Rs.10,000
deficit. .
The trial balance will still balance as one account has been debited with the right
amount (it does not matter that the account head is wrong) and one account has
been credited with the right amount. Hence this error cannot be detected by
preparing a trial balance.
4. Compensating error
Under this type of error, two errors are committed, in such a way that the total
debits remain equal to the total credits in the trial balance.
44
Goods sold to Jay for Rs.1,000 were recorded in the sales day book correctly but
were not recorded in Jay-receivables account. At the same time goods purchased
from Bob for Rs.1,000 were recorded in the purchase day book but not recorded
in Bob’s payables account.
The two accounting entries were as follows:
Purchases account Dr Rs.1,000
To Sales account Rs.1,000
The ultimate effect of the above error is that the debit in the first entry falls short
by Rs.1,000 and the credit in the second entry falls short by Rs.1,000. Therefore,
the two errors will compensate each other and the trial balance will agree in the
terms of debit and credit totals.
A sales invoice of Rs.1,400 was recorded as Rs.1,600 in the sales day book and
posted to the receivables ledger account as Rs.1,600. This error will not result in
any disagreement in the trial balance totals.
Step 2: Confirm that the cash and bank balances are duly included.
Step 3: Ascertain whether the trial balance itself or the subsidiary books contain
an item which is half the amount of the difference and, if so, whether that item
has been posted to the wrong side of the ledger account or inserted in the wrong
column of the trial balance.
Step 4: If the difference is divisible by 9, it means the figure has reversed, for
example, 342 has been posted as 432. Then check such figures.
Step 5: If these steps are unsuccessful, it may then be necessary to follow the
steps given below.
1) See that the ledger balances are correctly brought down, both at the
beginning and at the end of the period and that the closing balances are
correctly entered in the trial balance.
2) Check the additions of the subsidiary books, and of the ledger accounts.
3) Verify the postings of the individual items and the periodic or monthly totals
of purchases, sales, discounts and the like.
46
Where exercises are worked under examination conditions and candidates are
unable to make the totals of either the trial balance or the Balance Sheet agree,
methods similar to those given above should be adopted to discover the cause of
the disagreement. Badly-formed figures and the misplacement of figures such as
the units figure being placed under the tens (or the tens figure being placed under
the hundreds) are usual causes of error. Thoughtful attention should be given to
this feature of postings into principal ledger.
Capital expenditure increases the value of a non-current asset. This means that
the working capacity and the life of the asset are increased. This results in long
lasting benefits to the entity.
On 2 January 2006, Diana purchased land worth Rs. 900,000 from Jack. She paid
Rs.50,000 stamp duty on the purchase price. This amount of Rs. 50,000 is
included in the cost of the land bringing the total cost of the land purchased to
Rs. 950,000. In Diana’s accounts, the cost of the land will be recorded as
Rs.950,000.
2. Capital receipt
Therefore, capital receipt is income which is earned from activities that are
not ordinary activities / regular operations of an entity i.e. it is not income
realised by the sale of the merchandise of the entity.
Capital receipt
1. Sale of non-current asset
2. Receipt of share capital or capital
3. Receipt of loans and debentures
4. Premium received on issue of shares
49
These are those items which affect the profit and loss account.
Revenue items consist of two types: revenue expenditure and revenue receipt.
3
1. Revenue expenditure
‘Maintaining’ the existing capacity of the asset means keeping the asset in a
proper working condition so that the productivity of the asset is not reduced.
Revenue expenditure provides benefit of a current nature i.e. the benefit arising
out of revenue expenses expires in the same accounting period.
Mack purchased computers for Rs.1,500 and computer stationery for Rs.50.
These two expenditures will benefit Mack for different periods. The computers
will give benefit of an enduring nature i.e. benefit for a longer duration whereas
the expenditure on computer stationery will give benefit of a comparatively short
duration. Hence:
2. Revenue receipt
Revenue receipts are a result of sale of the merchandise of the entity and
other revenue items like rent received or commission received.
Michael gave his building on rent to Sam. The monthly rent received is Rs.5,000.
Therefore, the amount received by Michael is Rs.5,000 is his revenue receipt.
50
The chart given below shows why Better Plc classified the expenses it incurred
as capital or revenue expenses.
Certain expenditure may seem to be of a definite revenue nature, but the benefit
in such cases may be available for a period of two years or more. For example,
expenses over a publicity campaign initiated on a massive scale, preliminary
expenses and research and development expenses. These expenses will increase
the sales over the next few years. Such expenditure is known as deferred revenue
expenditure.
Accounting treatment:
The amount of deferred revenue expenditure is written off over the probable
useful life of the expenses incurred. Therefore, deferred revenue expenditure is
written off over a period of two or more years and not wholly in the year in
which it was incurred.
Cost of goods sold involves adjustment for inventory on hand at the beginning
and at the end of the accounting period.
Net profit = Gross Profit + / - Adjustment for all other income and expenses.
53
Cost of sales = Opening stock + purchases – closing stock - any other expense
(incurred to bring the purchased goods to the firm’s shop or otherwise to make
the goods ready for sale). For example, freight on goods purchased, customs
duty, octroi duty, etc.
Cost of sales = opening stock + purchase of raw materials – closing stock - any
other expense (incurred up to the time the goods are made ready for sale). For
example, wages paid to workmen, fuel and power used to run the machinery,
carriage on purchase etc. In short, all expenses incurred in the factory or
workshops are debited to the trading account.
Dr Trading account Cr
Amounts Amounts
Particulars Particulars
(Rs.) (Rs.)
Opening Stock X Sales X
Purchase X Less Returns X
Less Returns X
Carriage / Freight on
X Closing Stock X
purchases
Gross loss
Wages X X
(if Dr side > Cr side)
Fuel and power X
Lighting (factory) X
Rent and rates X
Gross profit
X
(if Cr side > Dr side)
Total XX Total XX
If the percentage of profit to sale varies widely from year to year, the reasons
should be investigated.
54
1. High material costs: an unduly high price might have been paid for
purchases.
2. Wastages: the materials might not have been properly used i.e. there could
have been wastages or pilferages.
5. Improper inventory valuation: the closing inventory might not have been
properly taken or its valuation might be wrong.
B Suzy is a sole trader dealing in furniture. A dressing table was sold by Suzy
for Rs.20,000; the amount received for this sale is a receipt. She
also sold a computer used in her showroom for Rs.5,000. This is a
receipt because it is a sale of a non-current asset.
55
Step 1: Start with the credit from the Trading account in respect of gross profit or
debit in case of gross loss.
Step 2: Transfer to the debit side of the profit and loss account, all the expenses
or losses which have not been debited to the Trading account. For example rent
paid, salary paid, etc.
Step 3: Transfer to the credit side of the profit and loss account any income
(which have not been credit to the Trading account besides the gross profit). For
example interest received, profit on sale of asset etc.
Expense = All monies spent on various accounts for earning the income of
the business
In other words Revenue Expenditure and losses will be debited to the Profit and
Loss account.
Income tax (In Debit income tax paid to Income tax is merely
respect of firms ) drawings account government’s share of a
person’s income
56
Outstanding expenses
Whether the interest is due or not, the accrual continues every day. Interest for
the period 1 January 2007 to 30 June 2007 is due on 30 June 2007. The reporting
date for Pallore Co is 31 March 2007 and it falls in between the interest
repayment period.
Interest for the period 1 January 2007 to 31 March 2007 is not due for payment
on reporting date, but still it has accrued. Therefore the amount of interest
outstanding which needs to be recognised is Rs.10, 00,000 x 9% x 3/12 = Rs.
22,500.
Note: the interest accrued during 2006-07 is transferred to the profit and loss
account even if there is no payment of interest. This is achieved by the accrual
adjustment.
Outstanding
expense recorded as
a liability
59
The interest expense will be added to the interest cost under finance costs in the
profit and loss account.
The interest accrued on the loan is shown in the balance sheet under current
liabilities.
3. Reversal of accrual
At the beginning of the next year, the journal entry is reversed. This is known as
reversal of accrual. In the example considered above, the entry to be made in the
next year is:
Interest expense
31/03/2008 Balance c/d 22,500 31/032008 (Jan 2008 to 22,500
March 2008)
45,000 45,000
Selection Ltd has taken a loan from Chartered Bank on 1 October 2010. Interest
is due on a six monthly timeline i.e. on 31 March, and 30 September. Each
interest instalments is Rs.6, 000. According to the local laws, Selection prepares
its financial statements to the year ended 30 June. What is the amount of accrued
interest that Selection would show in its financial statement for the year ended 30
June 2011?
A Rs.4,000
B Rs.12,000
C Rs.6,000
D Rs.3,000
61
Prepaid expenses
An insurance policy for fire and similar risks is obtained for the year from 1
November 2006 by paying a premium of Rs.24,000 for the full year in advance.
The reporting period is 31 December 2006.
Of the total premium paid of Rs.24,000, the premium accrued up to the end of the
reporting period is: 24,000 x (2/12) months = 4,000.
The part which relates to the current financial year is added to the insurance
expense account (in this case, two months: November and December 2006) and
the part which relates to the next financial year is carried forward as an asset –
‘prepaid expenses’. (in this case 10 months from January to October 2007).
The premium for the remaining 10 months, i.e., 24,000/12 x 10 = 20,000 accrues
in the next financial year i.e. it is paid in order to cover the fire and other risks for
the period 1 January 2007 to 31 October 2007.
When the payment was made, the accountant would have recorded the following
entry:
Now, at the end of the year, having determined that Rs.20,000 is a pre-payment,
the following entry is made:
Dr Cr
Rs. Rs.
Transferred to profit and loss
X 4,000
account (balancing figure)
Cash ( payments) 24,000
Prepaid insurance** 20,000
24,000 24,000
** Prepaid expense is shown here as a reduction from expense
The adjustment for prepaid insurance leads to an amount of Rs.4,000 i.e. the
amount of expense accrued. This amount is transferred to the profit and loss
account.
The insurance expense in the profit and loss account will be reduced by
Rs.20,000.
Moksh had business premises that were lying vacant. He rented it out for an
agreed rent of Rs.400 per month with effect from 1 April 2006.
The rent for the 9 month’s period from 1 April 2007 to 31 December 2007 must
be accounted as an expense.P/L
Rent for the 3 months from January 2007 to March 2007 had accrued even
though it had not actually been received by Moksh. Moksh needs to record an
amount of Rs.1,200 (Rs.400 x 3) in his accounts as rent receivable for the year
2006-2007.
Rs. Rs.
Cash Dr 3,600
To Rent income 3,600
(Being rent received)
Dr Cr
Rs. Rs.
Cash ( receipts) 3,600
Transferred to P/L (balancing
4,800
figure)
Income accrued
1,200
(outstanding)**
4,800 4,800
** Accrued income is added to income
Accrued income would lead to an increase in income. Hence the following two
effects are noticed:
The effect on the profit and the net assets in the next year, when the entries are
reversed, is the opposite of this.
66
6,000 6,000
Reversal of accrual adjustment ensures that Rs.1, 200 received during 2007-08
but relating to 2006-07 is not shown as an income of 2007-08.
A firm of lawyers received Rs.10,000 on 24 March 2007 as fees for a case that it
was handling and booked the same as revenue for the period. This amount
covered 2 court hearings requiring approximately similar time and effort. Up to
the end of the reporting period on 31 March 2007, only 1 hearing was complete.
The second hearing took place on 30 April 2007.
At the reporting date only half of the work was complete and therefore only half
of the fees must to be accounted.
Since, the fees for both the hearings was received in advance, it must be
accounted in the following manner:
Cash Dr Rs.10,000
To Professional fees Rs.10,000
(Being cash received)
10,000 10,000
** Fees received in advance shown here as a reduction from income
68
X
** Fees received in advance recorded here as a liability
The effect on the profit and the net assets in the next year, when the entries are
reversed, is the opposite of this.
5,000 5,000
** Transferred from professional fees received in advance account
69
Transfer of the amount received last year but pertaining to the current year (2007
- 2008) to this account enables us to show the income earned in the current year
(Rs.5,000) as current year’s income.
9.2 The following is a list of the usual expenses which appear on the
profit and loss account
9.3 The items usually found on the credit side of the Profit and Loss
account are:
Cash Discount Received or Commissions earned.
Interest and Dividend and Rents received.
Amount previously written off recovered.
Profit on sale of assets etc. etc.
It is prepared as on a certain date and not for a period: the balance sheet
shows the financial position on the date on which it is prepared and not on
any other day.
The total of all assets must be equal to the total of all liabilities, including
capital. Since capital is nothing but the difference between assets and
liabilities to the outsiders, it is easy to understand why the two sides of the
Balance Sheet should agree.
A balance sheet can be prepared only after the Trading account and the
Profit and Loss account are prepared.
The Balance Sheet must reflect the true financial position of a business.
Hence, it must be drawn up very carefully.
The balance of the Profit and Loss account included therein should be
carefully arrived at.
Both these statements, viz. Profit and Loss account and Balance Sheet
are interdependent. If any item of expense or income is omitted or over or
under stated, it will not only affect the accuracy of the net profit or loss but
will also equally affect the correctness of the Balance Sheet.
Likewise, if any asset or liability has been omitted from the Balance Sheet or is
over or under valued, not only would this affect the correctness of the Balance
Sheet but it would also falsify the net resultant profit or loss as disclosed by the
Profit and Loss account.
Apart from the joint stock companies, which have to follow the form prescribed
by the Companies Act, liabilities are generally shown in the order of the urgency
of payment. That is why sundry creditors and promissory notes given are shown
first; then come loan creditors as they have given an undertaking to wait for a
definite period. The capital comes last.
Joint stock companies have to follow the form prescribed by the Companies
Act.
In a partnership, usually the assets are shown in the natural order of their
realisability and the liabilities in the order in which they are payable.
Banks usually prefer to state their assets in order of their realisability. Thus,
the most liquid assets are set out first and are followed by assets which are
more difficult to realise .Liabilities are also shown similarly
Mr. G. Kapadia and Mr. C. Desai are in partnership. Profits are divided as 3/5 to
Kapadia and 2/5 to Desai. Interest at 5 per cent is to be credited on capital
accounts, but no interest is charged on drawings. Desai’s account is to be credited
at the close of the year with Rs. 3,000 as a partnership salary.
The Trial Balance extracted from the books as at 31 st December 2011 is given
hereinafter.
74
Trial balance
When preparing these accounts, the following points are to be taken into
consideration:
75
d) Interest at 5 per cent on the loan account for the half year to 31 st December
had accrued due, but no entries had been made.
e) No provision has been made for warehouse wages of Rs.320 and office
salaries Rs.900, which had accrued due on 31 st December.
f) A provision for bad debts equal to 5 per cent on the sundry debtors is to be
set up.
Required:
Prepare a Trading and Profit and Loss account for the year ended 31st December
2011 and a Balance Sheet as at that date.
Solution
Rs. Rs.
Dec.31 Stock account Dr 44,580
To Trading account 44,580
(Being value of closing stock)
76
Less : Returns
3,240 165,700
Outwards
To Warehouse
5,820
Rent and Rates
To Warehouse 42,870
Wages
320 43,190
Outstanding
To Inward
6,620
Carriage
To Gross Profit By Stock at
138,180 44,580
c/d 31st Dec.
397,270 397,270
78
Profit and loss account for the year ended 31 st December, 2011
Dr Cr
Rs. Rs. Rs. Rs.
To Office Rent and 2,100 By Gross 1,38,180
Rates Profit b/d
To Office Salaries 18,940
To Outstanding
Salaries 900 19,840
To Advertising 12,680
To Travellers Salaries
and Commission 32,410
To Outward Carriage 8,960
To Interest 720
To Interest on Loan 500 1,220
To Bad Debts 3,010
To Provision for Bad
Debts (5% on 5,430
Rs.1,08,600)
To Depreciation
Machinery and
Plant 8,540
Office Furniture 270
Showroom Fittings 600
Motor Lorries 4,290 13,700
To Net Profit 38,830
1,38,180 1,38,180
Profit and loss appropriation account for the year ended 31 st December,
2011
Dr Cr
Rs. Rs. Rs. Rs.
To Partnership Salary By Net Profit 38,830
C.Desai 3,000
Interest on Capital
G.Kapadia 7,500
C.Desai 2,500 10,000
To Division of balance of
Profits
G.Kapadia 3/5ths 15,500
C.Desai 2/5ths 10,330 25,830
38,830 38,830
79
Outstanding Expenses
Less : Depreciation 270 5,130
account:
Interest Outstanding 500 Showroom fittings 8,200
Warehouse Wages 320 Less : Depreciation 600 7,600
Office Salaries 900 1,720 Motor Lorries 28,600
Capital Accounts : Less : Depreciation 4,290 24,310
Kapadia A/c.
The Receipts and Payments account is the simplified form in which the treasurer
of a non-trading institution can render an account of his stewardship.
The actual cash receipts for a particular period: cash receipts are added
separately for each head of account and disclosed on the receipts side of the
Receipts and Payments account. For example, total subscriptions received
during the period will be shown as subscriptions received.
The actual cash payments for a particular period: cash payments are
added separately for each head of account and disclosed on the receipts side
of the Receipts and Payments account. For example, total salary paid during
the period will be shown as salary payment.
The balances of cash in hand at the end of the period: this account ends
with the closing balance of cash in hand, and cash in bank accounts.
82
Therefore, amounts reported in this statement are confined to cash received and
paid during the period without consideration to any outstanding receipts or
payments.
the payments (including payment of outstanding expenses) are set out on the
credit side; and
the balance of the cash on hand is carried forward to the next financial
period.
Therefore, this account does not necessarily reveal the actual income and expense
for the period it purports to cover.
Balance of the Income and Expenditure account = Surplus / deficit for the period
Accounting treatment of surplus / deficit for the period
Add surplus for the period to “capital” or “accumulated surplus” found in the
Balance Sheet.
Deduct deficit for the period from the “capital” or “accumulated surplus”
found in the Balance Sheet.
The distinction between the two forms of accounts is set out below:
Amounts reported here are confined This account includes the whole of
to cash received and paid during the the income and expenditure
period without consideration to any pertaining to the period covered,
outstanding receipts or payments. irrespective of whether actually
received or paid or not.
The matching principle requires that the expenses be recognised in the year in
which the revenue is recognised (cost is matched with the relevant revenue). If
the revenue from an asset is going to be earned over a number of years then its
cost should also be allocated over the same number of years. Hence, it is logical
to charge the cost of an asset to revenue over the useful life of the asset.
Physical wear and tear and obsolescence also result in the depreciating value of
an asset.
Like material costs, the depreciation on non-current assets is matched with the
sales revenue.
Provision for depreciation is over and above the amount spent for repairs and
renewals necessary to maintain these assets in their state of original efficiency.
1. Useful life of the assets: useful life The life of the asset and
is the period over which the asset is the salvage value would
expected to be available for an depend upon the technical
entity’s use estimate.
2. Salvage value at the end of the useful life: salvage value is the value which
the entity expects to realise from the disposal of the asset at the end of its
useful life; and
1. Straight-line method
Under this method, depreciation is charged uniformly over the life of the asset.
This method results in a constant charge over the useful life of the asset. The
asset’s residual value does not change and depreciation is calculated as a fixed
amount every year or a fixed percentage of the original cost.
The carrying value at the end of the asset’s useful life is equal to the disposal or
realisable value.
87
KPL Inc purchased machinery for Rs10,000 on 1 January 2004. Its expected life
is 4 years and the residual disposal value is Rs1,296. KPL charges depreciation at
40% using the reducing balance method. Calculate the depreciation amount for 4
years.
Answer
The depreciation charged in this method keeps reducing every year. In this case it
was Rs 4,000 in the first year, which gradually reduced to Rs864.
88
Under the diminishing balance method of depreciation, the carrying value at the
end of the useful life is equal to the disposal or realisable value.
The sum of the years of the life of asset is taken to be the denominator. The
numerator each year will be the digits taken in the reverse order.
Remaining useful life of asset x (Cost of the asset - Estimated residual value)
Depreciation =
Sum of years of life of asset
The diminishing balance method and the sum of the years’ digit methods are
known as accelerated method of depreciation for they charge heavier amounts in
the earlier years.
The repairs to the asset will be much less in the earlier years when compared to
the later years. If the above two methods are adopted, the sum total of
depreciation and repairs will be more or less a constant charge over the life of the
asset.
89
4. Annuity method
The annuity method takes into consideration the interest lost by the owner - the
interest that could have been earned if the amount would have been invested in
interest earning securities. Therefore, under the annuity method, the cost of the
asset and the interest at a given rate is written down every year by fixed amount.
This annual amount is determined with the help of annuity tables.
The asset is debited with the amount of interest on the diminishing value of the
asset and the amount of depreciation is ascertained with reference to the present
value of the capital investment or the original cost of the asset, usually with the
help of the Logarithmic Table. A formula can also be used to ascertain the
present value. This method is useful for long term leases.
A lease was acquired with a premium of Rs. 2,00,000 on 01.04.2006 for 4 years.
Depreciation under annuity system at 5% p.a. interest is charged. Rupee 1 is the
present value of 0.282012 payable over 4 years @ 5% p.a.
Workings
Rs. 2,686 has been r/off to balance the lease account as the amount of
annual depreciation is Rs. 56,402 and the opening balance is Rs. 53,718 in
the 4th year
W2 Annual depreciation
PQR Company Ltd obtained a machine for Rs. 3,00,000 with its useful life of 4
years on 01.04.2006. Replacement was to be done after 4 years by setting up a
depreciation fund, and an annual investment of Rs.70,647 would be required to
earn interest @ 4% p.a.
Machine account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2006 To Bank A/c 3,00,000 31.03.2007 By Balance c/d 3,00,000
3,00,000 3,00,000
3,00,000 3,00,000
3,00,000 3,00,000
Dr Cr
Date Particulars Rs. Date Particulars Rs.
1,44,120 1,44,120
2,20,532 2,20,532
Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.03.2007 To Bank A/c 70,647 31.03.2007 By Balance c/dc 70,647
70,467 70,467
01.04.2007 To Balance b/d 70,647 31.03.2008 By Balance c/d 1,44,120
This method is similar to the sinking fund method. Under this method, premiums
are paid on a policy taken out with an insurance company. When the policy
matures, funds become available for replacement of the asset.
The policy is made usually for a period equal to the useful life of the asset and
for a sum assured that is expected to provide enough funds for the replacement of
the asset. If annual interest is to be accounted for, the surrender value of the
policy at the particular year-end is referred to. This method is usually adopted in
the case of vehicles due to the uncertainty of their useful lives.
94
Bank account Dr X
To Insurance Policy account X
(Being amount of the policy received on maturity)
Bank account Dr X
To Asset account X
(Being sale of scrap, if any)
95
Shyam Ltd took a building worth Rs. 80,000 on lease for four years, starting
from 01 January 2010. Shyam Ltd has decided to make a provision for
replacement of the lease by means of an insurance policy purchased for an annual
premium of Rs. 18,300.
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.01.2010 To Bank A/c 18,300 31.12.2010 By Balance c/d 18,300
18,300 18,300
01.01.2011 To Balance b/d 18,300
To Bank A/c 18,300 31.12.2011 By Balance c/d 36,600
36,600 36,600
01.01.2012 To Balance b/d 36,600
To Bank A/c 18,300 31.12.2012 By Balance c/d 54,900
54,900 54,900
01.01.2013 To Balance b/d 54,900
To Bank A/c 18,300
To Depreciation 6,800 31.12.2013 By Bank A/c 80,000
fund A/c
80,000 80,000
Comparison between the sinking fund method and the insurance policy method:
The method of providing for depreciation by means of fixed rate per hour of
production calculated by dividing the value of the asset by the estimated number
of working hours of its life.
At the end of each year, assets are revalued and diminution in value is written off
as depreciation.
Provision refers to any amount written off or retained by way of providing for
depreciation, renewals or diminution in values of assets or retained by way of
providing for any known liability the amount of which cannot be determined with
substantial accuracy (e.g. provision for unexpired risk).
Reserve is a sum set aside out of the profits for some purposes which may or may
not subsequently be brought back into profit and loss account and allocated in
some other manner. Any excess provision may be treated as reserve.
In addition to depreciation, entries for provision for bad and doubtful debts and
provision for depreciation in the value of investment, if any, will have to be
made.
Accounting entries
If the depreciation is calculated using the written down value method, the book
value of the machinery on 30 June 2003 will be more by:
A Rs. 1,170
B Rs. 3,000
C Rs. 2,500
D Rs. 2,430
However, in actual practice, the two balances rarely agree for the following
reasons:
When cheques are received from clients, they are immediately deposited with the
bank and debited in the bank column of the cash book. But the bank does not
credit the customer’s account until the bank gets the cheque realized, especially
when it is drawn on another bank. In the meantime, therefore, the cash book will
show a higher balance than that shown by the pass book.
When cheques are issued to clients, they are immediately entered and credited
in the bank column of the cash book. But the bank does not make an entry in the
pass book as long as the cheques are not actually presented for payment, and are
paid. During this time lag, the cash book will show a lower balance than that
shown by the pass book.
These refer to items which are entered in the pass book only with no
corresponding entries appearing in the cash book and vice versa. Some of them
are given below such as:
The bank usually charges the customers for the services it renders to them. These
charges are known as bank charges. These bank charges, and sometimes, interest
on overdraft are entered in the pass book only. These are entered in the cash book
either on receipt of intimation from the bank or after the receipt of the pass book
by the customer. Until such time, the cash book will show a higher balance than
that of the pass book.
100
Sonia had issued a cheque of Rs. 20,000 to Sham. The cheque was dishonoured
due to insufficient balance in her account. For dishonour of cheque, the bank
charged her Rs. 200.
Sonia had no information about these bank charges until she got the bank
statement. So there was no entry in the cash book. This resulted in a difference of
Rs. 200 between the balance in the bank statement and in the cash book.
Whenever deposits are made directly into the bank account of a trader by his
debtors without the knowledge of the former, they are credited to the account of
that trader by the bank. This may also result in a difference between the cash
book balance and the pass book balance; the cash book will show a lower balance
than that of the pass book.
Furthermore, the bank is usually entrusted with the task of collection of interest
on securities or dividends on shares or proceeds of bills of exchange or
promissory notes on maturity on behalf of the customers. The bank credits the
customer’s account the moment the proceeds are collected whilst the customer
debits the bank account only after the receipt of information from the bank to that
effect. The bank may have also credited periodic interest on the customer’s
current and/or savings account, which will be known only after the receipt of the
pass book. During this time lag; the cash book will show a lower balance than
that of the pass book.
c) Standing order:
d) Cheques dishonoured
Sometimes, entries may be passed in the pass book by the bank for dishonored
bills or cheques and these may not find place in the cash book until the receipt of
the pass book by the customer from the bank. Accordingly, the cash book will
show a higher balance than the pass book during this period.
Madhav deposited a cheque received from one of his customers of Rs. 50,000.
The cheque was dishonoured by the bank because there was insufficient balance
in the customer’s account. This fact was not known to Madhav.
This resulted in a difference between the cash book and bank statement. Madhav
had shown this withdrawal but there was no corresponding entry in the bank
book.
e) Errors
There may be differences between the cash book and bank statement because of
errors committed either by the entity’s personnel or the bank’s personnel. Errors
may be in the nature of calculation mistakes, or they may be made while
recording a transaction. Some of the reasons for errors are as follows:
A clerical error on the part of a bank may also result in a difference between the
cash book balance and the pass book balance. For instance, the bank may credit
or debit the account of one customer wrongly for another.
A careless omission on the part of a customer in not depositing the cheque with
the bank for collection after entering it in the cash book or depositing it with the
bank without entering in the cash book may also result in a difference between
the cash book balance and the pass book balance.
Any mistake in casting and carry forward of the total as well as erroneous
balancing of the cash book or pass book may also result in a difference between
the cash book balance and the pass book balance.
102
All errors and omissions in the cash book are first rectified to determine the
correct balance according to the cash book. We then prepare bank reconciliation
statement.
Let us understand how to determine the correct cash book balance with the
following example:
On 30 June 2009, Superb Inc discovered a difference between the cash book and
the bank statement. The accountant of the company was unable to explain the
difference. The details of the balances are as follows:
On 30 June 2009, the balance in the cash book was Rs.900 (debit) and in the
bank statement was Rs. 1,000 (credit).
After verification, it was found that the difference was because of the following
transactions:
The only error in the cash book is that it is understated by Rs. 50 and issued
cheque is debited instead of credited. Hence, we will first correct this error.
The correction in the cash book is made as follows:
Cash Book
Dr Cr
Date Receipts Rs. Date Payments Rs.
Cheque wrongly
Balance b/d 900 recorded on receipt side 100
(50x2)*
Understated
50 Balance c/d 850
figure (a)
Total 950 Total 950
103
*The amount has been deducted twice: first for the reversal of the previous
wrong entry on receipt side, and later for the correct recording of the entry for
cheque issued.
Items b) and c) are not errors. They are items of timing differences which will
appear in the bank reconciliation statement.
A statement is prepared to reconcile the difference that exists between the cash
book and the pass book. This statement is known as Bank Reconciliation
Statement.
It should be remembered that entries appearing both in the cash book and the
pass book will cause no difference at all and hence, have to be ignored.
104
One of the balances will be taken up as the starting point and is adjusted
considering how the balance would have changed if the same entries were made
in the two books. This enables the management of business concerns to check
accuracy of the entries made in the cash book and also to keep track of cheques
either sent to the bank for collection and remaining unclear or issued to the
clients by the customer and remaining unpresented, for an unreasonably long
period. Ultimately, the management can ascertain the cause for delay and take
timely action.
Take the Cash Book Balance or Pass Book Balance as the starting point and then
check what has been done or has not been done in the other Book. For instance if
we take the Pass Book Balance as the starting Point, we would check up
carefully, what has been done or not done in the Cash Book and ascertain if the
entries passed in the Cash Book are also passed in the Pass Book and also if the
entries not finding a place in the Cash Book are removed from the Pass Book.
Step 1:
Compare the debit side of the cash book with the deposits column of the pass
book, item by item. Note down the following:
cheques deposited into the bank account (appearing in the cash book) which
are not credited by the bank
interest credited by the bank for which there is no corresponding entry in the
cash book
Cheques dishonoured (not recorded in cash book)
direct credits by customers (appearing in pass book) for which there is no
corresponding entry in the cash book
Step 2:
Compare the credit side of the cash book with the withdrawals column of the
pass book. Note down the following:
cheques issued during the period which have not been presented for payment
bank charges debited by the bank for which there is no corresponding entry
in the cash book
Standing order payments (appearing in pass book) for which there is no
corresponding entry in the cash book
interest debited by the bank for which there is no corresponding entry in the
cash book
Step 3:
Fill up the proforma of the bank reconciliation statement.
105
The following proforma can be used to reconcile the balances of cash book
and bank statement.
Rs
Balance according to cash book X
Add: Cheque issued but not presented X
Add: Bank interest X
Add: Direct credit by customers X
X
Less: Standing order (X)
Less: Cheques deposited in bank but not credited (X)
Less: Cheques dishonoured (not recorded in cash book) (X)
Less: Bank charges (X)
Balance according to bank statement X
Rs
Balance according to bank statement X
Add: Cheques deposited in bank but not credited X
Add: Bank charges X
Add: Cheques dishonoured X
Add: Standing order X
X
Less: Cheque issued but not presented (X)
Less: Direct credit by customers (X)
Less: Bank interest (X)
Balance according to cash book X
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The method of comparison of entries in the Cash Book with those found in the
Pass Book will be clear from the following:
M/s. Red and White Ltd, New Delhi in Current account with Indian Bank
Ltd, New Delhi
Dr Cr Dr Balance
Date Particulars Withdrawal Deposits Cr Rs.
Rs.
2011
July 1 By Cash 8,000 Cr 8,000
4 By Cheque Morris 400 Cr 8,400
4 To Bank Charges 2 Cr 8,398
5 To Dulles 1,400 Cr 6,998
8 By Cheque Jones 600 Cr 7,598
10 To Brown 1,200 Cr 6,398
11 By Cheque Allen 500 Cr 6,898
12 To Self 900 Cr 5,998
15 By Self 800 Cr 6,798
24 By Cheque Compton 400 Cr 7,198
24 To Bank Charges 3 Cr 7,195
26 To Hawkins 700 Cr 6,495
31 By Interest 500 Cr 6,995
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Step 1:
The cash book shows a balance of Rs. 5,600 whereas the pass book shows a
balance of Rs. 6,995. If one compares the debit side of the cash book with the
deposits column of the pass book, item by item, one will find that the following
cheques deposited into the bank were not credited by the bank till 31st July 2011:
Had these cheques been credited in the pass book, the pass book balance would
be showing Rs. 7,895, i.e. Rs. 6,995 plus Rs. 900.
Step 2:
While comparing the credit side of the cash book with the withdrawals column of
the pass book, one will find that the following cheques issued during the month
of July, 1991 have not been presented for payment till 31 st July, 2011.
Had these cheques been presented for payment, the pass book balance would
have been reduced to Rs. 6,095 i.e. Rs. 7,895 minus Rs. 1,800.
Furthermore, one finds that the bank has credited a sum of Rs. 500 for interest
collected. There is no corresponding entry in the cash book. Had the pass book
ignored this item temporarily, the balance at the bank as per the pass book would
have been Rs. 5,595 (Rs. 6,095 – Rs. 500). Then again, the pass book shows a
debit of Rs. 5 as bank charges on different dates for which there is no
corresponding entry in the cash book. Had the pass book ignored this item, the
balance shown by the pass book would have been higher, viz., Rs. 5,600 (Rs.
5,595 + Rs. 5) which agrees with the cash book balance.
Rs. Rs.
Bank Balance as per Pass Book. 6,995
Add: Cheques Paid in but not yet credited :
Parker 300
Evans 600
900
Bank Charges Debited in the Pass Book 5 905
Less: Cheques issued but not yet presented 7,900
Greig 1,200
Fraser 600
1,800
Interest collected and entered in the Pass
Book 500 2,300
But not in Cash Book
Bank Balance as per Cash Book 5,600
The above example can also be worked out taking the Cash Book Balance as the
starting point, as shown below.
Rs. Rs.
Bank Balance as per Cash Book 5600
Add : Cheques issued but not yet presented :
Greig 1,200
Fraser 600
The cash book shows a debit balance when the receipt (debit) side of the
cash book exceeds the payment (credit) side of cash book. This balance is
also known as a favourable balance.
Similarly, when the payment side of cash book exceeds the receipt side of
cash book, the balance is known as an unfavourable balance. This balance
is also called an overdraft balance in the cash book.
The bank statement has a credit balance or a favourable balance when the
credit side of the bank statement is higher than the debit side.
In the same manner when the debit side of bank statement is greater than the
credit side of the bank statement, it shows a debit balance or an
unfavourable balance. This balance is also known as an overdraft balance.
If you are given a question in which there is an overdraft balance in the bank
statement, it is advisable to highlight the negative balance by putting brackets
around the figure.
The bank statement of Euro Cleaners for the month of Jan 2012 shows an
overdraft balance of Rs. 35,000.The cash book showed a balance of Rs. 24,200.
A comparison of the bank statement with the cash book indicated the following
discrepancies:
On 31st March 1991, the Pass book of Mr. V. Shanmugham showed a credit
balance of Rs.9,250. A comparison of the pass book and the cash book revealed
the following:
Rs.
(1) Cheques deposited but not yet cleared by 31st March, 2011 1,500
(2) Cheques issued by Shanmugham but not presented for payment 2,000
before 31st March, 2011
Rs. Rs.
Which of the following does not cause a difference between the cash book
and the bank statement?
A Interest on bank overdraft debited in the bank account
B Cheques received and entered in the cash book, but not yet paid into the bank
for collection
C Cheques issued and presented for payment
D A customer directly deposited a certain amount into the bank
112
Summary
Rules of accounting
A ledger is the principal book as well as the book of final entries. It contains,
in a series of classified and summarised accounts, a permanent record of all
the trader’s transactions under various Heads of Accounts.
Journal entries are to be posted to the Principal Ledger twice. The amount
appearing against the account head in the Debit column of the journal is
posted to the debit side of the account in Principal Ledger and amount
appearing against the account head in the credit column of the journal is
posted to the credit side of the account in the Principal Ledger.
The cash book is a book of prime entry of a special kind as it is also a part of
the ledger system. The cash book is meant to record all cash transactions,
whatever may be their nature.
Steps for preparing the trading and profit and loss account and
balance sheet
Step 2: Transfer the balances of nominal accounts from the ledger to the
“Trading and Profit and Loss” account.
Step 3: Transfer the net profit / loss (arrived at in step 2) to the balance sheet.
Step 4: Transfer the balances of other accounts (personal and real) that are
not closed from the trial balance to the Balance Sheet.
Step 5: The two sides of the Balance Sheet are totaled and tallied.
Revenue transactions, relate to the income and expenses connected with the
normal day to day operations of the business. Revenue expenditure is that
expenditure which is incurred to maintain the existing capacity of an asset so
that it can do its daily work. A revenue receipt is a regular receipt i.e. these
transactions are regularly entered into in an entity in the ordinary course of
the entity’s activities.
The Balance Sheet must reflect the true financial position of a business.A
balance sheet is prepared as on a certain date and not for a period. The total
of all assets must be equal to the total of all liabilities, including capital.
If you are given a question in which there is an overdraft balance in the bank
statement, it is advisable to highlight the negative balance by putting brackets
around the figure.
Answer to TY 1
Except for the sale of the asset, all the others are correct pairs of a transaction
matched with its source documents. The source document for the sale of the asset
is an invoice issued by the entity to the purchaser, and not the cheque received
from the purchaser.
Answer to TY 2
Answer to TY 3
Step 1 Identify the six Bank Stock Furniture Debtors Creditors Capital
elements of the account account account account account account
transaction
Step 3 Identify the Debit what comes in Debit the Credit the giver of the
applicable receiver of benefit
accounting rules the benefit
Step 4 Identify the Debit bank Debit stock Debit Debit Credit Credit
account to be account by account by furniture debtors creditor capital
debited and Rs. 77,000 Rs. 80,000 account by account by account by account by
credited Rs. 60,000 Rs. 33,000 Rs. 90,000 Rs. 160,000
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Answer to TY 4
The correct option is A.
Step 1 Identify the three Cash Discount Om
elements of the allowed Enterprises
transaction
Step 2 Classify the Real account Nominal Personal
account as real, account account
personal or nominal
Step 3 Identify the Debit what Debit Credit the
applicable comes in expenses and giver of the
accounting rules losses benefit
Debit Credit
Rs Rs
Sales 50,000
Purchases 30,000
Bad debts 2,000
Depreciation 3,500
Accumulated depreciation 10,500
Rent received 3,500
Petty cash 500
Cash at bank 35,000
Share capital 12,900
Share premium account 6,000
Provision for bad debts 01/01/2009 3,000
Accrued expenses 6,300
Expenses 12,000
Discount received 600
Inventory: 01/01/2009 6,000
Loss on sale of asset 500
Amortisation of intangible asset 300
Intangible assets 3,000
Total 92,800 92,800
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Closing inventory is not a part of the trial balance. It is directly taken to the P/L
and B/S.
Provision for bad debts at the year end is also not a part of the trial balance
Answer to TY 6
Answer to TY 7
Answer to TY 8
(a) capital, revenue, capital
(b) revenue, capital
Answer to TY 9
The correct option is D.
The last installment of Rs.6,000 made on 31 March 2011 would include the
period from 1 October 2010 to 31 March 2011. The next installment of Rs.6,000
to be made on 30 September 2011 would include the period from 1 April 2011 to
30 September 2011. This installment would be made in the next accounting
period. Hence, the amount of interest accrued would be equal to 3 months
interest charge (from 1 April 2011 to 30 June 2011) Rs.3,000. This is the amount
of interest that has accrued, but has not been paid.
Answer to TY 10
The correct option is B.
All receipts and payments, whether on account of capital or revenue, are included
in the receipt and payment account.
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Answer to TY 11
The correct option is A.
SLM WDV
Method Method
Purchase price on 01 January 2001 50,000 50,000
45,000 46,170
Answer to TY 12
Cheques issued but not presented for payment will cause a difference between
the cash book balance and the bank statement balance.
119
Self-Examination Questions
Question 1
Which of the following options contains the journal entry for the following
transaction?
Oxy Beauty, who owed Shazia Enterprises Rs. 10,000, is declared insolvent.
Shazia Enterprises recovered 25 paise in a rupee from them on 15th July, 2011.
Question 2
A Rs. 12,000
B Rs. 9,000
C Rs. 6,000
D NIL
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Question 3
Milltone paid Rs. 24,000 as insurance on 1 January 2007. The insurance for a
year is Rs16,000. Therefore, in its balance sheet as on 31 December 2007, the
company adjusted Rs8,000 as prepaid insurance. In 2008:
Question 4
A (i)
B (iii)
C (i) and (iv)
D (ii) and (iii)
Question 5
Receivables outstanding at the beginning of the year were Rs. 10,000. During the
year, the following transactions occurred:
Credit sales Rs. 7,00,000
Cash sales Rs. 1,00,000
Prompt payment discounts given Rs. 3,000
Payment Rs. 6,00,000
What is the closing balance of receivables in the closing trial balance?
A Rs.107,000
B Rs 207,000
C Rs 210,000
D Rs 710,000
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Answer to SEQ 2
The correct option is C.
Profit on sale of machinery
SLM Method
Purchase price on 01 April 2006 1,20,000
Less: Depreciation on 31 December 2006 NIL
Book value of the machinery on 01 January 2007 1,20,000
Less: Depreciation on 31 December 2007 12,000
Book value of the machinery on 01 January 2008 1,08,000
Less: Depreciation on 31 December 2007 12,000
Book value of the machinery on 01 January 2009 96,000
Less: Depreciation on 31 December 2009 12,000
Book value of the machinery on 01 January 2010 84,000
Less: Depreciation on 31 December 2010 12,000
Book value of the machinery on 01 January 2011 72,000
Less: Depreciation on 30 September 2011 12,000
Book value of the machinery on 30 September 2011 60,000
Selling price of machinery 66,000
Profit on sale of machinery 6,000
W1 Annual Depreciation = (Rs. 1,20,000 – Rs. 12,000)/9 years = Rs.12,000
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Answer to SEQ 3
Answer to SEQ 4
Answer to SEQ 5
Receivables account
Rs. Rs.
Balance b/d 10,000 Discount received 3,000
Credit sales 700,000 Payment received 600,000
Balance c/f 107,000
Total 710,000 710,000
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CHAPTER 2
Chapter Introduction
This chapter aims to provide you with an understanding of the life insurance
business. You will also learn about the different regulatory bodies and their
guidelines towards insurance investment and audit. The chapter also deals with
basic concepts related to life insurance business and particulars of different
insurance plans.
In the year 1956, an ordinance was issued by the Government of India for
nationalising the life insurance sector in India. Life Insurance Corporation (LIC)
came into existence in the same year, through the merger of 154 Indian insurers,
16 non-Indian insurers and 75 Provident Societies. LIC dominated the insurance
business in India till 1990s, when insurance sector was reopened for private
sector.
Over the years, life insurance products have become quite popular because apart
from regular savings, an individual gets additional benefit in the form of
substitution of financial loss to the family due to the individual’s untimely death.
Life insurance
Based on above definition, the main features of life insurance can be summed up
as follows:
Life insurance is a contract between two parties: the Insurer and the
Policyholder.
The entire life insurance contract is based on the occurrence of a certain event.
This event could be premature death of the life insured, disability due to sickness
or accident, loss of employment etc. The event against which the insurer provides
protection to the insured has to be clearly mentioned in the policy document.
Death of the life insured: In the event of the unexpected death of the life
insured, the insurance company will have to pay the sum assured (along with
other benefits) to the beneficiaries of the life insured.
Maturity of the policy: If the life insured survives the policy term, then on
maturity of the policy , either a lump sum payment or regular payment of a
certain amount at periodic intervals have to be made to the policyholder.
Specific date at periodic intervals: The policyholder can also choose to
receive a certain amount of money at periodic intervals.
The sum assured that the insurance company agrees to pay on the happening of a
certain event is predetermined, and its calculation is based on the age, lifestyle,
income, mortality risk etc. of the individual.
e) Premium payment
The policyholder has to pay a certain amount of money known as premium to the
insurer for availing life insurance cover of a certain amount. These premiums
have to be paid at periodic intervals - monthly, quarterly, or annually for a fixed
period.
Life Insurance is superior to other forms of saving since its advantages are in the
form of:
Protection,
Aid to thrift,
Protection against creditors,
Liquidity,
Tax relief,
Cash estate and
Money when you need it.
127
These advantages outweigh the ones available in other kinds of savings such as
Bank Deposits, Unit Trust of India, Public Provident Fund, and Post Office
Savings etc.
Unlike other savings plans, it provides full protection against the risk of death. In
cases of death, the full sum assured is made available under a Life Insurance
Policy whereas under other saving schemes, the total accumulated savings alone
will be available.
One important difference between Life Insurance and other forms of insurance is
with respect to the ‘term’ of insurance.
In other forms of insurance viz. Fire, Marine, Miscellaneous, etc. the contract is
for a short period, usually for one year, and is renewable at the end of that period.
As against this, in Life Insurance, it is usually for a long period extending over a
number of years as the contingency insured against (i.e. the hazard of death) is
bound to happen, the uncertainty only being as to when it will happen. The risk
of death increases further with the age of the life insured.
If, therefore, the life insurance contract were to run for one year only and were to
be renewable year after year by mutual consent, the insurer will have to reassess
the risk and charge a higher premium commensurate with the increased risk due
to higher age. Thus, as the need for life insurance would increase with age, so
would the cost; and the latter would become prohibitive at advanced ages when
the need for insurance would be the greatest. To overcome this difficulty, life
insurance contracts usually run for a long period and a uniform or level annual
premium is charged to cover an increasing risk.
In all contracts of insurance, the proposer is bound to make full disclosure of all
material facts and not merely those which he thinks material. Misrepresentation,
non-disclosure or fraud in any document leading to acceptance of the risk
automatically discharges the Insurer from all liabilities under the contract.
b) The Insurer has to accept the proposal mentioning the precise terms on which
the proposal has been accepted.
c) The proposer has to carry out the terms of the acceptance letter; only then the
policy can be issued.
The financial aspect of Life Insurance is based on the Actuarial Principles which
are the most important and complicated ones. We will discuss them in detail in
the following sessions.
129
Insurance has been described as the institution which eliminates risk and which
substitutes certainty for uncertainty.
a) Measurement of risk
Risk in life insurance refers to the unceratinity related to a certain event, which, if
occurred, might result into occurrence of loss.
In life insurance business, it is important for insurers to correctly predict the risk,
as it helps them in determining the cost of insurance. The greater the degree of
accuracy with which this can be done, the more scientific will be the basis of life
insurance.
If insurers correctly predict the number of insurance claims that they will have to
pay in the next year, then they can also correctly determine the cost of insurance.
According to the law of large numbers, the larger the group for the past data, the
more accurate will be the future estimate of losses.
Risk can be measured with the help of the Law of Averages, which operates only
when we are dealing with large numbers.
Insurance companies can gather data for past claims that have been paid over a
certain period, which can help them in making an estimate of the probability that
a person will die at a certain age. This concept can be further understood by way
of the following example:
130
Let us assume that 10,000 healthy male persons all aged 40 having similar
prospects of long life, form an association (pool) for sharing losses in case of
their premature deaths.
There is a small chance that any one of these may die during the next year; but if
he dies, the loss of his earning power might prove disastrous to his family or his
business.
As it is not easy to estimate the financial value of the loss, let us assume for
simplicity that a sum of Rs.5,000 will suffice to meet the business or family
needs of any one of them who happens to die.
This means, on an average 100 people would die out of an association of 10,000
people and in respect of each of these deaths; a sum of Rs.5000 will have to be
provided. The total claims to be paid during the following year will, therefore, be
Rs.5,00,000. When these are shared among the 10,000 members, each person
will have to pay a sum of Rs.50 on an average.
Thus, here an uncertain loss of Rs.5000 which would be suffered by a few has
been replaced by a certain payment of Rs.50 to be made by every member, the
payment representing the cost of one year’s life Insurance at age 40 for Rs.5,000.
In this way, the risk of loss is eliminated by payment, on the part of a large
number of people, of a definite amount by way of premium, which is arrived at
by the application of the Theory of Probability and the Law of Averages.
For this purpose, the risk is measured on the basis of past experience under the
assumption that, under similar conditions, the future experience will closely
approximate to the past experience.
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1.7 Premium
For life insurers, premium is the cost of insurance, and for policyholders, it is the
money that they have to pay to avail certain amount of insurance cover.
Insurance companies are basically concerned with recovering two kinds of cost:
Mortality charges and Expenses.
i) Mortality charges: mortality charges are the ones that are used for providing
death benefit cover to the insured. Mortality charges are based on age and the
risk associated with the life insured.
Insurance companies maintain mortality tables based on their past data, which are
used for determining premium to be charged for a life insured.
Mortality tables
Mortality tables are tables that consist of probability that a person would die
before his next birthday.
The mortality tables are based on the past data of insurance companies’
experience with insured lives.
Morbidity tables contain data on sickness rate of individuals. The Tables are also
based on the experience of the general population.
The tabular rates or premium of the LIC are calculated on quarterly basis for
Rupees One Thousand Sum Assured. Where the frequency of the payment of
premium is less or the sum assured under a policy is large, the expenses incurred
are comparatively low and accordingly, some rebates are allowed on the tabular
premium.
ii) Expenses: the various expenses that an insurance company might incur
during a policy term are: administrative expenses, salaries, expenses for
managing the policy etc. The insurance company has to ensure that the
premium collected should help them in meeting these expenses over the
years.
132
Interest: the yield obtained by investing the fund and the rate of interest assumed
in premium calculations occupy an important place in the financial aspect of a
life insurance contract.
The Insurer gets huge funds in his possession to be utilized for getting maximum
yield. Collective investment of these large amounts under the expert advice
rendered by finance and investment experts enables the Insurer to secure a much
better yield, considering the degree of security provided, than would be possible
for an individual to do.
The individual policy holder is saved the trouble, inconvenience and risk of loss
of capital involved if he himself was to undertake investment of small funds. At
the same time, he gets the benefits of the better yield earned by the Insurer in the
form of a higher interest rate assumed in premium calculation or larger bonuses
at the time of periodical valuations.
The premium rates will vary according to the rates of interest assumed in the
premium calculations; the higher the rate of interest assumed, the smaller the
premium rates work out to and vice versa.
i) Net premium: net premium is also known as ‘pure premium’. Net premium
includes :
expenses of management
the possibility that the rates of mortality assumed will not be experienced
in practice,
the possibility that the rates of interest earned will be less than those
assumed and the need for providing profits for the with-profits
policyholders
133
Net premium covers only probable losses that the company might have to incur
due to occurrence of a certain unfavourable death, such as death of a life insured.
To cover these items, the net premiums are loaded and the premiums with these
“loadings” are usually known as “office” premiums.
ii) Gross premium: gross premiums are also known as office premiums. This is
the premium amount which is communicated to the policyholder. This is
calculated by loading expenses in the net premium.
In level premium, the amount of premium remains the same over the entire
policy term.
In life insurance, the cost of life insurance increases with age of the insured, and
the challenge with the insurer is to determine the premium that should be charged
which enables them to meet different expenses that may arise during the policy
term.
As the premium remains the same over the entire policy term, a higher premium
amount is collected in the initial years to cover the cost of insurance. The balance
is accumulated to form a fund which could be drawn upon to meet a part of the
heavy cost of insurance cover during later years, when the premium actually
received would be insufficient to cover that cost of insurance.
Thus the uniform premium method and long term nature of life insurance
contract give rise to funds, which are not utilized immediately to pay claims.
They are however, placed to the credit of policy-holders as the Life insurance
Fund to meet future obligations and are invested by the insurer so as to yield the
maximum rate of interest consistent with optimum security.
134
While at the time of renewal, the expenses are much lighter and consist of
This incidence of expenses has a bearing on the surrender value allowed to the
policyholders, which is discussed later on.
The Central Government has made certain amendments in the Insurance Act
1938 through the IRDA Regulations in 2000 (which have become the first
schedule of the IRDA Act) and the Life Insurance Act 1956 (this has become the
2nd Schedule of the IRDA Act). This amended Act will be applicable to Life
Insurers.
1. Investments accounts
Over the years, IRDA has issued several regulations for the purpose of regulating
investment.
IRDA has also issued The Insurance Regulatory and Development Authority
(Preparation of Financial Statements and Auditor’s report of Insurance
companies) Regulation 2002, Authority, for the purpose of preparation of
financial statements, Management report and auditor’s report. Regulation has
been divided into the following parts:
137
2. Audit
As per section 12 of the Insurance Act 1938, all insurance companies must be
audited annually by the auditors. There are three types of audits: Statutory Audit,
Internal Audit and Concurrent Audit. Accounts of every insurance company shall
be audited by auditors who are duly qualified to act as auditors of companies.
a) Eligibility Condition
ii) The firm should have been established and should be in continuous practice
for a period of 15 years or more;
iii)
(a) It should have
(b) Alternatively,
iv) In both the cases mentioned in 3 (a) and 3(b) above, at least one partner or
paid Chartered Accountant of the firm should have CISA/ISA or any other
equivalent qualification
One audit firm would not be permitted to carry out more than two statutory audits
of insurance companies (Life/Nonlife/Reinsurer).
139
ii) One of the Joint Auditor may have a term of 5 years and the other 4 years in
the first instance. Thereafter, the maximum duration for which the auditor
could be retained would be for a period of 5 years.
iii) There will be a cooling period of two years. An audit firm which completes a
tenure of five/four years as the case may be, at the first instance, in respect of
an insurance company should not accept statutory audit assignment of that
Insurance company in the next two years. However, audit firm may accept
statutory audit of any other insurance company subject to the compliance of
maximum two statutory audits.
LIC has also to follow up above mentioned guidelines. However LIC has to
obtain approval of the central government as per section 25 of LIC Act. Central
Government will fix the remuneration of statutory auditors.
All private life insurance companies have to appoint internal auditors as per
companies Act. However LIC has to appoint Internal Auditors who are full time
employees of corporation to audit accounts of all offices of corporation as per
regulation 46 of LIC Regulations 1956.
A summary of the reports of the auditors shall be placed before the Executive
Committee as soon as possible after the close of each financial year.
In addition to above, each insurer will appoint concurrent auditor who will not be
Statutory or Internal Auditor of the company. Such concurrent auditor will do
investment audit. The auditor shall comment on such review and its impact on
the investment operations, systems and process in their report to be placed before
Board Audit Committee. Concurrent auditor should be Chartered Accountant and
well experienced
140
Section 2 (11) of the Insurance Act 1938 defines life Insurance business as “The
business of effecting contracts of insurance upon human life including any
contract whereby the payment of money is assured on death (except death by
accident only) or happening of a contingency dependent on human life and any
contract which is subject to payment of premium for a term dependent on human
life and shall be deemed to include:
The function of insurance is to provide for the pooling of risks among many
persons who are exposed to similar risks. The primary purpose of life insurance
is to provide financial assistance.
As per the Insurance Act 1938, a maximum of how many statutory audits can be
conducted by one audit firm for a certain life insurance company?
a) Whole life Policies: in whole life policies, the sum assured is paid on the
death of the insured and the insured has to pay the premiums throughout his
life.
Reserve is the amount the insurer must have in hand to meet the liability under
the policy that future premiums will not cover.
The life insurance fund is the sum of the reserve held on all the policies in the
books of an Insurer.
Each year, the life insurance fund is increased by the actual premiums received
and the interest earned on investments and is depleted by the actual claims paid
and expenses incurred.
144
The reserves created under the level premium system enable the insurer to pay
cash up to the amount of the reserve held under a policy in case an assured
desires to surrender all his rights under the policy. This cash value is known as
the surrender value of the policy.
Apart from expenses, a portion of the premiums paid has already been absorbed
by the cost of the life insurance cover given, for although a claim may not
actually have arisen under a particular policy, claims under other policies have
been paid and this has been possible by drawing upon the funds accumulated
under all the policies in the same class.
In practice, however, the surrender value payable is always less than the reserve
value. This is mainly due to two reasons:
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There is the possibility of adverse selection – the possibility that persons who
withdraw are in a better state of health and represent lesser risks than the average.
It is unlikely that any man who is in bad health and anticipates an early death
would voluntarily surrender his policy; on the contrary such a man would try his
utmost to keep the contract in force. Therefore, the effect of withdrawals is
generally to upset the mortality assumptions and affect adversely the rate of
mortality amongst the balance of the lives assured.
The heavy initial expenses which are spread over all the premiums receivable
need to be recovered. Due to this, generally it is possible to pay any surrender
value only if premiums for at least two complete years are received.
The paid-up value may be considered the deferred payment of the surrender
value and the surrender value as the discounted value of the paid-up amount.
The actual experience of the insurer may, and often does, differ from the basis
used in the scale of premiums. The margin which is normally provided in the
loadings is, under ordinary circumstances, sufficient to meet temporary
fluctuations.
The profit or loss of an Insurer depends upon whether the actual experience is
favourable or otherwise in comparison with the assumption made in the scale of
premiums. This can truly be determined only after the last policy has exited as a
claim.
In the meantime, an Insurer has always to be careful to see that whatever be the
future experience, he would be able to meet his financial obligation. In other
words, for the solvent functioning of an Insurer, the assets in the Life insurance
fund must at any time be adequate to meet the future liabilities under the policies
issued by him.
If the experience regarding mortality, interest and expenses does not exactly
conform to the initial assumptions, the reserves or policy liabilities calculated on
the assumptions made in the premiums may be found to be too small or too large.
The Insurers, therefore, have to form fresh estimates, at intervals specified either
by Government or by the Insurers themselves of the amount of policy liabilities
in the light of fresh and more up-to-date experience regarding the three basic
factors involved.
The mere sizes of the Insurer’s assets or the rate at which they are growing are no
indication of its financial strength. What actually matters is whether the size of
the assets is adequate to meet the liabilities. It is, therefore, necessary to estimate
from time to time the Insurer’s policy liabilities and to compare them with the
assets. This is the purpose of the actuarial valuation.
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1. The actuary determines the present value of the future premiums receivable.
2. The actuary determines the present value of future claims payable.
3. Calculate net liability. The difference between the present value of future
claims and the present value of future premiums is known as the net liability.
ii) If the Life Fund is more than the net liability, the difference is the surplus but
if the net liability is more, there is deficit. This is known as actuarial
valuation.
Valuation surplus can also arise as a result of ‘loadings’ made in ‘with profits’
polices for bonus additions.
It is from this surplus that the bonuses are distributed to “with profits”
policyholders.
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Out of the surplus, the actuary provides for various reserves and funds and the
balance is available for distribution (95% to the policyholders and 5% to the
Government on the initial capital of Rs. 5 crores contributed by the Government).
a) Cash Bonuses
b) Bonuses in reduction of premiums and
c) Reversionary Bonuses.
The first two types of bonuses are self-explanatory. The third type of bonus is the
bonus that is added to the sum assured and paid at the time of claim. Once a
policy becomes paid-up, it is not entitled to future bonuses.
A Sum assured
B Claim amount
C Premium
D Interest
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For better understanding and appreciation of these life insurance plans, passing
references are also made to some schemes of Life insurance under which
previous insurers had issued policies; such policies will require servicing for
some years in future.
This is the purest form of permanent contract. Whole life insurance provides a
larger amount of “life cover” than any other permanent type of life insurance and
it is, therefore, the most inexpensive form of permanent protection for
dependents.
This insurance provides for payment of the sum assured at death but the
premiums are limited to a predetermined maximum number and include single
payment insurance.
Under this type of policy, it can be arranged that premiums cease at retirement
age so that the difficulties of maintaining the premiums in old age are removed.
When the premiums cease, the policy becomes fully paid-up.
“With profits” policies continue to participate in profits till the claim arises even
though the premiums have ceased .
This is undoubtedly the most popular form of life insurance plan at the present
time. This type of policy is really a combination of life insurance and investment.
Under this class of contract, the sum assured is payable at the expiration of a
fixed term of years or at death, shall that occur previously.
This plan is an ideal combination of both family protection and the savings
elements and answers most of the problems of the insuring public, especially
persons with families. It provides cover for a family during the selected term,
normally corresponding to the active years of the bread winner in service or in
business. Its other advantage is the compulsion to save during working years, the
accumulated saving being available on retirement.
In the case of policies running for long term, the insurance element predominates
while in the case of insurance maturing at the end of comparatively shorter terms
the actual cost of the life insurance is very small the bulk of the premium being
required for the investment portion.
Under this plan, two lives are simultaneously insured and the sum assured is
payable on the expiry of the term or/on the death of one of the assured lives
during the endowment period.
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The premiums are payable throughout the endowment period or till the prior
death of either of the lives assured.
one payment of the sum assured is envisaged even though two lives are
insured;
two payments on two deaths are not contemplated as the first death will
determine the contract
Term insurance plan is the oldest form of insurance plan available in the market.
In term insurance the sum assured is payable only in the event of death of the
life assured occurring within a defined period, the insurance coming to an
end should the life assured survive that period.
The policies can be issued for any period from a few months to a number of
years.
Premiums are usually payable throughout the policy or till the prior death of
the life assured though sometimes they are limited to a shorter period or even
to a single payment.
It is pure life insurance without any element of investment and is thus the
cheapest form of life insurance cover.
This plan is essentially a whole life insurance with the option to convert after 5
years from commencement, into endowment insurance effective from inception.
This plan is suitable for a young man earning a modest income for the time being
but with good prospects of higher income after a short period. The objective is to
provide maximum insurance protection at minimum immediate cost and at the
same time to offer a flexible contract which can be altered to an endowment
insurance at the end of 5 years from the commencement of the policy by which
time it is expected that there would be a rise in his income which would enable
him to pay the larger premium payable after conversion.
If the conversion option is not exercised, the policy would continue as whole life
insurance plan.
The policy issued by the LIC under this plan is a limited payment life insurance
with premiums ceasing at age 70, in case the option is not exercised.
Section 6 of the Married Women’s Property Act ( MWP Act), 1874 provides that
“a policy of insurance effected by any married man on his own life, and
expressed on the face of it to be for the benefit of his wife or of his wife and
children or any of them, shall ensure and be deemed to be a trust for a benefit of
his wife or of wife and children or any of them, according to the interests so
expressed, and shall not, so long as any object of the trust remains, be subject to
the control of the husband, or to his creditors, or form part of his estate”.
A policy taken out under the Act is entirely different from a gift so far as the
incidence of Estate Duty is concerned.
The function of the trustees under the Act is to receive, on claim arising, the
policy moneys and carry out the object of the trust, subject to the prevailing rules
in respect of Estate Duty. Where the beneficiaries are all minors, the trustees will
hold the amount for the benefit of the minors.
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This plan is suitable for those who, besides providing for their old age and
family, need lump sum benefit at periodic intervals.
Under this plan the life assured is either the parent or the guardian. The sum
assured is payable only on the expiry of the selected term whether the life assured
is alive or dead.
The premiums are payable throughout the selected term or till the death of the
life assured should it occur earlier. This insurance can be utilised to provide for
the marriage of a daughter, or “start-in-life” capital amount for a son.
It is similar to the fixed term (marriage) Endowment; the difference being that
instead of paying the benefit in a lump-sum, the benefit or the sum assured is
payable in half-yearly installments for 5 years.
Both these plans are issued by the LIC under “without profits” scheme only.
They can be “with profits” also and such policies have been taken over by the
LIC. In case of death of the child another child can be substituted to receive the
policy benefits.
Form of insurance has as its object the provision of future life insurance for the
child at a substantially lower rate of premium. Here the child is the life assured,
the parent or guardian being the proposer. The following points should be noted:
1. The actual life insurance commences at age 18 to 22; the contract being a
form of pure endowment in the meantime, i.e. during the deferment period
involving no death risk.
2. The contract is affected by the parent, but the intention is that it should be
vested in the child on his attaining a selected age between 18 and 22.
3. If the child dies before the vesting age, the premiums are returned without
interest.
4. By payment of an additional premium during the deferment period, the
proposer (parent) can secure the benefit of cessation of premiums from the
date of his death to the end of the deferment period. Of course, medical
examination of the proposer will be necessary in such a case.
5. In case of death of the Proposer (parent) unless No. (iv) above is applicable
premium must be continued by someone else till the Deferred Date.
6. There is a cash option available at the vesting age should the policy be
discontinued.
7. After the vesting age, the insurance s may be under limited payment life or
endowment insurance plan
8. No evidence of health is required at the vesting age; this ensures that life
insurance cover can be obtained whatever the state of health of the child may
then be.
9. Medical Examination of the child is required if the deferment period is less
than 10 years.
10. The life insurance cover available at the vesting age will be at a very low
rate of premium.
11. During the deferment period the control over the policy is exercised by the
Proposer (parent).
12. It is obligatory on the life assured (child) to adopt the policy in writing after
attaining majority but before the Deferred Date. On such adoption, the policy
will be deemed to be a contract between the insurer and the life assured
(child) as the absolute owner.
13. Loans are not granted during the deferment period.
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14. The policy participates in profits only from the deferred date.
15. One contract is issued to cover both the stages of the policy viz. the first
stage from the date of commencement of the policy to the deferred date
and the second stage from the deferred date to the date of claim.
There are various types of annuity, dependent upon the duration of life or
otherwise and these are discussed below.
a) Annuity certain
In return for the purchase price, periodical payments of a specified amount are
made during the subsequent life time of an annuitant. Such a contract can be
looked upon as just the opposite of a whole life insurance which provides a
capital sum on the death of the life assured in consideration of payments of
premiums during his lifetime.
Under the immediate life annuity the payments depend on the continued
existence of the annuitant; and it is not necessary for evidence of the state of
health of the annuitant to be obtained.
c) Guranteed annuity
i) The annuity may continue for fixed number of years whether the annuitant is
alive or dead. If he survives the period, payments continue thereafter until
death. Such annuities are issued by the Corporation.
ii) If the whole of the purchase price has not been paid out in the annuity
payments at the date of the annuitant’s death the balance of such purchase
money will be returned in one lump sum or by installments.
d) Deferred annuity
A deferred annuity is one in which the annuity payments start after a fixed
number of years and then continue in the same manner as under immediate life
annuity or guaranteed annuity. The consideration is either a lump sum payment
in the beginning or yearly (half-yearly, quarterly or monthly) premiums during
the deferment period. At the end of the period of deferment, a cash option can be
taken in lieu of the annuity. In the event of death of the annuitant before the
annuity commences the premiums are returned without interest.
Jeevan Akshay
This is an immediate annuity policy (with profits), where under, in return for a
lump sum consideration called purchase price, the proposer will have the option
to secure either –
i) a full pension, starting from the next month after payment of consideration
and lasting till an annuitant survives. The guaranteed Insurance sum (GIS)
together with Bonus is paid to the beneficiary on the death of an annuitant.
ii) a reduced pension with a survival benefit of 30% of the guaranteed insurance
sum at the end of 7 years from the commencement of the policy and return of
the guaranteed insurance sum along with bonus as reduced by survival
benefit, on death of an annuitant. The same pension amount will continue
even after payment of the survival benefit.
Jeevan Dhara
This is a with profit deferred annuity plan which provides monthly pension after
the vesting date during the life time of an annuitant and also allows for return of a
lump sum called Guaranteed Insurance Value Element (GIVE) along with a
terminal bonus on death.
Accounting procedure in the insurance industry is different for each kind of plan.
Hence policy holders get benefit of Investment as well as Insurance plan. Salient
features of this product are as follows
1. This plan is two in one i.e. it contains both Life Insurance and Investment
2. Generally, this plan is for longer period say for 10 to 15 yrs.
3. It has 5 year lock in period.
4. This plan gives multiple choices to policy holders in terms of return such as
growth, Balance, debt or gilt plan which gives varied return as per risk
appetite
5. Premium payment may be yearly, half yearly, quarterly or monthly.
Policyholders have a choice to make lump sum payment which is called
Single Premium.
6. Investment of ULIP is kept separate from other investment of Life Insurance
Plan.
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11. Insurer does not carry any risk of market fluctuation. The loss or profit on the
investment has to be borne by the policyholder.
IRDA has allowed the insurance companies to issue unit linked Pension Plan,
where most of the features resemble the unit linked plan.
i) In unit linked pension plan, at the time of maturity, NAV of outstanding units
are converted into corpus for the purchase of Annuity, so that Annuity
payment can be made out of corpus.
ii) 1/3rd of corpus can be commuted by the insured.
iii) Unit linked pension plan may or may not have life cover.
b) Premium is directly linked to the sum assured. However, this plan will not
have level premium and will increase with the age of the insured.
c) Health Plan is for making payment in case of treatment of critical illness and
Hospitalization. Under Mediclaim, reimbursement is restricted to expenditure
incurred by the policy holder irrespective of S.A (however, subject to
maximum of SA). A Health Insurance Plan payment is linked to the sum
assured irrespective of the expenditure incurred by the policyholder.
Premium can be paid yearly, half yearly, quarterly and monthly.
Summary
In India, Life insurance business commenced in 1818, with the establishment
of Oriental life insurance company in Calcutta.
Life insurance is a contract between an insurer and a policyholder, in which
the insurer promises to pay a certain amount of predetermined money to the
insured or his beneficiary, if a certain event occurs.
One important difference between Life Insurance and other forms of
insurance is with respect to the ‘term’ of insurance.
A contract of insurance is a contract of ‘utmost good faith’. The proposer,
who is one of the parties to the contract, is presumed to have means of
knowledge, which are not accessible to the insurer, who is the other party to
the contract.
In life insurance business, it is important for insurers to correctly predict the
risk, as it helps them in determining the cost of insurance. The greater the
degree of accuracy with which this can be done, the more scientific will be
the basis of life insurance.
Risk can be measured with the help of the Law of Averages which operates
only when we are dealing with large numbers.
For life insurers, premium is the cost of insurance, and for policyholders, it is
the money that they have to pay to avail certain amount of insurance cover.
The mortality tables are based on the past data of the insurance companies’
experience with the insured.
Net premium is also known as ‘pure premium’. Net premium includes:
mortality charges and interest.
Gross premiums are also known as office premiums. This is the premium
which is communicated to the policyholder. This is calculated by loading
expenses in the net premium.
In level premium, the amount of premium remains the same over the entire
policy term.
The Government of India constituted an Authority called the Insurance
Regulatory & Development Authority (IRDA) under the Insurance
Regulatory and Development Authority Act, 1999 (IRDA Act) to regulate
insurance business of the life insurers, non-life insurers and reinsurers. IRDA
regulates both government as well as private insurers.
As per section 12 of the Insurance Act 1938, all insurance companies must be
audited annually by the auditors. There are three types of audits: Statutory
Audit, Internal Audit and Concurrent Audit.
Accounts of every insurance company shall be audited by auditors who are
duly qualified to act as auditors of companies.
Reserve is the amount the insurer must have in hand to meet the liability
under the policy that future premiums will not cover.
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Answer to TY 2
The correct answer is B.
As per the Insurance Act, 1938, one audit firm would not be permitted to carry
out more than two statutory audits of insurance companies.
Answer to TY 3
The correct answer is C.
Premium is considered to be the main source of income for insurance companies.
Answer to TY 4
The correct answer is B.
In term insurance plan, the sum assured is payable only in the event of death of
the life assured occurring within a defined period.
Self-Examination Questions
Question 1
Which of the following is taken into account while calculating Net premium?
A Mortality charges
B Expenses of management
C Possibility that the rates of mortality assumed will not be experienced in
practice
D Possibility that the rates of interest earned will be less than those assumed
and the need for providing profits for the with-profits policyholders
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Question 2
Question 3
Question 4
is a periodical payment made, in exchange for purchase money
(capital payment), for the remainder of the life time of a named life or for a
specified period, irrespective of the duration of human life.
A Insurance
B Premium
C Annuity
D Claim
Question 5
Which of the following is also known as pure premium?
A Gross premium
B Net premium
C Office premium
D Level premium
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Mortality charges are taken into account while calculating Net premium.
Answer to SEQ 2
The Auditing firm should have been established and should have been in
continuous practice for a period of 15 years or more.
Answer to SEQ 3
Answer to SEQ 4
Answer to SEQ 5
CHAPTER 3
Chapter Introduction
This chapter aims to provide you with an understanding of the life insurance
accounting process for premiums received by insurance companies with respect
to different policies. You will also learn about the different types of books of
accounts that are maintained by insurance companies for reconciliation,
classification and posting to control accounts. In addition, this chapter discusses
the accounting process for premium received by insurance companies for ULIPs.
Risk will commence immediately in case of payment of cash. In all other cases,
the risk commences only after the receipt of premium by the insurer.
It is important to understand the difference between first premium and first year
premium as the Insurance Act allows higher allowance for expenses of
management for first premiums and first year’s premiums.
First premium
First year’s premium is the premium relating to the first year of the policy,
including the first installment.
Rahul Vyas is a 30 year old individual who has purchased an insurance plan on
6th June 2010. He has chosen to pay Rs 1500 per month for paying the premium.
Hence, his first premium will be equal to his first instalment of Rs 1500, whereas
his first year’s premium will be equal to the sum total of all the premiums that he
will pay monthly in his first year, including his first instalment.
Renewal premium
Premiums paid in subsequent years during the policy term are known as renewal
premiums.
a) Single Premium
In single premium life insurance plans, the policyholder has to pay a single lump
sum amount as premium to the insurance company and gets a life insurance
cover for his whole life.
Policyholder does not have to worry about arranging the funds for paying
premium every year.
Policyholders who do not have a regular source of income can choose single
premium option, if they have a lump sum amount available with them.
Policyholder does not have to remember due dates for premium payment
every year.
The advantage to insurance company is that it gets an upfront payment at the
time of accepting the risk.
“Jeevan Vriddhi” is a single premium non linked insurance plan that has been
recently launched by LIC in the market. Main features of this policy are:
The plan will provide risk cover of 5 times the premium that will be paid to
the policyholder.
Loan on policy can be taken after one year.
Policy term is fixed for 10 years.
Minimum age of entry is 8 years.
Minimum sum assured is Rs 1,50,000.
Minimum premium under the policy is Rs 30,000 (increases in multiples of
Rs 1000).
In case the life insured dies during the policy term, the basic sum assured ( 5
times the single premium paid, excluding extra premium , if any) will be paid
to his nominees or beneficiaries.
In Salary Savings Scheme or SSS, policies are group insurance plans in which
the insurance company signs a contract with the employer for providing
insurance to its employees.
In this scheme, the employer deducts the premium from the employee’s salary
and passes it on to the insurance company.
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Employer has to ensure that the employee signs an authority letter to the
employer, which authorises him to deduct a certain amount from his salary
towards payment of the premium.
Premium is calculated on a yearly basis and the figure is then divided by 12
to arrive at the amount that will be deducted monthly from the employee’s
salary.
The advantage of this scheme to the insurance company is that it is able to
cover a large number of individuals as a group for providing insurance cover.
Also, as the premiums are being paid by the employer, chances of a policy
lapsing is low.
Advantage to policyholder in SSS is that he can avail hassle free insurance
cover and does not have to remember premium due dates.
As discussed above, the first year premium includes all the installments that will
be collected in the first year from the policyholder/proposer.
Insurance agents generally collect an advance deposit from the proposers along
with the proposal form which is equivalent to the first installment premium.
This advance deposit has to be submitted by the insurance agent at the insurance
company office along with the proposal form.
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Once the underwriter decides to accept the risk, the insurance company then
forwards a letter of acceptance to the proposer along with the details of the
premium amount that he needs to deposit to the insurance company within a
specific period.
These advance deposists are kept in the Proposal Deposit Account /Suspense
account till the underwriter takes a deciosn regarding accpetance or rejection of
the risk.
Once the underwriter decides to accept the proposal, this deposit is then taken out
of the suspense account and credited to premium account.
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Date Amount
Cash or Bank A/c Dr.
To Proposal Deposit A/c
(Being record amount received towards proposal
deposit)
3. Is the deposit amount equal to the first premium that needs to be paid by
the proposer?
The deposit amounts collected may either be in excess of the required first
premium or less than the required first premium.
i) Deposit amount is less than the required premium
If the amount falls short of Re 1 the shortfall is not collected from the
policyholder but debited to Short Remittance Account.
Cash Book/Adjustment Book entries will be as follows
Date Amount
Proposal Deposit A/c Dr.
Short Remittances Account Dr.
To First Premium A/c
(Being record amount adjusted towards first premiums
by debiting proposal deposit and shortfall to Short
Remittance)
If the shortfall is more than the permissible limits of Short Remittance, the
balance amount is collected from the proposer and credited to proposal
deposit.
Cash Book/Adjustment Book entries will be as follows:
Date Amount
Cash or Bank A/c Dr.
To Proposal Deposit A/c
(Being record amount received towards proposal
deposit)
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The two deposit amounts (the advance deposit collected earlier and the shortfall
amount) are then linked and adjusted towards first premium by debiting proposal
deposit.
ii) Deposit amount is more than required premium
If the excess of proposal deposit is up to Rs 10, it is credited to “Short
Remittance Account”.
Cash Book/Adjustment Book entries will be as follows:
Date Amount
Proposal Deposit A/c Dr.
To First Premium A/c
To Short Remittance A/c
(To record amount adjusted towards first premium and
crediting the excess to short remittance)
Date Amount
Cash/Bank A/c. Dr.
To Policy Deposit A/c.
(Being record amount kept in policy deposit)
b) On receipt of the late fees or balance premiums, the policy deposit is adjusted
towards premiums.
Date Amount
Policy Deposit A/c. Dr.
To Renewal Premium A/c.
To Interest on Premiums A/c
(Being record amounts adjusted from policy deposit
towards renewal premium and late fees).
Where, however, the premiums are short, an entry is passed debiting “X”
charge on premiums and crediting premiums as follows for the purpose of
premium control.
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Date Amount
Cash / Bank A/c. Dr.
“X” charge on Premiums A/c. Dr.
To Renewal Premium A/c.
(Being record adjustment of short premiums by
debiting “X” charge account).
When an “X” charge is created under a policy, it must be recovered from the
first available payment made to a policyholder, such as Loan, Survival
Benefit, Surrender Value, Claim, Refund of Deposit or Refund of Premium
due to any reason.
Date Amount
Cash / Bank A/c. Dr.
To Discounted value of premium deposits A/c.
(Being record discounted value of premium deposits)
Interest will be added to these deposits annually and, as and when premiums fall
due, they will be adjusted from the discounted value of premium deposits.
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Date Amount
Interest Sundries A/c. Dr.
To Discounted value of premium deposits A/c.
(Being record interest due on discounted value of
premium deposits).
Date Amount
Discounted value of Premium Deposits A/c.
Dr.
To Renewal Premium A/c.
(Being record premiums appropriated on due dates
from Discounted value of premium Deposits).
In case the proposal is rejected by underwriters due to high risk associated with
the life insured, the advance deposit needs to be refunded to the proposer.
Date Amount
Proposal Deposit A/c. Dr.
To Cash/Bank A/c.
(Being refund of proposal deposit when proposal is
declined).
Date Amount
Cash/Bank A/c. Dr.
To Renewal Premium A/c.
(Being record amount received towards Renewal
Premium).
In case where the deposits received are in excess of the permissible “Short
Remittance” limits after adjustment, they are refunded to proponents.
If the proposal is declined then also the entire amount of proposal deposit is
refunded.
The proposal deposit towards Single Premium is credited to Single Premium A/c
by debiting Proposal Deposit A/c as shown below. Lump sum premium received
under any plan other than Annuity is credited to ‘Single Premium’ (S.P.).
Date Amount
Proposal Deposit A/c. Dr.
To Single Premium A/c.
(Being record adjustment of proposal deposit towards
Single Premium)
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Date Amount
Proposal Deposit A/c. Dr.
To Consideration for Annuities Granted A/c.
(Being record adjustment of proposal deposit towards
Consideration for Annuities Granted)
Date Amount
Cash/Bank A/c. Dr.
To SSS Collection A/c.
(Being record amounts received from paying
authorities).
Subsequently, the software program gives the break-up of “Other First Year” and
“Renewal Premium”.
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Date Amount
SSS Collection A/c. Dr.
To “Other First Year Premium” A/c.
To “Renewal Premium”.
To SSS Deposits (Policy),
(Being record appropriation of SSS collection to
“Other First Year” and Renewal Premiums and
Deposit).
Proposal Deposits which are outstanding for two years and more and Policy
Deposits which are outstanding for four years and more from the date of
collection, as at 31 st March are written back to Revenue Account.
Date Amount
Proposal Deposit Dr.
To old Outstanding and Unclaimed Deposits
Written Back Account
(Being the entry for writing back old and outstanding
deposits)
Cash Book / Adjustment Book entry for policy deposist will be as follows
Date Amount
Policy Deposit Dr.
To old Outstanding and Unclaimed Deposits
Written Back Account
(Being the entry for writing back old and outstanding
deposits)
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All deposits written back must be listed with full particulars in the prescribed
Registers/Schedules to be maintained for this purpose. Whenever a policyholder
claims these deposits after they are written back, the amounts can be
adjusted/refunded to the party after due and proper examination and after
checking the genuineness of the party’s claim. A counter remark is to be taken
against the original credit entry in the Register / Schedule to avoid duplicate
payment / adjustment.
Date Amount
Old outstanding and Unclaimed Deposits
Written back paid during the year Account
Dr.
To Bank Account
(First Year or Other First Year or Renewal Premium)
Date Amount
Old outstanding and Unclaimed Deposits
Written back paid during the year Account Dr.
To Premium etc. Account
(First Year or Other First Year or Renewal Premium)
a) Reinsurance ceded
The difference between limit of issue and limit of retention will be ceded to the
reinsurance companies. When reinsurance is ceded, premiums will be debited
and Bank account will be credited.
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Date Amount
Reinsurance Premium Ceded – First Year A/c Dr.
Reinsurance Premium Ceded – Renewal Premium A/c.
Dr.
To Bank A/c.
(Being record insurance premiums ceded)
b) Reinsurance accepted
When the company accepts reinsurance from other Life Insurance Companies,
the reinsurance premiums are received by the company.
Date Amount
Bank Account Dr.
To Premium on Reinsurance Accepted – First Year
A/c
To Premium on Reinsurance Accepted – Renewal
A/c.
(Being record reinsurance premiums accepted)
During the financial year, premiums are accounted for on cash basis. At the end
of the financial year, the outstanding premiums are provided for in the accounts
for Revenue Account and Balance Sheet purposes.
184
Premiums which have fallen due on policies but have not been paid, the days of
grace for payment which have not expired and the earlier premiums not in arrears
are treated as outstanding premiums.
Under the Insurance Act, two methods are allowed for provision of outstanding
premiums.
a) Method 1: the total outstanding premiums are set out above without
deduction of commission (commission shown as expense).
Date Amount
Outstanding Premiums – First Year
Dr.
Outstanding Premiums – Renewal
Dr.
To First Years' Premium
To Renewal Premium
(Being record outstanding premiums of first year and
renewal)
b) Method 2: On a net basis under which the outstanding Premiums less the
Commission payable on the outstanding premium are provided.
Date Amount
First year Commission Dr.
Renewal Commission Dr.
To outstanding Commission (First Year)
To outstanding Commission (Renewal)
(Being record outstanding commission on outstanding
premium)
In this case, Premium Account or Deposit Account will be debited and Bank
Account will be credited.
Date Amount
First Premium A/c. Dr.
Or
Other First Year Premium A/c. Dr.
Or
Renewal Premium A/c. Dr.
Or
Proposal Deposit A/c. Dr.
Or
Policy Deposit A/c. Dr.
To Bank A/c.
(To record dishonour of cheque).
In which of the following accounts does the insurance company record the
advance deposits received by the proposer for the purchase of the policy?
b) Register of claims
2. Subsidiary books
The insurance company receives a deposit either for a new proposal or towards
the existing policy. These deposits can be received by the insurance company via
different modes of payment such as cash, cheque, demand draft, pay order etc.
The insurance company has to maintain a record of all such deposits received on
a daily basis in a deposit cash book.
188
Following is the list of deposits that a branch office of ABC insurance company
has received in a day.
Accounting entries for Deposit cash book for above entries will be as follows
The following adjustments for the Deposit have been made in the Branch office
of ABC insurance company in a day.
S. No BOC No.
1 Rs.400/- paid towards 350/- Renewal Premium, 50/- 12345914
interest on premium Pol.No.06135790
2 Rs.510/- paid towards loan under policy No.07890124 11355914
3 Rs.1,100/- paid towards loan (Rs.1000/-) + Loan Interest 10489914
(Rs.100/-) Policy No.07090345
The main source of income for an insurance company is premium. Apart from
premium, an insurance company also recieves income from repayment of loan
interest, agent’s license fee, via sales of diaries, calenders etc.
The insurance company has to maintain a record of all such reciepts of income in
Premium etc cash book on a daily basis.
190
The following collections have been made at the Branch office of ABC
insurance company in a day.
v 01579357 STU 95 95
vi 6581912 TUV 15 15
(Ag. Code)
vii - WZY 250 250
560 1665 5 200 655 15 1000 95 265
192
In Branch Offices, there are two Cash Paid Books that have to be maintained:
(For illustration purpose all entries are recorded in one Branch cash paid Book
The following are some of the payments made at Branch Office 916 of Life
Insurance Corporation of India, on day : 31-12-2010
Which of the following will not be recorded in the premium etc. cash book?
ULIPs are market linked insurance plans, in which policyholders are alloted units
on the basis of their premium, and NAV is declared on a daily
basis.
Generally, outstation cheques are realised late and usually, banks levy collection
charges. For the insurers, it becomes very difficult to know when a cheque has
been realized. Hence, insurers avoid Outstation Cheques / Drafts.
195
In case of ULIPs, the insurance company has to record the following entries.
1. On receipt of cash/cheque
Date Amount
Bank Account Dr.
To Premium Deposit (Proposal) / Application Money.
Submission of application money does not implicate that the insurance company
will provide insurance cover to the proposer. Once the application form is
received by the insurance company, the underwriter assesses the risk and then
takes the decision regarding acceptance/rejection of risk.
If the underwriter decides to accept the risk, then a letter is sent to the proposer
along with details of the premium amount that he needs to submit within the
stipulated period.
Once the insurance company receives the first premium/single premium, the
following entry will be recorded:
Date Amount
Premium Deposit (Proposal) / Application Money Dr.
To First Premium Received
To Single Premium Receipt
196
Date Amount
Bank A/c Dr.
To First Year Premium / Renewal Premium
2. Allocation of premium
Date Amount
Premium Allocation Charges Dr
To Mortality Charges
To Accident Benefit Charges
To Policy Administration Charges
To Service Tax on risk cover
To Education cess on service tax on risk covers
In case of health insurance, the below mentioned charges will be recovered every
month by cancelling the unit (This entry will substitute the above mentioned
entry).
Hospital cash benefit and major surgical benefit shall depend upon the individual
age near birthday of each of the members covered as at the policy anniversary.
Furthermore, the charges will also depend on whether the person covered is
standard or Non-Standard life as per the underwriting decision.
Date Amount
Premium Allocation Charges Dr.
Repurchase of unit capital account for recovery of charges
Dr.
Repurchase of unit capital premium account for recovery
of charges Dr.
(If NAV is more than Face value charges)
To Repurchase of unit Capital Premium account for
recovery of charges
(If NAV is less than face value)
To Hospital Cash benefit charges
To Major Surgical benefit charges
To Policy Administration charges
To Service Tax and Education cess on Service Tax on
health cover
198
Dishonour of cheques
Date Amount
Proposal Deposit (Premium) / Application Money Dr.
To Bank A/c
When a proposal has resulted into a policy, and subsequently a cheque has
been dishonoured, the following entry will be passed
Date Amount
FYRP / Renewal Premium Received Dr.
To Bank A/c
Entry passed under the heading Allocation of Premium and Premium Allocation
charges will be reversed. To clarify, the following entry will be passed:
Date Amount
Unit Capital A/c Dr.
Unit Capital Premium A/c Dr.
(If NAV is more than Rs.10/ Face value)
To Unit Capital Premium A/c
(If NAV is less than Rs.10/ Face value)
Premium Allocation Charges Dr.
Sundry adjustment charges Dr.
In the case of ULIPs, if the cheque is dishonoured and the amount paid by the
proposer is still held as application money, then:
Summary
First premium represents the first instalment premium whether monthly,
quarterly, half-yearly or yearly.
First year’s premium are premiums relating to first year of the policy,
including the first instalment.
Premiums paid in subsequent years during the policy term are known as
renewal premiums.
In single premium life insurance plans, the policyholder has to pay a single
lump sum amount as premium to the insurance company and gets a life
insurance cover for his whole life.
In Salary Savings Scheme or SSS, policies are group insurance plans in
which, the insurance company signs a contract with the employer for
providing insurance to its employees.
Advance deposit is a minimum amount that needs to be paid by the proposer
along with the proposal form. This advance deposit has to be submitted by
the insurance agent at the insurance company office along with the proposal
form.
The advance deposits are recorded in the Proposal Deposit Account
/Suspense account till the underwriter takes the decision regarding
acceptance or rejection of the risk. Once the underwriter decides to accept
the proposal, this deposit is then taken out of suspense account and credited
to premium accounts.
During the financial year, premiums are accounted for on cash basis. At the
end of the financial year, the outstanding premiums are provided for in the
accounts for Revenue Account and Balance Sheet purposes.
Amounts appropriated towards premiums or deposits require reversal when
those amounts are received by cheques and the cheques are subsequently
dishonoured.
Insurance companies have to maintain two types of books: Statutory books
and Subsidiary books.
For reconciliation, classification and posting to control accounts, the
following primary books of accounts are used: Deposit Cash Book, Deposit
Adjustment Book, Premium etc. Cash Book, Cash Paid Book.
In Unit Linked Policies, policyholder can pay premium via Cash, Local
Cheques, Pay order or Draft Payable at par at the place where the premium is
received.
Insurance Companies don’t accept outstation cheques / outstation demand
drafts in the case of ULIPs, because in unit linked policies, NAV is given of
the same day if premium is collected before 3pm and if premium is collected
after 3pm; then NAV is given of the next day.
200
The insurance company records the advance deposits received by the proposer
for the purchase of the policy in either the proposal deposit account or the
suspense account.
Answer to TY 2
Amount of claims paid will not be recorded in the premium etc cash book.
Answer to TY 3
In the case of ULIPs, if the cheque is dishonoured and the amount paid by the
proposer is still held as application money, then the proposal deposit account will
be debited.
If the initial deposit amount paid by the proposer of the policy falls short of Re 1,
then the
Question 2
Which of the following entries will be recorded in the cash paid book?
A Management expenses
B Survival benefits
C Loans
D Surrenders
Question 3
A Unit capital
B Unit capital premium account
C Premium allocation charges
D Unit allocation charges
Question 4
In the case of ULIPs, which of the following will not be accepted by the
insurance companies for premium?
A Cash
B Local cheques
C Outstation cheques
D Pay order
If the initial deposit amount paid by the proposer of the policy falls short of Re 1,
then the shortfall is not collected and is debited to Short remittance account.
202
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
CHAPTER 4
ACCOUNTING PROCEDURES -
DISBURSEMENTS
Chapter Introduction
This chapter aims to provide you with an understanding of the accounting
process for loans that are taken against life insurance policies. You will also learn
about the accounting process for claim payments for life insurance policies,
ULIPs, Unit linked health policies and Unit linked pension plans.
One of the biggest advantage of buying life insurance policies , is that the
policyholder can avail loan against these policies, when need arises!
In Loan Against Policy ( LAP), , policyholder can apply for loan against his
insurance policy. The loan amount depends upon the surrender value of the life
insurance policy.
When a request for loan against insurance policy is received, the status of the
policy is reviewed by insurance comapny to ascertain that
the policy is in force and
that there is sufficient surrender value, which is acquired generally three
years after a policy is taken.
In case the total debt exceeds the surrender value of the policy, insurance
company can terminate the policy.
The policy holder is entitled to get additional loans subsequently, if the
increase in surrender value of the policy permits such additional loan.
If the insurance policy gets matured before the loan is repaid by policyholder,
then insurancec company can deduct the loan amount from maturity amount.
The total of loans disbursed and collections are posted to general ledger control
accounts.
Policy Loan ledger sheets must be prepared for every loan and would contain
following details:
the amount of loan disbursed interest due and paid and
policy loan repayments.
Loan against policies are shown as assets in the Balance Sheet of Insurance
Company. However, loans against policies are not handled by the Investment
Department even though these are in fact investments.
When a request for policy loan is received, the status of the policy must be
reviewed to ascertain that the policy is in force and that there is sufficient
surrender value, which is acquired generally three years after a policy is taken.
When loan is approved, unpaid due premiums are deducted from the loan and
balance is paid.
206
Policyholder has to to pay interest against the loan amount that has been taken
by him on time, other wise interest gets compounded.
Hence premiums are computed on the assumption that the reserves will be
continually invested at fixed rates of interest.
The due dates of interest payment are half yearly coinciding with the policy
anniversary. Broken period interest from the date of loan to the next half yearly
will be due if the loan is taken in between.
Policyholder can choose the repay the loan against policy during the policy term.
Foreclosure action is taken in case of lapsed policies ,where interest and loan
amount exceed the surrender value of the policy.
Lapsed policies
Lapsed policies under which policyholder has failed to pay premiums to keep it
in force.
Foreclosure action
Foreclosure action means surrendering the policy to recover loan and interest
dues.
In case the Surrender Value is more than the Policy loan amount and Interest
dues, the balance is refunded to the policyholder.
208
If policyholder does not claim the refund, the same is credited to ‘Surrender
Value Unclaimed A/c.’
Amounts lying for more than three years in ‘Surrender Value Unclaimed
A/c.’ are written back as at the year end to ‘Old Outstanding and Unclaimed
As at the close of the financial year, the outstanding and accrued interest due on
policy loans are brought into books by means of the following entries :
It should be remembered that these are only adjustment entries and would be
reversed during the next year.
A General journal
B General ledger control accounts
C Policy loan ledger sheets
D Bank account
210
Claims are policy benefits payable according to the terms of policy contract.
a) Death claims: Death claims are payments of the insured amount of the
policies in the event of the death of the policy holders together with bonus
additions in the case of with-profit policies.
Accounting entries for each type of claim payments, can be divided in 2 steps:
Accounting process
Under this method, as soon as a claim arises, the total amount payable less all
deductions i.e. policy loan, interest on policy loan, due premiums etc. is treated
as an outstanding claim.
212
Annuity payments
Surrender payments
There can be cases, where some claim payment remain outstanding for more than
a year due to various reasons such as
Such outstanding claims over five years or so are written back to revenue
account.
214
Accounting entries for such transactions are recorded at the end of the year
as follows:
The Claims Written Back are treated as income and shown in the revenue
account of Insurance Company. Whenever payments are made out of these
Written back amounts, such payments are made after noting down the particulars
in the record of such written back amounts.
these amounts are refunded after due and proper examination and after
confirming genuineness of the party claiming the amounts and after making a
remark in the Register / Schedule.
215
The Claim Account Codes for ordinary policies are different from the
Account Codes for Pension and Group Schemes.
While creating liability for net amount of claims payable, the heads of
Account which are credited are different from those which are debited while
making claim payment, or while taking writing back action or repudiating
claim.
At the year end, all debit entries for liquidation of claims under both account
heads are set off against credit entries passed at the time of creating liability
and the balance amount of outstanding claims is to be arrived at.
The balance amount of outstanding claims will be shown as liability in the
Balance Sheet, separately under Death / Maturity heads.
For ULIP policies, there is different procedure for claim payment as
discussed later on.
A Death claims
B Maturity claims
C Surrender value payments
D Annuity payments
216
Let us discuss accounting entries for each of these claim payments in case of
ULIP in detail.
217
a) Creation of liability
In case of death of the policyholder when the cover is in full force, the nominee/
legal heir shall be eligible to get – ‘higher of sum assured or the fund value of
the unit held in policyholder’s unit account as at the date of booking the
liability’.
In this case, claim payment will be made from unit fund. When the fund value of
the unit is higher than sum assured, no liability will be payable from the Non-
Unit Fund.
In this case, claim payment will be made from both unit fund and non-unit fund.
218
iii) There is excess of sum assured over the fund value of units as on the date
of booking liability.
Accounting entry will be as follows:
Date Particulars Amount Amount
Claims by death Dr
Claim by accidental Death Dr.
(If Death is due to accident and policyholder
has opted for accidental cover)
To Claim outstanding on death - Non Unit
Fund
To Claim outstanding on accidental death –
Non Unit Fund
b) Payment of claim
After receipt of papers (Discharge Form + Death Certificate + Policy Documents)
etc. from nominee / legal heir, payment will be made and following entry will be
recorded.
a) Creation of liability
It is important to note that on maturity, no claim payment will be made from non-
unit fund (Insurance Amount)
b) Payment of claim
Once, Insurance Company receives all the papers (discharge form and policy
bond) from policyholder, payment will be made to policyholder.
Policyholder can surrender his policy after 5years under ULIP Plans. If a
policyholder surrenders his policy, policy cannot be reinstated.
220
a) Creation of liability
If the policyholder chooses to surrender the policy after 5 years, then following
accounting entry will be recorded:
If the policy holder wants to discontinue his policy before completion of 5yrs of
policy, be can discontinue his policy, but no amount be payable before
completion of 5yrs.
Also, no charges shall be recovered thereafter by canceling the policyholder’s
units. The payment will be made only after 5yrs from the date of commencement
of the policy at NAV as on the date of application of surrender.
Accounting entry will be as follows:
Date Particulars Amount Amount
Repurchase of unit capital account Dr.
Repurchase of unit capital premium account Dr.
(If NAV is more than Rs.10/- Face Value)
To Repurchase of unit capital premium
account .
(If NAV is less than Rs.10/-Face Value)
ToDiscontinued charges
To Deferred Surrender Value A/c
221
Policyholder if wish can withdraw his units in parts after completion of 5yrs.
Following entry shall be passed on partial withdrawal.
As discussed above, payment will be made only after completion of 5 years the
date of commencement of the policy at NAV as on the date of application of
surrender.
In which of the following cases, will the death claim payment be made from unit
fund only and non –unit fund will not be touched?
b) Claim payment
Once insurance company receives all the relevant papers from nominee / legal
heir, it releases the claim amount (fund value).
b) Claim payment: once insurance company receives all the relevant papers
from nominee / legal heir, it releases the claim amount.
a) ICU hospitalisation
Claim payment- Accounting entry in case of ICU hospitalisation benefit and non
-ICU benefit will remain same.
Creation of liability: Insurance companies also provide benefit for some major
surgeries in case of Unit linked hospitalisation benefits.
226
Claim payment
Claim payment
Claim payment process in case of unit linked pension plans is also different as
compared to other unit linked policies, due to the different features associated
with the pension plan.
228
The purpose of pension plan is to provide long term benefit (annuity) after
maturity (deferment period) of policy.
In pension plan, insurance company does not provide a lump sum
payment to policyholder as it does in case of other policies. However, in
some cases option is given to policyholders to commute 1/3 rd of his fund at
the end of deferment period (maturity).
It should be noted that pension plans cannot be surrendered.
Since Pension plan is socially oriented plan, hence to protect policyholder’s
interest and corpus in case of deficiency, policyholders are paid Guaranteed
Maturity Value.
Claim payment
IRDA allows policyholders to opt for annuity from other insurance companies. In
such case the, existing insurance companies will issue cheque in the name of
other insurance company.
If the policyholder chooses to continue with the same insurance company for
annuity, then accounting entry will be as follows:
If policyholder chooses to continue with LIC for his annuity, then accounting
entry will be
Creation of liability
Claim payment
Creation of liability
Claim payment
Creation of liability
Claim payment
In this insurance company will have to make payment for commutation and for
payment of annuity.
5.2 Accounting entry for claim payment in case of death of life insured
before vesting
In case of death of the policyholder, the Policyholder’s Fund Value as at the date
of booking the liability shall be payable to the nominee. It is optional for the
nominee either to take the benefit
a) in lump sum
b) in form of annuity
c) Partially as lump sum and balance as annuity.
Creation of liability
234
Claim payment
Transfer of liability
In this case, liability will be created by transferring it to a lump sum amount and
annuity.
Claim payment
Note - Readers may note that above mentioned accounting treatment has been
given for simple unit linked policies (Insurance / Pension / Health), because now
insurers are issuing these products along with riders for which there can be
different accounting treatment.
Section 14(6) of Insurance Act states that every insurer shall maintain a register
or record of claims in which shall be entered
every claim made together with the date of claim and name and address of
the claimant and
the date on which the claim was discharged or
In case of a claim which is repudiated the date of repudiation and grounds
thereof.
Performa of claims intimation registers both for maturity and death claims and
surrenders are as follows
236
CREDIT ACCOUNTS
Reduction LOAN Other Accoun Total Net Admitt Initial Payme Cheque No. REM
in Sum Accoun t Amoun ed s of nt Date and ARKS
Assured ts Code t Rejecte Asst / passed Bank on
(State Princip Interest Payable d Sup by. which
reason in al With Per. drawn
Remarks Date
Col.) and
Ground
for
Rejecti
on
b) Register of Surrenders
MONTH……………
Sr. Policy D.O.C. Sum Table Surren Other Ac Total
No. Number Date of assured der Accou co
Initials of Lapse Term value nts un
Life Due Premium includi t
Assured month installme Mode ng Co
of first nt cash de Rs. Ps.
unpaid value
premiu Rs. P. of
m bonus
Rs.Ps.
………………….
………………….
Month…………..
DEDUCTIONS PAYMENTS
Pol Int on Due Other Acco Net Initial Initial Che
icy Pol.L Month Accou unt Amt s of of que Rem
Lo oan of int. nts Code Rs. P. Asst / Comp No. arks.
an. Install S.H. etent Dat
ment Author e
ity
A ULIP
B Unit linked health policies
C Unit linked pension plans
D Endowment plans
241
Summary
In Loan Against Policy (LAP), policyholder can apply for loan against his
insurance policy. The loan amount depends upon the surrender value of the
life insurance policy.
When an insurance company provides loan to policyholder against his
insurance policy, policy needs to be ‘absolutely assigned’ to the insurance
company as a security for repayment of the loan.
The total of loans disbursed and collections are posted to general ledger
control accounts.
Policy Loan ledger sheets must be prepared for every loan and would contain
following details: the amount of loan disbursed interest due and paid and
policy loan repayments.
Death claims are payments of the insured amount of the policies in the event
of the death of the policy holders together with bonus additions in the case of
with-profit policies
Maturity claims are payments made to the surviving policyholders on the
expiry of the terms of the policies, together with bonus in case of with profits
policies.
The policyholder may terminate the policy during its currency and claim cash
surrender value of the policy. These payments are known as surrenders.
Under single premium immediate annuity, the annuity payments begin
immediately, whereas Under deferred plans the annuity payments are
deferred to future date.
In case of death claim, as soon as insurance company recieves notice of life
death of life insured, it is customary to treat the policy amount as a claim and
enter it in the death claims intimation register
In the case of maturity and annuity claims Insurance Company will initiate
the transaction by sending claim discharge forms.
Outstanding claims over five years or so are written back to revenue account.
The Claims Written Back are treated as income and shown in the revenue
account of Insurance Company
In case of death of the policyholder when the cover is in full force, the
nominee/ legal heir shall be eligible to get – ‘higher of sum assured or the
fund value of the unit held in policyholder’s unit account as at the date of
booking the liability’.
In case of unit liked health policy no sum assured is payable to the nominee
or legal heir by insurance company. However, fund value has been paid to
nominee / legal heir by insurance company in case of death before maturity.
The purpose of pension plan is to provide long term benefit (annuity) after
maturity (deferment period) of policy.
242
Answer to TY 2
Maturity claims are payments made to the surviving policyholders on the expiry
of the terms of the policies.
Answer to TY 3
If Fund value of units is higher than sum assured the death claim payment will be
made only from unit fund only and non –unit fund will not be touched
Answer to TY 4
Answer to TY 5
Question 2
What would happen to such claim payment that remains outstanding for more 5
years?
Question 3
In case of death claim payment, if sum assured value is higher than fund value of
units, then claim payment will be made from .
A Only unit funds
B Only non-unit funds
C Either unit funds or non-unit funds
D Both unit and non-unit funds
Question 4
Which of the following is true for Unit linked health policies?
A In case of death of life assured before maturity, no sum assured is payable to
the nominee or legal heir by insurance company.
B In case of death of life assured before maturity, sum assured is payable to the
nominee or legal heir by insurance company.
C In case of death of life assured before maturity , sum assured and fund value
is payable to the nominee or legal heir by insurance company
D In case of death of life assured before maturity, no fund value is payable to
the nominee or legal heir by insurance company
244
Question 5
In unit linked pension plans amount of fund value can be commuted by
policyholder at maturity.
A Full lump sum amount
B ½ of his fund
C 1/3 of his fund
D No amount can be withdrawn in pension plans at maturity
Answer to SEQ 2
The correct answer is C.
Such claim payment that remain outstanding for more 5 years, are written back to
revenue accounts.
Answer to SEQ 3
The correct answer is D.
In case of death claim payment, if sum assured value is higher than fund value of
units, then claim payment will be made from both unit and non-unit funds.
Answer to SEQ 4
The correct answer is A.
For unit linked health policies, In case of death of life assured before maturity ,
no sum assured is payable to the nominee or legal heir by insurance company
Answer to SEQ 5
The correct answer is C.
In unit linked pension plans 1/3 rd amount of fund value can be commuted by
policyholder at maturity.
245
CHAPTER 5
Chapter Introduction
This chapter aims to provide you with an understanding of how the accounting is
done for commission payments made and other expenses of management
incurred by a life insurance company.
1.2 Commission
b) To maintain accounts both for the amounts due to and recoverable from the
agents.
The following entries are necessary to record the various aspects of commission
transactions listed above:
Wherever an agent introduces / brings a new business proposal and where the
same is accepted and preserved, first premium commission is paid to him.
This commission is paid to him as a percentage of first premium received
from the proposer / policyholder. This is called commission on first
premium
Subsequently when the policyholder starts remitting the first year’s renewal
and subsequent premiums, a percentage of the first year’s renewal premium
and subsequent renewal premium is also paid to the agent known as
commission on first year’s renewal premium and renewal premium.
249
The percentage of commission payable is dependent on the table and term of the
policy issued. Normally, the higher rate of percentage of commission is payable
on the premiums relating to the first policy year than those of the subsequent
years. Also the agent may be paid a percentage of first year’s commission as
bonus commission, subject to certain conditions being fulfilled by an agent.
When the tax deducted at source is subsequently paid to the authorities the
Income-Tax Deducted Account will be debited and bank will be credited.
At the end of the year, the outstanding commission payable to agents will have to
be brought into account.
Under the first method, various commission accounts are debited and their
outstanding amounts credited as indicated above.
The other method is to provide the outstanding premiums only for the net
amount i.e. premium less commission.
All the branch offices are required to maintain a special instructions register to
note down important information regarding stoppage of commission due to
death of an agent,
prohibitory order,
attachment of commission or
any other reason
252
As soon as the monthly / fortnightly commission bills, cash books and cheques
are generated by data processing department, the sales section in the branch
office has to scrutinize the bills with the entries in the cash book and has also to
tally the amount of the bill with the net amount payable as shown in the cash
book and cheques printed by the data processing department. Thereafter the
branch office is required to scrutinize the bills with the entries in the special
instructions register to ensure that before the payment is made, the necessary
action with regard to stoppage of commission, correction in the bill / cheque etc.
as noted in the register is carried out.
Control over commission payment
Since the entire job is decentralised to branch office and divisional office does
not get any return for vouching the commission payments, test checking of about
5-10% of first premium commission, renewal commission and bonus commission
bills settled by branches has to be carried out by manager (sales) or any other
official from the controlling divisional office, during Periodic Quality Control
Visits. Such sample checking is to be done with a view to ascertaining whether
there are any glaring mistakes in preparation of printed bills as well as manually
prepared bills with regard to eligibility as per agents register, rates of commission
particularly in respect of policies under excepted tables where commission rates
are far less and recoveries in respect of cheque dishonored advices, medical fees,
and other advances, have also to be checked.
253
Agents are eligible to receive gratuity depending upon the number of qualified
years and age and also to receive term assurance benefit in case the agent dies
while the agency is in force.
For procuring more and more insurance business, incentives are given to
Development Officers in the form of bonus commission. These are generally
given to those Development Officers whose cost ratio does not exceed a certain
limit, say 20%. The other eligibility conditions besides cost ratio are
improvement in quantum of business,
conservation of first year’s premium income,
strengthening agency organisation and
spreading insurance cover to larger number of lives
Wherever an agent introduces / brings a new business proposal and where the
same is accepted and preserved, first premium commission is paid to him. What
will be the accounting entry passed for this transaction?
A Bank A/c will be debited and Commission on First Premium A/c will be
credited.
B Commission on First Premium A/c will be debited and Bank A/c will be
credited.
C Commission on First Premium A/c and Bank A/c will be debited.
D Commission on First Premium A/c and Bank A/c will be credited
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1. Policy stamps
Since all the policies pertaining to the year may not be issued during the said
year, it is necessary to provide for outstanding expenses relating to policy
stamps required to be affixed on the unissued policies, by passing following
accounting entry:
During the year all purchases of stationery (including data processing cards /
running stationery) are debited to this expenses account.
During the year all expenses incurred related to postage, telegram and receipt
stamps are debited to this expenses account.
Accounting entry for year-end stock of postage, telegram and receipt stamps
including franking machine balances
5. Depreciation
There are two types of expenses of management which are related to unit linked
plans (insurance pension and health).
1. Direct expenses
2. Indirect expenses
1. Direct expenses: These are expenses which are incurred on unit linked
business. These expenses include:
Amortisation of expenses
The expenditure is allocated as per business done in each category. Further some
expenses are allocated for unit linked business among various unit linked
products. These expenses are as follows:
Accounting Entry
1. Direct expenses
2. Indirect expenses
Summary
Expenses of management include commission payments of all kinds and
other expenses of management.
Some of the expenses of management are salaries, travelling expenses,
auditor’s remuneration, medical fees, advertisements, telephone charges,
electricity charges, rent, depreciation, other miscellaneous expenses etc.
Commission payment is classified as:
Commission on first premium
Commission on first year’s renewal premium
Commission on renewal premium
Bonus commission
When the commission is paid to the agent, it is recorded by debiting the
respective commission account and crediting the bank account.
Under reorganised system of working of LIC offices, each branch office is an
independent accounting unit and prepares its own trial balance at the end of
each month.
LIC agents are eligible to receive gratuity depending upon the number of
qualified years and age and also to receive term assurance benefit in case the
agent dies while the agency is in force.
While recording other expenses of management (policy stamp, contribution
to staff PF, printing, postage), the respective expense account is debited and
the bank account is credited.
The expenses of management which are related to unit linked plans are
classified as direct expenses and indirect expenses.
Direct expenses incurred on unit linked business include commission,
incentives, policy expenses, medical expenses, advertisement and publicity,
fund management expenses etc.
Direct expenses such as advertisement, promotional expenses of the policy
etc. which are of one time in nature are amortised over a number of years.
Indirect expenses incurred on unit linked business include employee
remuneration and welfare benefits, rent, repairs and maintenance, printing
and stationery, auditor’s fees, communication expenses, receipt stamps,
training expenses and other miscellaneous expenses.
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Commission on First Premium A/c will be debited and Bank A/c will be credited.
Answer to TY 2
Self-Examination Questions
Question 1
At the time of payment of commission to agents, TDS is deducted. When the tax
deducted at source is subsequently paid to the authorities, what is the accounting
entry that is passed?
A Income-Tax Deducted A/c will be debited and Bank A/c will be credited
B Bank A/c will be debited and Income-Tax Deducted A/c will be credited
C Income-Tax Deducted A/c and Bank A/c will be debited
D Income-Tax Deducted A/c and Bank A/c will be credited
Question 2
of the Insurance Act, 1938 specifies limitations on expenses of
management in life insurance business.
A Section 40A
B Section 40B
C Section 40C
D Section 40D
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Question 3
As per accounting practice adopted by LIC which of the below is true with
regards to depreciation?
Question 4
When the tax deducted at source is subsequently paid to the authorities, the
Income-Tax Deducted Account will be debited and Bank A/c will be credited.
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
Direct expenses such as advertisement which are of one time in nature are
amortised over a number of years.
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CHAPTER 6
INVESTMENTS
Chapter Introduction
This chapter aims to provide you with an understanding of the regulations issued
by IRDA for life insurance companies for the investment of premium collect by
them. The chapter also explains the regulator’s guidelines regarding asset
classification, non-performing assets, provisioning of loss on account of loans
and income recognition
Every life insurance company has to invest its surplus in the manner as approved
by competent authorities (IRDA) so that they can
earn interest and profit on their investment to enable them to give returns in
the form of bonus to those policyholders who are participating in profit
cover shortfall arising due to death claims and
cover expenditure of its operations
Most of the life insurance companies including Life Insurance Corporation (LIC)
of India are having centralised investment department (sometimes called treasury
also) to look after investment of funds, monitoring and accounting.
After coming into existence, Insurance Regulatory and Development Authority
(IRDA) have issued regulations to control investment of insurance companies.
IRDA does not want that life insurance companies recklessly invest hard earned
money of policyholders who have placed their trust in the insurance companies.
At the same time insurance companies should be able to earn adequate return for
policyholders to fulfill their aspirations.
IRDA issued regulations for investment for the first time in 2000 which is called
as Insurance Regulatory and Development Authority (Investment) Regulations
2000. After that IRDA has made several amendments and latest amendments
have been made in 2008 which is called Insurance Regulatory and Development
Authority (Investment) (fourth Amendment) Regulations 2008.
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IRDA has defined investment assets vide regulation 2ba. Investment assets mean
all investments made out of
Controlled Fund: As per the explanation for Section 27A of Insurance Act,
Authority has determined that assets relating to
pension business,
annuity business and
all categories of unit linked business
shall not form part of controlled fund for the purpose of that section
Explanation: In this section, ‘controlled fund’ means all the funds of the insurer
appertaining to its life insurance business, capital redemption insurance business
and annuity certain business, but does not include any fund or portion thereof in
respect of which the Controller is satisfied that such fund or portion thereof, as
the case may be, is regulated by the law of any county outside India or in respect
of which the Controller is satisfied that it would not be in the interest of the
insurer to apply the provisions of this Section.
Approved securities
b) Debentures or other securities for money issued under the authority of any
Central Act or Act of a State Legislature by or on behalf of a Port Trust or
Municipal Corporation or City Improvement Trust in any Presidency town;
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Rule 10-B states assets deemed to be approved investments. For the purpose of
Sub-section (1) of Section 27 of the Act, the following assets shall be deemed to
be assets invested or kept invested in approved investments specified in Sub-
section (1) of Section 27-A of the Act:
The IRDA (Investment) Regulations were issued for the first time in 2000. In
2008 IRDA made some amendments and released the Insurance Regulatory and
Development Authority (Investment) (Fourth Amendment) Regulations, 2008.
Every insurer carrying on the business of life insurance shall invest and all times
keep invested his investment assets other than funds relating to pension and
general annuity business and all categories of unit linked business in following
manner.
c) Investment in infrastructure:
(Explanation: Subscription or purchase of bonds
/ debentures, equity and asset backed securities
with underlying infrastructure assets would
qualify for the purpose of this requirement.
‘Infrastructure facility’ shall have the meaning
as given in clause (h) of Regulation 2 of
Insurance Regulatory and Development
Authority (Registration of Indian Insurance
Companies) Amendment Regulations, 2008)
Here infrastructure facility means
1. A road highway, bridge, airport, port,
railway unloading BOLT, road transport
system, water supply project, irrigation
project, industrial parks, water treatment
system, solid waste management system,
sanitation system
2. Generation or distribution or transmission of
power
3. Telecommunication
4. Project for housing
5. Any other public facility which may be
notified by IRDA
Every insurer shall invest and at all times keep invested funds belonging to
pension and general annuity business in the following manner
Note: For the purposes of this sub-regulation no investment which falls under
‘Other Investments’ as specified under Section 27A (2) of Insurance Act 1938
shall be made. However, funds pertaining to Group Insurance Business, except
One Year Renewable Pure Group Term Assurance Business (OYRGTA) shall
form part of Pension and General Annuity Fund. OYRGTA funds shall follow
the pattern of investment of life insurance business.
3. Investment pattern for Unit Linked Insurance Business
Unit Linked Insurance Plan (ULIP) is a unique product which gained popularity
during last one decade after constitution of IRDA. In these kinds of policies,
policyholder seeks to get profit / gain from policy according to their risk appetite
along with life insurance benefit. Generally, insurers give several fund options in
one plan to policyholders to maximise their return. Popular fund options are as
follows:
Balanced Money
Equity Fund Debt Fund
Fund Market Fund
This fund This fund invests major This fund This fund
invests major portion of the money in invests in a invests money
portion of the Government securities mix of equity mainly in
money in (e.g. Government Bonds), and debt instruments
equity and Corporate Bonds, Fixed instruments. such as
equity related Deposits etc. In these The Treasury Bills,
instruments. funds, it is expected that proportion of Certificates of
the income, being interest equity and Deposit,
on securities and bonds, debt Commercial
will be steady and almost component Paper etc.
guaranteed, but there may may vary from
not be much capital fund to fund
appreciation.
This fund is This fund is for those This fund is This fund is for
for those investors who don’t want for those those investors
investors who to take high risk and are investors who who want to
are willing to satisfied with lesser but are willing to preserve their
take high risk guaranteed returns. take moderate capital and are
and are risk and are satisfied with
looking for looking for lesser returns.
high returns. moderate
returns.
Sometimes Sometimes also called as Sometimes also
also called as bond funds called as liquid
growth funds funds.
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As per IRDA regulations, every insurer shall invest and at all times keep invested
his segregated fund of unit linked business as per pattern of investment offered to
and approved by policyholders where the units are linked to categories of assets
which are both marketable and easily realisable. However, the total investment in
Other Investments as specified under Section 27A (2) of Insurance Act, 1938
category shall at no time exceed 25% of such fund(s).
As stated earlier, every policyholder put his hard earned money in insurance to
secure his future and to gain from his investment. At the same time, it is the
endeavour of every insurance company to maximise return for its policyholders
so that they may be able to keep premium at lower side and at the same time, stay
competitive.
There are chances that these insurance companies may also invest in group
companies. For example HDFC Life in HDFC or HDFC Bank, ICICI Prudential
in ICICI Bank or Reliance Life in Reliance group companies.
To keep exposure in group companies within limit, IRDA has set exposure /
prudential norms for life (unit linked business) business for both:
b) other investments as permitted under 27A (2) and 27B (3) of the Insurance
Act, 1938
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As per the explanation for Section 27A of Insurance Act, Authority has
determined that assets relating to shall not form part of controlled
fund.
A Pension business
B Annuity business
C All categories of unit linked business
D All of the above
real estate,
debt market,
equity market or
loan to companies
carries some kind of diminution risk. However the degree of risk may be varying.
In case of debt, risk is less than risk in case of equities.
IRDA has mandated insurers to classify their loan / advances into four categories
for the determination of minimum provisions of loss on account of loans and
advances.
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Classification of assets into these categories shall be done taking into account the
ability of the borrower to repay and the extent of value and realisability of
security. Provisioning is done as per classification of assets as follows.
i. Standard assets
Standard asset is one which does not disclose any problem and which does not
carry more than normal risk attached to the business. Such types of assets are not
considered as non-performing assets.
An asset which has been treated as a NPA on 1 st April 2011 would be treated as a
sub-standard asset only up to 31st March 2012.
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A doubtful asset is one which has remained as NPA for a period exceeding 12
months.
A loan facility to a borrower which is treated as NPA on 1st April 2010 would be
treated as doubtful from 1 st April 2011.
A loss asset is one where loss has been identified by the insurer or its internal or
statutory auditors or by IRDA but the amount has not been written off wholly. In
other words, such an asset is considered un-collectible and as such its
continuance as a bankable asset is not warranted although there may be some
salvage or recovery value.
i. Standard assets
100% provision of the extent to which asset is not covered by the realisable
value of the security to which insurer has a valid recourse and the realisable
value is estimated on realistic basis.
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Over and above the first point, depending upon the period for which asset has
remained doubtful, 20% to 100% provision of the secured portion (i.e.
estimated realisable value of the outstanding) should be made on following
basis:
The entire asset should be written off. If the assets are to remain in the books due
to any reason, 100% of the outstanding should be provided.
Income in respect of any asset classified as NPA shall not be recognised unless
realised. However, any adjustment towards overdue interest against any
fresh/additional loan shall not be considered as realised.
To document the basis of investment decision and to bring about uniformity and
transparency of investment decision every insurer shall draw up annually an
investment policy (fund wise in case of unit linked insurance business) and place
the same before its Board of Directors for its approval.
While framing such policy, the Board shall ensure compliance with the
following:
Issues relating to liquidity, prudential norms, exposure limits, stop loss limits
including securities trading, management of all investment risks,
management of assets liabilities, scope of internal or concurrent audit of
investments and investment statistics and all other internal controls of
investment operations, the provisions of the Insurance Act, 1938 and
Insurance Regulatory and Development Authority (Investment) Regulations,
2000, guidelines and circulars made thereunder.
The Board shall review the investment policy and its implementation on a half-
yearly basis or at such short intervals as it may decide and make such
modification to the investment policy as is necessary to bring it in line with the
investment provisions laid down in the Act and Regulations made there under,
keeping in mind protection of policyholders’ interest and pattern of investment
laid down in these Regulations or in terms of the agreement entered into with the
policyholders in the case of unit linked insurance business.
The details of the investment policy or its review as periodically decided by the
Board shall be made available to the internal or concurrent Auditor. The auditor
shall comment on such review and its impact on the investment operations,
systems and processes in their report to be placed before the Board Audit
Committee.
IRDA has mandated that the insurer shall clearly segregate the functions and
operations of front, mid and back office. This shall ensure proper internal control
of investment functions and operations.
The cost and sale price of the investment is net i.e., after adjustment for
commission and brokerage.
The insurers act as underwriters and brokers and therefore, they are entitled to
underwriting commission and brokerage on new issues underwritten. The
insurers underwrite and subscribe to the shares for themselves, subject to
allotment, whereas other underwriters do not necessarily subscribe but take over
only the balance of shares which are not subscribed by the public. The
underwriting commission and brokerage received is reduced from the purchase
price and the net amount is taken as the book value.
The following are the entries recorded when loans are advanced, investments
purchased and house property purchased etc.
As per IRDA guidelines for provisioning for loans for sub-standard assets a
general provision of of total value outstanding remaining sub-standard
is required to be made.
A 5%
B 10%
C 25%
D 40%
E 50%
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Summary
Life insurance companies invest surplus premium to earn interest and profit,
cover shortfall arising due to death claims and cover expenditure of its
operations.
The IRDA issued called Insurance Regulatory and Development Authority
(Investment) (fourth Amendment) Regulations in 2008.
Investment assets mean all investments made out of
Shareholder funds, non-unit reserves of unit linked business,
participating and non-participating funds of policyholders
Policyholders funds of pension and general annuity fund at carrying
value and
Policyholders unit reserves of unit linked business at their market value
Every life insurer shall invest not less than 25% of its surplus / investible
sum in Government securities
Every life insurer shall invest not less than 50% of its surplus / investible
sum in Government securities or other approved securities (including above
25%).
Every life insurer shall invest not exceeding 35% of its surplus / investible
sum in specified approved investments and other investments.
Every life insurer shall invest not exceeding 15% of its surplus / investible
sum in housing and infrastructure.
Every insurer shall invest and at all times keep invested not less than 20%
funds belonging to pension and general annuity business in Government
securities.
Every insurer shall invest and at all times keep invested not less than 40%
funds belonging to pension and general annuity business in Government
securities and other approved securities (including above 20%).
Every insurer shall invest and at all times keep invested not exceeding 60%
funds belonging to pension and general annuity business in specified
approved securities.
As per IRDA regulations, every insurer shall invest and at all times keep
invested his segregated fund of unit linked business as per pattern of
investment offered to and approved by policyholders where the units are
linked to categories of assets which are both marketable and easily realisable.
IRDA has mandated insurers to classify their loan / advances into four
categories: standard assets, sub-standard assets, doubtful assets and loss
assets.
An asset is classified as an NPA if the interest and / or installment and / or
installment of principal remain overdue for more than 90 days (i.e. one
quarter).
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Answer to TY 2
As per IRDA guidelines for provisioning for loans for sub-standard assets a
general provision of 10% of total value outstanding remaining sub-standard is
required to be made.
Self-Examination Questions
Question 1
As per IRDA investment guidelines insurers are required to invest not less than
of their investible funds in housing and infrastructure.
A 5%
B 10%
C 12.5%
D 15%
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Question 2
Every insurer shall invest and at all times keep invested not less than of the
investible funds belonging to pension and general annuity business in
Government Securities.
A 5%
B 10%
C 15%
D 20%
Question 3
A Equities
B Government Securities
C Commercial Paper
D Mix of equities and debt
Question 4
A 6 months
B 12 months
C 18 months
D 24 months
Question 5
A Four
B Three
C Two
D One
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As per IRDA investment guidelines insurers are required to invest not less than
15% of their investible funds in housing and infrastructure.
Answer to SEQ 2
Every insurer shall invest and at all times keep invested not less than 20% of the
investible funds belonging to pension and general annuity business in
Government Securities.
Answer to SEQ 3
Answer to SEQ 4
Answer to SEQ 5
CHAPTER 7
Chapter Introduction
Every insurance company has to prepare their final accounts as per the IRDA
(Preparation of Financial Statement and Auditor’s Report of Insurance
Companies) Regulation 2002. IRDA has mandated that an insurer carrying on
life insurance business after the commencement of this regulation shall comply
with the requirement of Schedule A. In this chapter, we will be learning various
parts of Schedule A and its applicability in accounting for life insurance
companies.
Post 2002, the financial statements and audit reports of insurance companies are
to be prepared strictly as per the IRDA (Preparation of financial statements and
auditor’s report of Insurance Companies) Regulations, 2002. Following are the
relevant provisions of the said schedule:
As per the IRDA regulations, separate financial statements i.e. Revenue account
and Balance Sheet are required to be prepared for participating and non-
participating policies and linked and non-linked business. Furthermore, for non-
linked business, separate statements are required for ordinary life, general
annuity, pension and health insurance.
Every life insurance company shall have to follow the accounting standards
issued by the ICAI while preparing its financial statements, except that:
b) Premiums
Premium shall be recognised as income when due for linked business, the due
date for payment may be taken as the date when associated units are created.
c) Acquisition costs
Acquisition costs are those that vary with and mainly related to the acquisition of
new and renewal insurance costs. Examples of these costs are commission to
agents, policy stamps etc. Acquisition cost shall be expensed in the period in
which they are incurred.
XYZ Ltd., an insurance company, pays Rs.10 crores to its authorized agents and
Rs.5 crores for policy stamps. Both these expenses form the acquisition costs for
XYZ Ltd.
d) Claim costs
Cost of claim shall comprise the policy benefit amount. These include maturity
claims, death claims, surrender, annuity etc. and specific settlement costs such as
claim investigation expenses panel interest etc.
e) Actuarial valuation liability for life policies
It is to be remembered that any premium received by an insurer is not its
income as such. Rather, the company is creating liabilities against policies.
The estimation of liability against life policies shall be determined by
Appointed Actuary (Chief Actuary) of the insurer. This exercise is done
every year.
Surplus valuation is also declared on the basis of Actuarial Valuation.
Actuarial assumptions are to be disclosed by way of notes to the accounts.
The liability is calculated in such a manner that, together with future
premium payments and investment income, the insurer can meet all future
claims (including bonus entitlements to policyholders) and expenses.
f) Valuation of investments
Following are the different classes of investments for which a life insurance
company has to undergo a valuation exercise in every period.
Diagram 2: Valuation of investments
iii) Equity Securities and Derivation Instruments that are traded in active
markets
Listed equity securities and derivative instruments that are traded in active
markets shall be measured at fair value on the balance sheet date. For the
purpose of calculation of fair value, the lowest of the last quoted closing
price at the stock exchange where the securities are listed shall be taken. The
insurer must also assess on each balance sheet date, whether or not there is
any impairment in the value of the listed securities.
The insurer shall assess on each balance sheet date whether any
impairment occurred. An impairment loss shall be recognized as an
expense in Revenue/ Profit & Loss Account to the extent of the difference
between the re-measured fair value of the security / investment and its
acquisition on cost as reduced by any previous impairment loss recognized as
expense in Revenue/ Profit & Loss Account.
Any reversal of impairment loss earlier recognized in Revenue/ Profit & Loss
Account shall be recognized in Revenue/ Profit & Loss Account.
iv) Unlisted and other than actively / traded equity securities and derivative
instruments
Unlisted equity securities and derivatives & listed equity securities &
derivatives which are not activity traded shall be measured at historical cost.
X Ltd, an insurance company, purchased 1000 equity shares of ABC Ltd on 1 Jan
2011 for Rs.450,000. The value of the investments would be recorded at Rs.
450,000.
i) On 31 March 2011, the lowest quoted closing price on the exchange was Rs.
500.
Since the shares are listed and the lowest quoted closing price is available, that
price itself will be the fair value. The value of such shares on the date of balance
sheet will be 1,000 shares x Rs. 500 per share = Rs. 5,00,000.
The increase in the value of the shares due to fair value increase is Rs.50,000.
This will involve a creation of Fair Value Change Account. The unrealized gain
arising due to change in the value of listed equity shares shall be taken to equity
under the head ‘Fair Value Change Accounts’.
ii) On 8th April 2011 the shares were sold for Rs. 522,000
g) Loans
h) Linked business
Segregated Funds
a) Segment Reporting
b) Revenue Account
c) Managerial remuneration
d) Related party transactions
e) Transfer of securities to policyholder’s account
f) Guidelines for recognition of claims
g) Bank reconciliation as at 31 st March
h) Provision for ‘free look’ period
i) Catastrophe reserve
j) Investments of policyholders and shareholders
k) Social sector business
l) Preliminary expenses.
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Now, we will see the disclosure requirements for each of the above items, in
detail
a) Segment Reporting
For non-linked business, separate statements are required for ordinary life,
general annuity, pension and health insurance.
Insurers can lay down accounting policies in line with the Accounting
Standard -17 and the Regulations issued by the Authority in this regard, and
consistently follow the same.
b) Revenue Account
In case of deficit in the Revenue Account, where the deficit is made up through a
transfer from the Profit and Loss Account, as “Transfer from the Shareholders’
account”, it shall be depicted as under:
c) Managerial remuneration
Students must note that there should be a limited review for quarterly accounts
by the statutory auditors and full audit review for Annual Accounts in the month
of March.
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All securities are required to be transferred to the policy holders Account at:
A Cost price
B Cost price or market price, whichever is higher
C Market Price
D Cost price or market price, whichever is lower
The said IRDA regulations have given certain instructions while preparing the
financial statements of the insurer. The main intention behind issuing these
instructions is to enhance the overall quality of disclosures and bring about
uniformity with respect to certain specific issues affecting the financial
statements of an insurance company.
Point number 4 has been classified as (I) and (II). The entire point has been
given under the tag “Important”. This point holds special importance when
it comes to understanding the meaning and requirements of certain specific
terms.
i) The corresponding amounts for the immediately preceding financial year for
all items shown in the Balance Sheet, Revenue Account, Profit and Loss
Account and Receipts and Payments Account shall be given.
ii) The figures in the financial statements may be rounded off to the nearest
thousand.
(I) For the purposes of financial statements, unless the context otherwise
requires:
a) The expression ‘provision’ shall, subject to (II) below mean any amount
written off or retained by way of providing for depreciation, renewals or
diminution in value of assets, or retained by way of providing for any known
liability or loss of which the amount cannot be determined with substantial
accuracy;
b) The expression ‘reserve’ shall not, subject to as aforesaid, include any
amount written off or retained by way of providing for depreciation, renewals
or diminution in value of assets or retained by way of providing for any
known liability or loss;
c) The expression ‘capital reserve’ shall not include any amount regarded as
free for distribution through the profit and loss account; and the expression
‘revenue reserve’ shall mean any reserve other than a capital reserve;
d) The expression "liability" shall include all liabilities in respect of expenditure
contracted for and all disputed or contingent liabilities.
(II) Where:
a) any amount written off or retained by way of providing for depreciation,
renewals or diminution in value of assets, or
b) any amount retained by way of providing for any known liability or loss, is in
excess of the amount which in the opinion of the directors is reasonably
necessary for the purpose, the excess shall be treated as a reserve and not
provision.
iv) The company shall make provisions for damages under lawsuits where the
management is of the opinion that the award may go against the insurer.
v) Extent of risk retained and re-insured shall be separately disclosed.
vi) Any debit balance of the Profit and Loss Account shall be shown as
deduction from uncommitted reserves and the balance, if any, shall be shown
separately.
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ii) Certification that all the dues payable to the statutory authorities have been
duly paid;
iii) Confirmation to the effect that the shareholding pattern and any transfer of
shares during the year is in accordance with the statutory or regulatory
requirements;
300
iv) Declaration that the management has not directly or indirectly invested
outside India the funds of the holders of policies issued in India;
vi) Certification to the effect that the values of all the assets have been reviewed
on the date of the Balance Sheet and that in his (insurer’s) belief the assets
set forth in the Balance sheets are shown in the aggregate at amounts not
exceeding their realisable or market value under the several headings
Headings
vii) Certification to the effect that no part of the life insurance fund has been
directly or indirectly applied in contravention of the provisions of the
Insurance Act, 1938 (4 of 1938) relating to the application and investment of
the life insurance funds;
viii) Disclosure with regard to the overall risk exposure and strategy adopted to
mitigate the same;
ix) Operations in other countries, if any, with a separate statement giving the
management’s estimate of country risk and exposure risk and the hedging
strategy adopted;
xi) Certification to the effect as to how the values, as shown in the balance sheet,
of the investments and stocks and shares have been arrived at, and how the
market value thereof has been ascertained for the purpose of comparison with
the values so shown;
the management has taken proper and sufficient care for the maintenance of
adequate accounting records in accordance with the applicable provisions of
the Insurance Act 1938 (4 of 1938) / Companies Act, 1956 (1 of 1956), for
safeguarding the assets of the company and for preventing and detecting
fraud and other irregularities;
Provided that an insurer shall prepare Revenue Account and Balance Sheet for
the under mentioned businesses separately and to that extent the application of
AS 17 shall stand modified:-
Now, we will see the formats of the financial statements as given in Part V
303
FORM A-RA
TOTAL (A)
304
Commission 2
TOTAL (B)
APPROPRIATIONS
TOTAL (D)
Notes:
* Represents the deemed realised gain as per norms specified by the Authority.
** Represents Mathematical Reserves after allocation of bonus
The total surplus shall be disclosed separately with the following details:
FORM A-PL
PROFIT & LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH, 20 .
TOTAL (B)
APPROPRIATIONS
(a) Brought forward Reserve/Surplus from the Balance Sheet
(b) Interim dividends paid during the year
(c) Proposed final dividend
(d) Dividend distribution on tax
(e) Transfer to reserves/ other accounts (to be specified)
Profit carried forward to the Balance Sheet
Notes:
a) In case of premiums, less reinsurance in respect of any segment of insurance business of total premium earned, the
same shall be disclosed separately.
b) Premium income received from business concluded in and outside India shall be separately disclosed.
c) Reinsurance premiums whether on business ceded or accepted are to be brought into account gross (i.e. before
deducting commissions) under the head reinsurance premiums.
d) Claims incurred shall comprise claims paid, settlement costs wherever applicable and change in the outstanding
provision for claims at the year-end
e) Items of expenses and income in excess of one percent of the total premiums (less reinsurance) or Rs.5,00,000
whichever is higher, shall be shown as a separate line item.
f) Fees and expenses connected with claims shall be included in claims.
g) Under the sub-head "Others” shall be included items like foreign exchange gains or losses and other items.
308
h) Interest, dividends and rentals receivable in connection with an investment should be stated as gross amount, the
amount of income tax deducted at source being included under 'advance taxes paid and taxes deducted at source”.
i) Income from rent shall include only the realised rent. It shall not include any notional rent.
FORM A-BS
Shareholders’ funds:
Share capital 5
Reserves and surplus 6
Credit/[debit] fair value change account
Sub-Total
Borrowings 7
309
Policyholders’ funds:
Credit/[debit] fair value change account
Policy liabilities
Insurance reserves
Loans 9
Fixed assets 10
Current assets
Cash and Bank Balances 11
Advances and Other Assets 12
Sub-Total (A)
310
Current liabilities 13
Provisions 14
Sub-Total (B)
Contingent Liabilities
Schedule – 1
Premium
Total Premium
Notes:
Reinsurance premiums whether on business ceded or accepted are to be brought into account, before deducting
commission, under the head of reinsurance premiums.
312
Schedule- 2
Commission expenses
Net Commission
Note:
The profit/ commission, if any, are to be combined with the Re-insurance accepted or Re-insurance ceded figures.
313
Schedule – 3
Notes:
a) Items of expenses in excess of one percent of the net premium or Rs.5,00,000 whichever is higher, shall be shown as a
separate line item.
b) Under the sub-head "Others", `Operating Expenses (Insurance Business)' shall include items like foreign exchange
gains or losses and other items.
SCHEDULE – 4
BENEFITS PAID [NET]
Particulars Current Year Previous Year
(Rs.’000). (Rs.’000).
1. Insurance Claims
(a) Claims by Death,
(b) Claims by Maturity,
(c) Annuities/Pensions in payment,
(d) Other benefits, specify
2. (Amount ceded in reinsurance) :
(a) Claims by Death,
(b) Claims by Maturity,
(c) Annuities/Pensions in payment,
(d) Other benefits, specify
3. Amount accepted in reinsurance :
(a) Claims by Death,
(b) Claims by Maturity,
(c) Annuities/Pensions in payment,
(d) Other benefits, specify
Total
315
Notes:
Schedule – 5
Share capital
Notes:
Schedule – 5a
Pattern of shareholding
Schedule – 6
Note:
Additions to and deductions from the reserves should be disclosed under each of the specified heads.
318
Schedule - 7
Borrowings
Notes:
a) The extent to which the borrowings are secured shall be separately disclosed stating the nature of the security under
each sub-head.
b) Amounts due within 12 months from the date of Balance Sheet should be shown separately
319
Schedule- 8
Investments-shareholders
3. Other Investments
(a) Shares
(aa) Equity
(bb) Preference
(b) Mutual Funds
(c) Derivative Instruments
(d) Debentures/ Bonds
(e) Other Securities (to be specified)
(f) Subsidiaries
(g) Investment Properties-Real Estate
320
Total
Investments
1 In India
2 Outside India
Total
Note:
Schedule- 8A
Investments-policyholders
3. (a) Shares
(aa) Equity
(bb) Preference
(b) Mutual Funds
(c) Derivative Instruments
(d) Debentures/ Bonds
(e) Other Securities (to be specified)
(f) Subsidiaries
(g) Investment Properties-Real Estate
4. Investments in Infrastructure and Social Sector
5. Other than Approved Investments
Total
Investments
1 In India
2 Outside India
Total
a) Investments in subsidiary/holding companies, joint ventures and associates shall be separately disclosed, at cost.
i) Holding company and subsidiary shall be construed as defined in the Companies Act, 1956:
ii) Joint Venture is a contractual arrangement whereby two or more parties undertake an economic activity, which is
subject to joint control.
iii) Joint control - is the contractually agreed sharing of power to govern the financial and operating policies of an
economic activity to obtain benefits from it.
323
iv) Associate - is an enterprise in which the company has significant influence and which is neither a subsidiary nor a
joint venture of the company.
v) Significant influence (for the purpose of this schedule) -means participation in the financial and operating policy
decisions of a company, but not control of those policies. Significant influence may be exercised in several ways,
for example, by representation on the board of directors, participation in the policy making process, material inter-
company transactions, interchange of managerial personnel or dependence on technical information. Significant
influence may be gained by share ownership, statute or agreement. As regards share ownership, if an investor
holds, directly or indirectly through subsidiaries, 20 percent or more of the voting power of the investee, it is
presumed that the investor does have significant influence, unless it can be clearly demonstrated that this is not the
case. Conversely, if the investor holds, directly or indirectly through subsidiaries, less than 20 percent of the
voting power of the investee, it is presumed that the investor does not have significant influence, unless such
influence is clearly demonstrated. A substantial or majority ownership by another investor does not necessarily
preclude an investor from having significant influence.
b) Aggregate amount of company's investments other than listed equity securities and derivative instruments and also the
market value thereof shall be disclosed.
c) Investments made out of Catastrophe reserve should be shown separately
d) Debt securities will be considered as “held to maturity” securities and will be measured at historical costs subject to
amortisation
e) Investment Property means a property [land or building or part of a building or both] held to earn rental income or for
capital appreciation or for both, rather than for use in services or for administrative purposes.
324
Schedule - 9
Loans
Notes:
a) Short-term loans shall include those, which are repayable within 12 months from the date of balance sheet. Long term
loans shall be the loans other than short-term loans.
b) Provisions against non-performing loans shall be shown separately.
c) The nature of the security in case of all long term secured loans shall be specified in each case. Secured loans for the
purposes of this schedule, means loans secured wholly or partly against an asset of the company.
d) Loans considered doubtful and the amount of provision created against such loans shall be disclosed.
326
Schedule - 10
Fixed assets
(Rs.’000)
Particulars Cost/ Gross Block Depreciation Net Block
Opening Additions Deductions Closing Upto For On Sales/ To As at Previous
Last The Adjustments Date year Year
Year Year end
Goodwill
Intangibles
(specify)
Land-Freehold
Leasehold Property
Buildings
Furniture &
Fittings
Information
Technology
Equipment
Vehicles
Office Equipment
Others (Specify
nature)
Total
Previous year
Note:
Assets included in land, property and building above exclude Investment Properties as defined in note (e) to Schedule 8.
327
Schedule- 11
Note: Bank balance may include remittances in transit. If so, the nature and amount should be separately stated.
328
Schedule – 12
Notes:
(a) The items under the above heads shall not be shown net of provisions for doubtful amounts. The amount of provision
against each head should be shown separately.
(b) The term ‘officer’ should conform to the definition of the word ‘officer’ under the Companies Act, 1956.
330
Schedule – 13
Current liabilities
Schedule – 14
Provisions
Total
332
Schedule – 15
Miscellaneous expenditure
Notes:
a) No item shall be included under the head “Miscellaneous Expenditure” and carried forward unless:
some benefit from the expenditure can reasonably be expected to be received in future, and
the amount of such benefit is reasonably determinable.
b) The amount to be carried forward in respect of any item included under the head “Miscellaneous Expenditure” shall
not exceed the expected future revenue/other benefits related to the expenditure.
333
After the above three steps, reconciliation with the corresponding balances in the
principal ledger account should be made.
X Ltd., an insurance company, has a bank account with the State Bank of India
(SBI). The insurance company has to obtain a certificate of balance from the
bank. Let’s say the certificate shows a balance of Rs. 10 crores. The actual
balance as per the books of account is, say, Rs. 9.99 crores. Hence, there is a
difference of Rs. 1,00,000, which must be mandatorily reconciled. The balance of
Rs. 1,00,000 must not be allowed to remain in the suspense account.
336
c) Saleable items should be valued at the sale price. All non-saleable and other
items like printed forms, books, stationery, etc. should be valued at original
cost price. Obsolete items which are no longer in vogue should be listed
separately and should not be valued for the purpose of closing of Accounts.
In the case of obsolete or unusable Building Materials (if any), the value (less
scrap value realized, if any) will be required to be written off under sanction
of competent authority.
d) Accounts Department should take steps to get all the inventories in time and
verify that they are correct and have been prepared and are in agreement with
the books of account as well as stock records.
Serial No.
Distinctive Number allotted.
Description.
Location (Office, Room & Place).
Date of purchase.
Purchase Price.
Remarks.
337
Office Services Department should compare the inventory with the last year’s
inventory, and reconcile all additions or depletions on account of purchase, sale
or other reasons with the corresponding entries in the books of accounts and
certify the same as to the additions or depletions during the year.
A list of vehicles classified into Motor Cars, Motor Cycles, Scooters showing
the name of the Officials, designations, Place and amount advanced and
recovered should be prepared. A certificate, as per the specimen given below,
should be obtained from the officer concerned.
This is to further certify that the above conveyance was in my possession and
was in good running condition as at .................... and was duly registered in the
name of the Company.
Place:……
(Signature)
Date :
(Designation)
A certificate should be obtained from the officers who have been supplied with
the Company’s Motor Cars as per specimen given below :
338
Place:
(Signature)
Date :
(Designation)
Following are the broad guidelines for year-end provisions and preparation
of schedules for important items of Assets and Liabilities
7. Loans on policies
i) Schedule of policy loans as at the close of the year should be extracted from
the loan ledgers. If the work relating to Policy loan accounting is
mechanized, the schedule of outstanding Policy loans will be extracted on a
computer. However, the said schedule is to be scrutinized in conjunction with
the Loan Ledgers or Policy Loan dockets so as to establish one to one
correspondence between the schedule and other subsidiary records.
Debits Credits
Outstanding Loans Other Loans Other Outstanding
As on 1st advanced debits (C) repaid credits (E) as on 31st
April (A) during the during the March
year (B) year (D) (F = A +B
+C – D –E)
iii) The totals of each column of the schedule should be tallied with the
corresponding figures extracted from the Principal Ledger.
339
Debits Credits
Outstanding Loans Other Loans Other Outstanding
As on 1st advanced debits (C) repaid credits (E) as on 31st
April (A) during the during the March
year (B) year (D) (F = A +B
+C – D –E)
100,00,000 50,00,000 Nil 25,00,000 Nil 125,00,000
8. Outstanding premiums
This account is used only at the time of the closing of accounts and entries made
are reversed in the next financial year. Premiums which satisfy the following
conditions should alone be treated as outstanding premiums:
In all cases where amounts become due to the company from any persons on
account of goods supplied, or where the services rendered to the customer are in
excess, or a less payment has been received, the sundry debtors account should
be debited.
The schedule of sundry debtors should include all the items grouped as sundry
debtors and advance. However, those debtors which are specifically shown
separately in the balance sheet need not be shown again in the schedule.
Proper analysis should be given in the schedule under different heads of account.
The account of identical nature falling under one head say Sundry Deposits or
Advances should be grouped together and shown as a separate item. The
Amount
Sr. Particulars Rs.
Total :
Amount of
reserve
Name provided if
Sr. Amt Outstanding
of the Description considered Remark
No Rs. since (date)
Debtor doubtful of
recovery
Rs.
1.
2.
3.
Total
Any other sundry deposits should be verified using the following steps for the
purpose of finalisation:
Schedules should be prepared and tallied with the balance in the Principal
Ledger.
Confirmation of the deposit should be obtained from the parties concerned to
the effect that they hold the amount in deposit as at the close of the
accounting year.
For prepaid expenses for the part of the current assets, the following steps are
laid down to verify the same for finalisation:
This account is used only at the time of the closing of accounts and the
entries are reversed in the next financial year.
Expenses incurred during one financial year, the benefit of which is spread
over to next financial year, should be brought into account by debiting this
account and crediting the appropriate expense account e.g. Telephone rental,
motor and fire insurance premium etc.
Students should note that the following calculation forms the core for
calculations of claims outstanding as on the date of the balance sheet. The format
presented must be learnt as it is.
No. Amt
Claims outstanding at the beginning of the year (Net)
Add: Claims Intimated during the year (Gross)
Less: Net claims paid during the year
Less: Amount adjusted for netting of claims
Less: Claims written Back during the year
Less: Claims repudiated during the year
Claims outstanding at the end of the year (Net)
345
The Schedule should include all items under different heads of Account other
than those shown separately in the Printed Accounts. The accounts of identical
nature falling under one head, say outstanding commission on first year’s
premium and renewal premium, salaries etc. should appear separately in the
schedule of Sundry Creditors. The Proforma of the Schedule is given hereunder:
Amount
Sr.No. Particulars
Rs.
Outstanding Expenses :
(a) Commission First year
(b) Commission Renewal
(c) Bonus Commission to Agents
(d) Bonus Commission to Dev. Officers
(e) Allowances to Agents other than Commission
(f) Salary, D.A. & House Rent Allowance etc.
(g) Travelling Expenses
(h) Telephone Charges
(i) Electricity Charges
1.
(j) Medical Fees
(k) Rents of other Offices occupied by the Corporation
(l) Postage and Telegrams
(m) Stationery & Printing
(n) Law Charges
(o) A.M.C Charges
(p) Tabulating Machines Rental & Maintenance
(q) Motor Car Expenses under various schemes
(r) Policy Stamps
(s) Other items to be specified.
2. Salaries unpaid
3. Income-tax on Salaries
4. Co-operative Society Deductions
5. Insurance Premium Deductions
6. Motor Car Deposit Deductions under various schemes
7. Licence Fee Deductions
8. Other Deductions from Salaries
9. Interest on Staff Security Deposit
346
Outstanding
Name of the Amount
Sr.No. since Remarks
Creditor Rs.
(date)
1.
2.
3.
4.
5.
Total
Outstanding expenses
Proper provision should be made for all expenditure relating to the year
ending which remains unpaid on that date.
Any expenses for which bills have not been paid as disclosed by the Register or
other records should also be included in the outstanding expenses for which the
above entry is made.
Schedule should be prepared on the same lines, as mentioned above, for such
bills as for outstanding expenses, but the credit will be to “Provision for
outstanding Accounts and Bills of Capital nature” Account and not to
outstanding expenses account.
Such bills should be brought into the accounts only if the relevant assets have
been delivered on or before the close of the accounting year and taken in stock.
Outstanding commission
The following items should be taken into account whilst providing for
outstanding commission (First year, Renewal and Bonus).
348
a) All commission bills prepared prior to the last date of the accounting year
which remained unpaid by that date:
A detailed schedule of all such bills pending should be prepared, taking care
to include bills that might be paid in the next accounting year but before the
preparation of the schedule.
Where bills remained unpaid because the eligibility of the agent to receive
commission has not been determined, the bills should be included in the
schedule but where the bills have remained unpaid because the agent was not
eligible to receive commission, only the bills in respect of which the agency
was likely to continue and the commission was likely to be paid should be
included.
b) Commission bills prepared subsequent to the close of the accounting year but
relating to premiums received and adjusted prior to close of the accounting
year:
Special effort should be made to prepare these bills and make payment as
soon as possible and at the same time to prepare a schedule which will be
entered simultaneously with the bills being prepared and before payment is
made.
The schedule will be closed when all the bills relating to premiums adjusted
up to and including the last date of the accounting year have been prepared.
c) Bonus Commission Bills for Agents whose agency year ended on or before
the last date of the Accounting year:
These Bills will be dealt with in the same manner as the commission bills
referred to in (a) and (b) above.
A schedule should be prepared for all agents who are qualified for Bonus
Commission in the accounting year and provision should be made for such bonus
commission on the premium income from the close of the agency year to the end
of the accounting year at the rate of bonus commission earned by the agent for
the Agency year which ended during the financial year.
349
A Schedule should be prepared and if there are any items more than a month old
as at the close of the accounting year, necessary Explanatory Note should be
added to the Schedule.
25. Amounts due to the trustees of staff provident fund and pension fund
Under the above heading the amounts realized from the staff being their
contributions towards the Provident Fund, Additional Provident Fund, P.F.
Loan Deduction, P.F. Loan Interest Deduction and Pension Fund Deductions
not handed over to the trustees of the Provident Fund or Pension Fund should
be included.
The provision for Company’s Contribution to Provident and Pension Fund
should be included under this head and not under outstanding expenses.
350
Extract from the annual accounts of LIC for the year 2010-11, relating to
‘contingent liabilities’ appearing in the notes to accounts
Claims
The claims settled and remaining outstanding for a period of more than 6 months
as on the balance sheet date:(As certified by the Management).
Number Amount
(in lacs)
Current Previous Current Year Previous Year
Year Year
Claims by 4222 3062 1687 1446
death
Claims by 611226 509074 68035 49951
maturity
The first step in the reconciliation of bank balances as per books with the bank
balances as per bank statement is:
A Obtaining certificate of balances from all the banks that have the insurer’s
account.
B Clearing stale cheques.
C Writing off old balances
D Not to be shown anywhere.
A Supplementary cash book must not be incorporated in the main cash book.
B Imprest cash system should be followed for huge cash balances
C Imprest cash system should be followed for small cash balances.
D Stamp records fall under ‘cash’ records
One of the peculiar features in case of finalizing and verifying the expenses is
that:
A The amount of expense should tally with the amount in the principal ledger
B The amount of expense needs reconciliation with the amount in the principal
ledger.
C The amount of expense should tall with the amount of revenue
D The amount of expense need not tally with the amount in the principal
ledger.
From the following balances as at 31 st March 2008 given in the books of National
Life Assurance Co. Ltd. Prepare Profit and Loss account and Balance Sheet as on
that date.
Commission :
- On Direct : First Year
40,500
Cash with Bankers on - Renewal
Current Account 40,500 - On Reinsurance 2,000
12,000
accepted
4,000
- On Reinsurance ceded
Cash with Bankers on
Deposit (short-term) 20000 Claims
account
--By death (In India
Cash in hand 7000 2,00,000
1,30,000)
State Government --By maturity (In India
7,25,000 2,20,000
securities 1,40,000)
Furniture and Fixtures 39000 Bank Loan 21750
Outstanding premiums 66000 Salaries 30400
Auditor's fees 5000
Law charges 3400
Rent paid 3600
Other management
750
expenses
Travelling expenses 1950
Interest and rents
1,95,000
received (gross)
Proposed dividend @
10%
Transfer the surplus amount if any to Life Fund for the year ended 31 st March
2008. Dividend at the rate of 5% was also proposed.
354
Solution
Form A – PL
Profit and Loss Account for the year ended 31 st March 2008
Shareholder’s Account (Non-technical Account)
Notes:
Form A – BS
Balance Sheet As On 31st March 2008
Shareholder’s Account (Non-technical Account)
(B)Application of funds
Investments 8 40,00,000
(Shareholder's and Policyholder's)
Schedule 1
Premium
Notes:
Schedule 2
Commission Expenses
Notes:
Schedule 3
Notes:
Schedule 4
Benefits Paid (Net)
Total 5,01,750
Notes:
Schedule 5
Share Capital
1. Authorised Capital
Equity Shares of Rs. ...... Each
2. Issued Capital
Equity Shares of Rs. ...... Each
362
3. Subscribed Capital
Equity Shares of Rs. ...... Each 20,00,000
4. Called - up Capital
Equity Shares of Rs. ...... Each
Total 20,00,000
Notes:
Schedule 5A
Promoters
----Indian
----Foreign
Others
Total
Schedule 6
Reserves and Surpluses
1. Capital reserve
2. Capital redemption reserve
3. Share premium
4. Revaluation reserve
5. General reserve 2,25,000 2,25,000
Less: Debit balance in profit and loss A/c
Less: Amount utilised for buy back
6. Catastrophe Reserve
7. Other reserves (to be specified) Life fund 35,85,750 34,00,000
8. Balance of profit in profit and loss A/c --- ---
Total 38,10,750 36,25,000
364
Notes:
Additions to and deductions from the reserves should be disclosed under each of
the specified heads.
Schedule 7
Borrowings
1. Debentures/Bonds ---
2. Fixed Deposits ---
3. Banks 21,750
4. Financial institutions ---
5. Other entities carrying on insurance business 47,500
6. Others (to be specified) ---
Total 71,050
Notes:
The extent to which the borrowings are secured shall be separately disclosed
stating the nature of the security under each sub-head.
Amounts due within 12 months from the date of Balance Sheet should be
shown separately.
365
Schedule 8
Investments
Note:
Schedule 9
Loans
1. Security-wise classification
Secured
(a) On mortgage of property
(aa) In India 14,32,500
(bb) Outside India ---
(b) On Shares, bonds, Govt. securities etc. ---
Unsecured
(a) Loans against policies 2,10,000
(b) Others to be specified ---
Total 16,42,500
2. Borrower-wise classification
(a) Central and State government ---
(b) Bank and financial institutions ---
(c) Subsidiaries ---
(d) Companies ---
(e) Loans against policies ---
(f) Others to be specified ---
Total
3. Performance-wise classification
(a) Loans classified as standard
(aa) In India
(bb) Outside India
(b) Non-standard loans less provisions
(aa) In India
(bb) Outside India
Total
367
4. Maturity-wise classification
(a) Short-term
(b) Long-term
Total 16,42,500
Notes:
Short-term loans shall include those that are repayable within 12 months
from the date of balance sheet. Long term loans shall be the loans other than
the short term loans.
Provisions against non-performing loans shall be shown separately.
The nature of the security in case of all long term secured loans shall be
specified in each case. Secured loans for the purposes of his schedule, means
loans secured wholly or partly against an asset of the company.
Loans considered doubtful and the amount of provision created against such
loans shall be disclosed.
Schedule 10
Fixed Assets
Goodwill
Intangibles (specify)
Land-freehold
Leasehold property 63,300
Buildings
Furniture and fittings 39,000
Information technology
Equipment
Vehicles
Office equipment
Others (specify nature)
Total 1,02,300
368
Notes
Schedule 11
Cash and bank balances
Total 67,500
369
Schedule 12
Advances and other assets
Schedule 13
Current Liabilities
Schedule 14
Provisions
From the following balances appearing in the books of Alpha Life Insurance Co.
Ltd. prepare the Trial balance as at 31 st March 2010.
Amount
Sl.No. Head of Account
(in hundred Rs.)
Solution:
Credit
Sr No. Head of Account Debit
Rs. In Hundreds
1. Life Insurance Fund as at 1.4.1990 * 5,00,000 ( R)
2. Premium Deposits 11,500 (BS)
3. Building Depreciation Account 3,000 (BS)
4. Commission paid 2,505 ( R)
5. Income-tax paid 4,500 ( R)
6. Management Expenses 31,000 ( R)
7. Sundry Creditors 3,500 (BS)
8. Loans on Policies 32,500 (BS)
9. Dues from Agents 1,000 (BS)
10. Contingency Reserve 1,500 (BS)
11. Taxation Provision (Reserve) 3,000 (BS)
12. Interest, Dividends & Rents 18,000 ( R)
13. Registration & Other Fees 20 ( R)
14. Advance payment of Income-tax 500 (BS)
15. Refunds of Income-tax 600 ( R)
16. Furniture & Office Equipments reserve 400 (BS)
17. Sundry Deposits 1,000 (BS)
18. Printing & Stationery Expenses 770 ( R)
19. Loans on Mortgages 1,500 (BS)
20. Consideration for annuities granted 20 ( R)
21. House Property at cost 54,000 (BS)
22. Cash & Stamps on hand 300 (BS)
23. Annuities paid 60 ( R)
24. Death Claims paid 22,000 ( R)
25. Maturity claims paid 15,000 ( R)
26. Furniture & Office equipments at cost 2,500 (BS)
372
*The Closing balance of this head of account will find a place both in the
Revenue Account and in the Balance Sheet of the Company
Write the Journal Entries in respect of the following annual closing entries as at
31st March2010 :
Rs.
Solution:
Journal
Date J.V. Particulars L.F. Debit Credit
No. No. Rs. Rs.
From the following balances appearing in the Principal Ledger of Sunny Life
Insurance Co.Ltd., as at 31 st March 11, prepare the Trial Balance as at 31st March
11
Amount
Sr.
Head of Account (Rupees in
No.
Lakhs)
Solution
1. Provide for Reserve for Doubtful Debts in respect of sundry debtors Rs. 21
lakhs
2. Provide 2% as reserve for House Property.
3. Annuities due and unpaid amount to Rs. 15 lakhs.
4. Premiums outstanding in respect of renewal premiums Rs. 7753 lakhs.
5. Interest, Dividend & Rents accruing but not due as at 31 st March 91
amounted to Rs. 11200 lakhs.
6. Interest, Dividend & Rents outstanding as at 31 st March 11 Rs. 7500 lakhs.
7. Outstanding Management Expenses amount to Rs. 200 lakhs
8. Repudiated claims which are not recognised as liability Rs. 400 lakhs.
Solution:
Journal entries in the books of Sunny Life
Insurance Co. Ltd.
(Amt in Rs.)
Sr.
Particular Debit Credit
No
i) Transfer To Reserve For Bad & 21,00,000
Doubtful Debts … (Revenue) ….. (outgo)
To Reserve for Bad & Doubtful 21, 00,000
Debts (B/S) (Liability)
(Being the entry for making provision for Bad & Doubtful debts as at 31.3.11).
378
vii) No entry shall be passed in respect of this item. However, a note shall be
made after the Balance Sheet under the heading “Contingent Liability”.
379
From the following Trial balance of Mr. Santosh as at 31-12-2010 prepare Final
Accounts after making the necessary adjustments. Also give the closing and
adjusting entries.
Trial Balance
(Amount in Rs)
Debit Credit
89,600 89,600
380
Adjustments
Solution
Mr. Santosh's
Trading Accountfor the year ended 31-12-2010
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
68,000 68,000
381
26,798 26,798
382
Mr. Santosh's
Balance Sheet as on 31-12-2010
Liabilities Rs. Rs. Assets Rs. Rs.
55,459 55,459
383
Summary
Every life insurance company has to prepare Revenue Account as per Form
A-RA., Profit and Loss Account as per Form A-PL., Balance sheet as per
Form A-BS., and Receipt and payment A/c.
Every life insurance company shall have to follow the accounting standards
issued by the ICAI while preparing its financial statements.
It is to be remembered that any premium received by an insurer is not its
income as such. Rather, the company is creating liabilities against policies.
The value of investment property shall be determined at historical cost,
subject to revaluation at least once in every three years.
Debt securities shall be considered as held to maturity securities and shall be
measured at historical cost subject to amortization.
Loans shall be measured at historical cost subject to impairment provision.
Preparation of financial statements does not achieve its intended purpose
unless appropriate and reasonable disclosures are made at the right place.
Insurers can lay down accounting policies in line with the Accounting
Standard -17 and the Regulations issued by the Authority.
No catastrophe reserves have been prescribed by the IRDA till now.
The insurers are required to deduct the preliminary expenses from the paid
up equity share capital as indicated in Schedule 5 of the Regulations
The expression "liability" shall include all liabilities in respect of expenditure
contracted for and all disputed or contingent liabilities.
Any debit balance of the Profit and Loss Account shall be shown as
deduction from uncommitted reserves and the balance, if any, shall be shown
separately.
The main purpose of the management report is to assure the readers of the
financial statements about the business and financial prudence observed by
the management while carrying out the business of the insurance company.
The auditors will be verifying cash on hand as at close of the accounting
year.
There should be no attempt to reconcile Bank Accounts by transferring any
un-reconciled balances to “Suspense Account”.
There should be a physical stock checking of stock on hand of printed forms
and Stationery, other Stationery, publicity material remaining unused,
saleable Literature and Publicity materials, stock of Building materials.
Schedule of policy loans as at the close of the year should be extracted from
the loan ledgers.
The schedule showing salaries paid in advance should be prepared.
384
Answer to TY 2
All the securities are transferred to policyholders account at cost or market price,
whichever is lower. This is in line with the principle of conservatism. It prohibits
from booking unrealized profits in the books of accounts.
Answer to TY 3
The debit balance in Profit and loss account (which means a loss) has to be
adjusted by reduction from any uncommitted reserve.
Answer to TY 4
Answer to TY 5
Answer to TY 6
The first step in the reconciliation of bank balances as per books with the bank
balances as per bank statement is obtaining a certificate of balances from all the
banks having the insurer’s account. Without this step, the process of
reconciliation cannot commence.
Answer to TY 7
It is true that imprest cash system should be followed for small cash balances.
Supplementary cash book must be incorporated in the main cash book. Stamp
records fall under ‘cash’ records only.
Answer to TY 8
One of the peculiar features in case of finalizing and verifying the expenses is
that the amount of expense should tally with the amount in principal ledger. If it
does not tally, there is some error in the accounting procedure.
Answer to TY 9
Answer to SEQ 2
The premium received from business concluded in and outside India should be
separately disclosed. Other options are not right with respect to such premium
incomes.
Answer to SEQ 3
Income from rent includes only the rent which has been actually realized. It must
not include the notional rent.
Answer to SEQ 4
Answer to SEQ 5
The vouchers relating to the expenditure of the previous year should be rubber
stamped as “Outstanding”.
388
CHAPTER 8
Chapter Introduction
This chapter aims to provide an understanding of budgeting. Planning an optimal
budget requires realistic forecasts, proper analysis of available historical data and
the ability to make smart estimates. Budgets help the organisation to forecast
what will be the future financial result if certain strategies or changes are
implemented.
a) What is a budget?
b) Explain the types of budgets.
c) Explain how budgeting is done in an insurance company.
d) Describe budgeting activity and performance budget.
e) Explain performance review and financial ratios.
389
1. What is a budget?
[Learning Outcome a]
1.1 Budget
A budget is prepared and approved before the start of the accounting period
(known as the budget period).
The budget for the year 2012 needs to be prepared before the start of 2012, i.e. by
the end of year 2011.
It is all about planning for the future period and controlling the activities
(and in turn the costs) of an organisation by pursuing management policies.
b) Identify the steps necessary in order to achieve the objectives and work out a
detail course of action with exact planning.
XYZ Ltd has given the reponsibilty to Ram to prepare a budget for the company,
keeping in mind the shortcomings they faced in their last budget, which need to
be ovecome, resulting in better profits and improved financial performance.
v) Understand the actual profitability of the organisation and how the business
might perform if certain policies or changes are made.
i) Minimize all losses and wastages to have better and much improved
efficiency.
ii) Provide motivation to achieve organisational goals and set targets on which
the performance of the people will be judged.
iii) Better planning and control of the work so there is no delay in execution.
iv) To keep a check on the amount of the expenditure that has been budgeted. If
the expenditure crosses the budgeted amount, it should be analyzed even
before it’s incurred.
v) Appropriate classification of the actual work that all the people have to do.
There should be no overlapping and no work should be left unfinished.
vi) Comparison of actual and budgeted performance which will show where
supervision is needed.
392
b) The period of budget must be fixed. Usually, a budget is drawn for a year.
c) Factors that usually affect the working of the organisation must be identified.
Normally, sales are a limiting factor, but sometimes other factors like capital,
problems with labour or raw materials also have an impact on the working of
an organisation.
e) Budget should be flexible and it should be in a way that can be molded into a
new budget with further changes to it. It should adapt quickly if the actual
business conditions differ from what was expected.
393
1. Sales budget
The sales department is responsible for making the sales budgets which includes
the various products, periods and areas. With the help of past trends, facts and
figures, the sales budget is estimated for the future.
The contribution of all the members of the organisation is necessary as the sales
forecasting is the initial stage, and involves:
People accountable for leading the entire budgeting and planning and with
leadership, direction, and correctness to the expected forecast.
394
Finally, the approval and support of top executives for the plan.
The sales budget is very important while planning; any inaccuracy in this has a
huge impact financially. Hence, proper steps should be taken to develop the sales
budget. The sales budget is expressed in terms of number of units and expected
revenue.
Quarter
1 2 3 4
Budgeted Sales of
10,000 40,000 25,000 60,000
boxes
Expected total
250,000 10,00,000 6,25,000 15,00,000
sales
2. Production budget
After the sales budget has been drawn by the sales department, the production
budget is prepared. It specifies the needed quantity of units that has to be
manufactured in each budget period so that the products are available for sale.
While deciding the production budget, inventory levels in each budget period are
crucial and hence, inventories must be calculated and added carefully. There
should be no unnecessary inventory held, and at the same time, there should be
no shortfall.
395
Quarter
1 2 3 4
To determine the minimum and maximum stock level, Last in First out (LIFO) or
First in first out (FIFO) methods are used by an organisation.
The budget helps to maintain the minimum and maximum stock needed from
time to time so that the material is available and the production does not stop.
It is necessary to have a complete list of required materials to produce one unit of
finished product. Purchase budgets are a part of decision making and thus, very
important in deciding the level of inventory.
396
Continuing the above example of ABC Co, below is the purchase and material
budget
Quarter
1 2 3 4
The time and motion study department helps to determine how much labour is
needed to produce one unit of output. Apart from labour, various other expenses
of production are divided into the following categories:
Fixed Expenses
Variable Expense
Semi-Variable Expense
Continuing the above example of ABC Co, below is the work expense and labour
budget
Quarter
1 2 3 4
Other expenses that are not a part of the manufacturing expenses are included
under the office and administrative budget. All work expenses and office
expenses that cannot be added to the manufacturing expense are included here.
Apart from the existing products for sale, there should be a budget that estimates
the cost for research of new products and development of existing products. New
and improved methods of production must be used.
7. Capital Budget
8. Cash Budget
Cash budget is the most important budget for the management. Cash budget is a
comprehensive statement showing how the cash funds will be generated and how
they will be spent. It is prepared after all the functional budgets are ready. Cash
budget shows the inflows and outflows of cash in the organisation.
Cash sales, other receipts, dividend, interest income or disposal of asset are all
examples of cash inflows.
After all, the operational activity of cash inflows and outflows is done if there is
any cash surplus or deficit it should be reported to the management. The
management then should take a decision if any additional working capital is
required in case of deficit or if there is any surplus of cash, the management
should decide if investments are to be made or how to maintain the extra cash.
9. Master Budget
Operating Budget
Capital Budget
Expenditure Budget
Cash Budget
Projected financial position.
1. Budget review
The budget that has been prepared needs to be reviewed constantly to check and
be sure that there are no discrepancies or any other shortfall which may lead to
deviation in the budget. The budget loses its importance, and it is of no use if its
not been reviewed. Review, control and comparison is sine-qua-non of budgeting
excerise.
2. Flexible Budget
Normally a fixed budget or static budget is inflexible as its based on one level of
activity and a particular set of strict conditions which do not change and are not
helpful for contol. But a flexible budget is opposite to this; the word flexible
itself means elastic. A flexible budget is designed in a such way that it can adapt
to any condtions and provide information for different levels of activty.
What two methods are used by an organisation to maintain the minimum and
maximum level of inventory?
The role of Branch office at the base has undergone a sea change after the
reorganisation of offices in LIC. A Branch office is now treated as:
a) Growth Center
b) Profit Center
c) Single window Servicing Center
Thus, the Branch office is concerned with the increase in the profit by increase in
the level and mix of business, keeping the cost of administration at a specific
level. For this, a ‘Planning and Performance Budgeting’, a detailed budget, has
been introduced in LIC.
Thus we can say that to achieve these objectives, a short tem plan as well as a
long term plan of growth is essential. The long term plan is typically of 3 years
and involves preparation of profile of the Branch office whereas the short term
plan is a Performance budget of 1 year only. A Performance budget is like the
Master Budget.
To assess the likely growth of New business, the Divisional Office will help
branch offices to make a profile showing:
403
While planning for the budgeting, the preparation of the profile of the Branch
office is a long term plan of and short term plan of for the
performance budget.
i) Before the commencement of the financial year, the Chairman of LIC will
issue guidelines 2-3 mths in advance. He will analyze the overall economic
situations and trends, specifying corporate goals to be achieved in all key
areas like New Business, Premium Income, Claims Operation, Clearance of
Policy Deposits etc.
ii) On the basis of the above guidelines, each Zonal Office will frame its own
guidelines to correspond to circumstances in various Divisional /Branch
offices in its jurisdiction.
iii) When Branches have prepared their performance budget, they will submit it
to the Divisional Office. The divisional office will then analyze the budget
and hold a discussion with each Branch Manager. After the budget is agreed
upon by all, then the Budget for the Divisional Office will be prepared.
iv) The Divisional Office in turn will discuss their budget with the Zonal Office,
and after the Zonal Budgets are completed by the Central office, the
Divisional Office will be informed of the approved budgets.
Budgets prepared under this are expected to have much better and superior
degree of participation and commitment on the part of concerned employees and
will have a favourable motivational influence in organisation.
We have already studied that the Branch office prepares a short term budget of 1
year, called the performance budget. The performance budget can be divided into
four main parts:
The Growth Budget
The Finance Budget
Customer Service Budget
Capital Budget
405
Under the restructured system of working, the Divisional office does not have a
source of income other than the income earned by way of interest on mortgage
loan and rent. Thus, the budget of the divisional office is mainly an Expenditure
Budget whereas the Finance budget is prepared with Income, Expenditure, and
customer services in a combined, collective proposal.
The consolidated budget is then discussed with the Zonal Authorities and the
same strategy is planned for the entire zone; the budget is then finalized for all.
A 3-4 months
B 1-2 months
C 2-3 months
D 2-4 months
A Budget is prepared to plan and forecast the strategy for an organisation. Thus,
a budget is prepared with all details and figures to achieve goals that are put
before the organisation. After the budget is prepared and approved by the person
responsible, it is broken down into monthly targets, and thus, is a ‘live’
document.
This live document is monitored to see whether it is on the right path and there
are no discrepancies in it. If the budget is not reviewed, it loses its importance.
Hence, actual comparisons with the budgeted figures are necessary. All Branches
and divisional offices are required to send observation report in the form of
monthly and quarterly reports (as per the Report Format) to the controlling
Divisional and Zonal Offices.
407
After the re-organised set-up, the Branch Office is an operating unit and the
Divisional Office is the controlling office.
The Divisional offices have to evaluate any variations between the actual and
targeted figures by classifying them into margianl, fairly large or very wide.They
also have to find the resasons for the lack of performance and adopt corrective
measure.
The different types of ratios that are required by the branch office while
preparing budget targets are as follows:
The idea of the Budget and Review is to accomplish the objectives agreed to by
each unit. A Monthly Report in the Reporting Format to Zonal Office and Central
Office is submitted by Divisional Offices on the basis of performance. This
report is like management information to the Zonal Office and Central Office.
The success of any business depends on the participation of all those who are
responsible for it. For an insurance company, to achieve the desired goal, every
member of the Supervisory Staff, other staff-members and Managers must
participate in the preparation of budgets and control of operations.
A 15%
B 10%
C 20%
D 25%
410
Summary
Answer to TY 3
Answer to TY 4
Answer to TY 5
Self-Examination Questions
Question 1
Under the re-organised set-up, the Branch office is the controlling office.
A True
B False
Question 2
A Income Budget
B Growth Budget
C Expenditure Budget
D Capital Budget
412
After the re-organised set-up, the Divisional office is the Controlling office and
the Branch office is the Operating office.
Answer to SEQ 2
There is no source of income for the Divisional office other than the income
earned by way of Interest on mortgage loan and rent. Thus, the budget of the
divisional office is mainly an Expenditure Budget.
413
CHAPTER 9
Chapter Introduction
This chapter aims to provide you with an understanding of the concept of value
added statement and its advantages and limitations. The chapter also discusses
the concept of human resource accounting and the different models of human
resource accounting.
In economic terms, value added is the market price of the output of an enterprise
less the price of the goods and services acquired by transfer from other firms.
Value added can provide a useful measure in the gauging performance of the
reporting entity.
Value-added
Income 22,742 21,693 4.8
Less: Operating expenses
excluding personnel costs
Software development and
business process 1,461 1,656
management expenses
416
Note: The figures above are based on the consolidated Indian GAAP financial
statements.
417
A NVA = S + B + Dep = R – W – I – T – DW
B NVA = S – B – Dep = R – W – I – T – DW
C NVA = S – B – Dep = R + W + I + T + DW
D NVA = S + B + Dep = R + W + I + T + DW
Few models have been suggested for the purpose of valuation of human assets.
This model is simple and easy to understand and satisfy the basic principles of
matching cost and revenue.
421
Disadvantages
This model distorts the value of highly skilled human resources. Skilled
employees require less training and therefore, will be valued at lesser cost.
Thus this model distorts the value of highly skilled human resources.
Replacement cost indicates the value of sacrifice that an enterprise has to make to
replace its human resources by the identical one. Flamholtz has mentioned two
different concepts:
The individual replacement cost refers the cost that would have to be incurred to
replace an individual by substitute who can provide the same set of services as
that of the individual being replaced.
The positional replacement cost refers to the cost of replacing the set of services
required of any incumbent in a defined position. Thus, the positional replacement
cost takes into account the position in the organisation currently held by an
employee and also future position expected to be held by him.
This model uses the opportunity cost i.e. if we put employee in alternative use, as
a basis for estimating the value of human resources, what will be value. In this
model, managers must bid for any scarce employee. A human asset, therefore,
will have a value only if it is a scare resource i.e. when its employment in one
division denies it to another division.
In this method the major drawback is circumstances in which managers may like
to bid for an employee would be rare.
This model was conceived by Lev and Schwartz in 1971. This model involves
determining the value of human resources as the present value of estimated future
earnings of employees (in the form of wages, salaries etc.) discounted by the rate
of return on investment (cost of capital).
Since an individual may not stay in the organisation throughout the period of his
productive service life, another measure of value i.e. expected realisable value,
has to be worked out. This is the amount actually expected to be derived taking
into account the person’s likelihood of turnover.
423
Jaggi and Lau proposed that proper valuation of human resources is not possible
unless the contributions of individuals as a group are taken into consideration. A
group refers to homogeneous employees whether working in the same
department or division of the organisation or not. An individual’s expected
service tenure in the organisation is difficult to predict but on a group basis, it is
relatively easy to estimate the percentage of people in a group likely to leave the
organisation in future. This model attempts to calculate the present value of all
existing employees in each rank.
HRA makes a systematic and scientific attempt to measure the value of human
resource of an enterprise and presents the information in the financial statements
in order to communicate the change in the value of human resources.
2) To evaluate whether the human resources are being properly utilised and
allocated and
Leading public sector units like OIL, BHEL, NTPC, MMTC, SAIL etc. have
started reporting ‘Human Resources’ in their Annual Reports as additional
information from late seventies or early eighties. Thus Indian companies adopted
the model of Human Resource Valuation propounded by Lev and Schwartz
(1971) with some modification because the Indian companies focused their
attention on the present value of employee earning as a measure of human
capital.
The below extract has been taken from the Infosys Annual Report 2009-10
We have used the Lev and Schwartz model to compute the value of human
resources. The evaluation is based on the present value of future earnings of
employees and on the following assumptions:
425
a) Employee compensation includes all direct and indirect benefits earned both
in India and overseas
b) The incremental earnings based on group / age have been considered
c) The future earnings have been discounted at the cost of capital of 10.60%
(previous year – 12.18%).
Inflation Accounting
As mentioned above, historical cost based accounts do not take inflation into
account. In hyper inflationary situation, profit of a company will be on higher
side if assets are purchased at lower cost and recorded on historical cost which is
not true, as replacement cost of assets will be much higher. Similarly historical
based accounting reflects assets at their historical cost instead of current cost. It
results in under-statement of net worth of an enterprise.
In India, Inflation Accounting has been used in a limited way. Only recently,
IRDA has come out with regulation that each life insurer should revalue its assets
once in 3 years to bring it near to current cost. However, this measure also does
not reflect inflation fully. The rate of inflation has been changing very fast and
presently it is rising day by day. Hence, according to experts, it is not considered
desirable to take cognizance of inflationary factors in accounting under the
present circumstances.
Summary
Value Added Statement is a supplementary financial statement that shows
how much value (wealth) a reporting entity has been able to create during a
specified period, through the utilisation of its capacity, capital, management,
human resources and other resources.
Gross Value Added is arrived from the following formula
R = S – B – Dep – W – I – T – Div
Net Value Added can be defined as Gross Value Added less depreciation.
Some of the advantages of VA statement are as follows:
Improves attitude of employees
Productivity linked bonus scheme
Diagnostic and predictive tools
Measure of the size and importance of a company
Contribution to national income
Basic conceptual foundation
Limitation of Value Added Statement
It is non-standardised
It cannot substitute the traditional income statement
Giving more weightage to shareholders in VA statement is not possible
Human resource reporting is an attempt to identify, quantify and report
investment made in human resources of an organisation that are not presently
accounted for under conventional accounting practice.
American Accounting Association has defined human resource accounting as
“the process of identifying and measuring data about human resources and
communicating this information to interested parties”.
Cost based models of HRA include:
Capitalisation of historical costs
Replacement cost
Economic value models of HRA include:
Opportunity cost
Discounted wages and salaries approach
Flamholtz model
Jaggi and Lau model
Inflation accounting is an accounting system that adjusts values for changes
in purchasing power.
Inflation accounting is an attempt to account for the price level changes and
adjust the financial statement accordingly.
IRDA has issued regulation that each life insurer should revalue its assets
once in 3 years to bring it near to current cost.
428
Answer to TY 2
Self-Examination Questions
Question 1
Value added statement shows wealth created by a reporting entity through the
utilisation of its .
Question 2
A Investment income
B Depreciation
C Extra ordinary income
D Total dividend payable for the year
429
Question 3
Question 4
Question 5
Value added statement shows wealth created by a reporting entity through the
utilisation of its capacity, capital, management, human resources and other
resources.
Answer to SEQ 2
Net value added can be defined as gross value added less depreciation.
Answer to SEQ 3
Value added statement cannot substitute the traditional income statement (i.e.
Profit and Loss A/c).
Answer to SEQ 4
Answer to SEQ 5
The Hekimian and Jones Model of HRA is known as opportunity cost model.
431
CHAPTER 10
ACCOUNTING STANDARDS
(APPLICABLE TO LIFE INSURANCE
COMPANIES)
Chapter Introduction
As with any profession, people who practice accountancy are expected to possess
certain expertise. Under this assumption, society accepts advice from
professional accountants in good faith and acts on this advice.
The main area in which this faith is evident is the reliance on financial statements
prepared by professional accountants. Readers should be able to accept them
without question and in turn base their decisions on them.
This study guide will discuss the basic contents of the accounting standards and
the terminologies like ‘historical cost convention’, ‘accrual basis of
accounting’.
Now, people want better reporting from these companies since it involves
their money and they wish to compare results with other entities.
A Recommendatory
B Mandatory
C Not applicable since IRDA can issue their own accounting standards
D Approved by the IRDA
AS
A S Title Applicability
No.
1 Disclosure of Accounting Policies Mandatory for all companies
2 Valuation of Inventories Mandatory for all companies
3 Cash Flow Statements Mandatory for specified
companies but encouraged for
others. Direct method is
adopted for General
Insurance Companies as per
IRDA regulations.
4 Contingencies and Events Occurring Mandatory for all companies
after the Balance Sheet Date (Stands
withdrawn pursuant to AS 29 except
those relating to impairment of assets
not covered by any other AS)
5 Net Profit or Loss for the Period, Mandatory for all companies
Prior Period Items and Changes in
Accounting Policies
6 Depreciation Accounting Mandatory for all companies
7 Construction Contracts Mandatory for all companies
8 Accounting for Research and Stands withdrawn pursuant to
Development AS 26
9 Revenue Recognition Mandatory for all companies
10 Accounting for Fixed Assets Mandatory for all companies
11 The Effects of Changes in Foreign Mandatory for all companies
Exchange Rates
12 Accounting for Government Grants Mandatory for all companies
13 Accounting for Investments Mandatory for all companies
other than General Insurers.
14 Accounting for Amalgamations Mandatory for all companies.
15 Accounting for Retirement Benefits Mandatory for all companies
16 Borrowing Costs Mandatory for all companies
17 Segment Reporting Mandatory for specified
companies including general
insurance companies.
18 Related Party Disclosures Mandatory for listed/specified
companies.
436
Now we will discuss the Accounting Standards which are broadly applicable to
the Life Insurance Industry. The Accounting Standards are discussed in detail
below along with its implications for financial statements.
Accounting policy refers to the specific accounting principles and the method of
applying those principles adopted by enterprises in the preparation and
presentation of financial statement. Accounting policy adopted by one enterprise
may be different from other enterprise. For example, some enterprise adopts
WDV Method of depreciation and some enterprise adopts straight line method of
depreciation.
a) Accounting assumptions
Due to an outdated production method, the demand for a product is reduced and
therefore the company has to reduce its production substantially. This affects the
going concern assumption.
438
The difference in accounting for an entity which is a going concern and that
which is not a going concern:
The value for an asset which
has to be sold forcibly
Section 209 of the Companies Act has been amended so as to provide that proper
books of accounts shall not be deemed to have been maintained by a company, if
the same are not maintained on accrual basis.
The term “Accrual” has been explained in the Accounting Standard I – (AS-1) as
under:
439
Revenues and costs are accrued, that is recognised as they are earned or incurred
[and not as money is received or paid] and recorded in the financial statements of
the periods to which they relate.
AS – 1
Almond Inc purchased goods on 5 December 2006, but paid the supplier on 8
February 2007. Here, Almond Inc became the owner of the goods on 5 December
2006 even though the payment was made later. Hence the purchase transaction
should be recorded on 5 December 2006.
440
Under the accruals system, all the elements of the profit and loss and the balance
sheet are recognised as follows:
Under this concept, it is assumed that Accounting Policies are consistent from
one period to another.
Until 2005, ICC Plc followed the reducing balance method (RBM) for charging
depreciation on assets. However, in 2006, the company calculated depreciation
according to the straight line method (SLM). Here, ICC Plc has not followed the
principle of consistency.
441
Red Co valued its inventory under the last in first out method (LIFO) until 2004.
But IAS 2: Inventories does not permit the LIFO method of inventory valuation
and is applicable to the accounting periods in 2005. Therefore the company has
to follow a different method for valuing inventory from 200 5.
Let us imagine that Keira Co makes cakes. Shali bought a cake and ate it. She is
now in a hospital suffering from food poisoning and all tests indicate that the
cake from Keira Co is to blame.
Shali decides to take legal action against Keira Co and demands payment of her
hospital bill from Keira Co. The lawyers have told Keira that it is virtually
certain that Keira will lose the case. In this situation, it would make sense for
Keira Co to put an additional legal expense in the financial statements, to cover
the potential cost of losing the legal case. Therefore, including the potential expense
of the legal case in the financial statements is the application of the prudence concept.
442
BBG Inc provided domestic staff to its directors. BBG Inc pays Rs. 1,000
directly to the staff. In the legal sense, these domestic personnel are employees of
BBG Inc but they are actually working for the directors. Hence, the wages paid to
the domestic staff should be treated as payments to the directors and not as
company expenses.
BBG Inc
Profit and Loss A/c - 1 Profit and Loss A/c - 2
Legal form accounted for Substance accounted for
Rs. Rs.
Sales 50,000 Sales 50,000
Cost of goods sold (30,000) Cost of goods sold (30,000)
Gross profit 20,000 Gross profit 20,000
Expenses Expenses
(including wages paid
to domestic staff) (11,000) (10,000)
Directors’ fees
(including wages paid
Directors’ fees (5,000) to domestic staff) (6,000)
Profit 4,000 Profit 4,000
vii) Materiality
Financial Statements should disclose all material claims. Materiality means
relative importance. Material items are important items that the users of the
financial statements must know. The financial statements should show all the
material items separately.
443
The concept of materiality relates to the time, efforts and the cost of accounting
in relation to the usefulness of the data generated. Materiality requires that only
those items which have a bearing on the determination of financial position and
computation of profit and loss during the accounting period should be recorded
and disclosed in the financial statements.
Gemini Plc is a large manufacturing firm. The total of the company’s debtors for
the year 2008 is Rs. 950,000. One of the company’s stationery providers to
whom Rs. 100 was given as advance, closed his business. It was clear that the
company would not be able to recover the advance. Here, considering the
company’s scale of operations, Rs. 100 is not a material amount. Hence, Gemini
Plc need not adjust the total debtors amount immediately. The financial
statements would still be fair.
Gemini Enterprises was penalised by the sales tax authorities for non-compliance
with tax rules. The penalty amount was Rs. 20,000. However, Gemini Enterprises
included this amount of penalty under miscellaneous expenses which amounted
to Rs. 50,000 excluding the penalty. Hence miscellaneous expenses inclusive of
penalty are Rs. 70,000 (Rs. 50,000 + Rs. 20,000).
Here, penalty forms 28.5% of miscellaneous expenses. Hence it is a material item
and must be disclosed separately.
Gemini Enterprises
SOCI
Materiality followed Materiality not followed
Rs. Rs.
Sales 10,00,000 Sales 10,00,000
Cost of goods sold (6,00,000) Cost of goods sold (6,00,000)
Gross profit 4,00,000 Gross profit 4,00,000
Expenses Expenses
Miscellaneous expenses (50,000) Miscellaneous expenses (70,000)
Penalty (20,000)
Profit 3,30,000 Profit 3,30,000
Payment of a penalty is a material item hence
should be deducted from miscellaneous
expenses and disclosed separately
444
Every enterprise including Life Insurance Companies has to adopt AS1 and has
to disclose its accounting policy at appropriate place preferably in the notes of
accounts.
Depreciation:
Assets whose actual cost does not exceed five thousand rupees are written off
in the year of acquisition, by retaining 1 per asset as book value.
Cost of Lease Hold properties have been amortised over the period of Lease.
445
Cash Flow Statement (or Receipt & Payment accounts) exhibits the flow of
incoming and outgoing cash and assesses the ability of the company to generate
cash and cash equivalents and ability to utilize the cash and cash equivalents
generated. It also assesses the liquidity and solvency of the company.
All life Insurance Companies (whether listed or unlisted) have to prepare cash
flow statement using Direct Method called Receipt and Payment Account
Cash Flow Statement has to be prepared for operating, Investing and Financing
Activities.
Before we move further, we should understand the terms which are used in a
Cash Flow Statement.
Financing activities are activities that result in changes in the size and
composition of owner’s capital (including preference share capital) and
borrowing of company.
Cash flows from operating activities are primarily derived from the principal
revenue generating activities of the enterprise.
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Purchase and sale of properties which has been kept for long period
Cash payment to acquire share, warrant, debentures etc. and sale of share,
warrant debenture etc.
Loan to companies and its repayment
Receipt of dividend, interest from above activities
Padmaja Ltd provides you the following information. Prepare a cash flow
statement using the direct method:
Particulars Amount
Sales for the year Rs. 50,00,000 (All sales in cash) 50,00,000
Cash paid to suppliers during the year 30,00,000
Selling and Administrative expenses paid in cash 2,00,000
Tax paid during the year 1,00,000
Cost of new Plant acquired and paid 4,00,000
Payment of Dividend 1,50,000
Opening cash balance 80,000
Closing cash balance 12,30,000
2.4 Accounting standard 5 - Net profit or loss for the period, prior
period items and changes in accounting policies
Extra ordinary items are those items of incomes and expenses which are clearly
distinct from the ordinary activities of the business. They are not expected to
recur in the future periods.
Ordinary activities are those activities which are carried out by a business entity
as a part of its business operations and include any incidental activities
undertaken to further the main ordinary activity.
Prior period items are those items of incomes or expenses which arise in the
current period owing to errors or omissions in the preparation of the financial
statements of one or more prior periods.
449
The term prior period items as defined in this statement refer only to income or
expenses which arise in the current period as a result of errors or omissions in the
preparation of the financial statement of one or more prior periods.
Disclosure of prior period is required for income tax purpose as expenses of prior
period are disallowed by income tax department.
Accounting policies are the specific accounting principles and the methods of
applying those principles adopted by an enterprise in the preparation and
presentation of financial statements.
Suppose there are two insurance companies, A Ltd and B Ltd. It may happen that
both these companies adopt different accounting policies for a given financial
item. It may also happen that the policies followed by these companies are
different for different accounting periods. If this happens, different users of the
financial statements of these companies will evaluate the companies differently.
However, if meaningful and consistent conclusions are to be drawn then a proper
disclosure of significant accounting policies of both these companies is a must.
450
The Daily Press Ltd was incorporated on 1 January 2009. The draft statement of
financial position for the year ended 2010 and 2009 is given below:
2010 2009
Rs. Rs.
Property, plant and equipment 434 358
Research and development 17 17
Other assets 1,349 1,350
Total assets 1,800 1,725
Workings
2009
Rs.
Retained earnings as given 75
Less: R & D expenses (17)
Balance c/f 58
vi) Accounting estimates are items in the financial statements which cannot be
measured with precision. In such cases an entity has to make a judgement to
estimate the value of these elements.
For example: Bad debts, inventory obsolescence (inventory that is slow moving
or difficult to sell), the useful lives of, or expected pattern of consumption of, the
future economic benefits in depreciable assets etc.
All items of income and expenses, which are recognised in a period, should be
included in the determination of net profit or loss for the period unless an
Accounting Standard requires or permits otherwise.
Diagram 4: Essence of AS 5
454
Useful life is either (a) the period over which a depreciable asset is expected to
be used by the enterprise or (b) number of production units expected to be
obtained from the use of asset by the enterprise.
Basis for providing depreciation must be consistently followed and disclosed. For
example if any insurance company is adopting Written down Method (WDV) it
should disclose that it is adopting WDV Method.
Depreciation Method used should be disclosed. If rates applied are different from
the rates specified in the governing statute, then the rates and useful life should
also be disclosed.
This standard deals with depreciation accounting and applies to all depreciable
assets, except to certain specified items to which special considerations will
apply. Different accounting policies for depreciation are adopted by different
enterprises. Disclosure of accounting policy for depreciation followed by an
enterprise is to be made.
Where the depreciable assets are revalued, the provisions for depreciation
should be based on the revalued amount and on the estimate of the remaining
useful lives of such assets. In case the revaluation has a material effect on the
amount of depreciation, the same should be disclosed separately in the year
in which revaluation is carried out.
If any depreciable asset is disposed of, discarded, demolished or
destroyed, the net surplus or deficiency, if material, should be disclosed
separately.
456
Disclosure requirements:
Fixed Asset is an asset held with the intention of being used for the purpose of
producing or providing goods or services and is not held for sale in the normal
course of business.
Fair market value is the price that would be agreed to in an open and
unrestricted market between knowledgeable and willing parties dealing at arm’s
length who are fully informed and are not under any compulsion to transact.
Gross book value of a fixed asset is its historical cost or other amount
substituted for historical cost in the books of account or financial statements.
When this amount is shown net of accumulated depreciation, it is termed as net
book value.
Capitalisation
Cost of fixed assets should include purchase price (including import duties and
other non-refundable taxes and levies) and directly attributable costs of bringing
asset to its working condition for the intended use. Trade discounts and rebate are
deducted for calculating purchase price. Self constructed assets are to be
capitalized at cost that are specifically related to the asset and those which are
allocable to the specific asset
Details Rs.
Purchase price 135,000
Freight 4,000
Installation 3,500
Trial run costs 4,200
Total 146,200
Administration and other general overhead expenses are usually excluded from
the cost of fixed assets because they do not relate to a specific fixed asset.
Therefore office rent is not considered in the cost of the machinery.
Revaluation
Answer
The previous reduction of Rs.5,000 must have been recognised in the profit and
loss account. The following entry should now be made:
The decrease should be recognised in the profit and loss account. However, if
there is a balance in the revaluation reserve in respect of that asset (which had
resulted from a revaluation performed earlier), such a decrease is recognised in
revaluation reserve account.
Answer
Other points
Profit & Loss on disposal of asset should be recognised in profit & loss
statement.
Disclosure requirements
All other post-employment benefit plans are defined benefit plans. Defined
benefit plans may be unfunded, or they may be wholly or partly funded.
Under these plans, i) the enterprise’s obligation is to provide the agreed
benefits to current and former employees and ii) actuarial risk (that benefits
will be less than expected) and investment risk (that assets invested will be
insufficient to meet expected benefits) fall on the enterprise.
To account not only for its legal obligation under the formal terms, but also
for any other obligation that arises from the enterprise’s informal practices.
To determine the present value of defined benefit obligations and the fair
value of any plan assets with sufficient regularity so that the amounts
recognised in the financial statements do not differ materially from the
amounts that would be determined at the balance sheet date.
462
To use Projected Unit Credit Method to measure its obligations and related
costs
To deduct the fair value of any plan assets from the present value of the
defined benefit obligation at the balance sheet date. Certain reimbursement
rights that do not qualify as plan assets are treated in the same way as plan
assets except that they are presented as a separate asset rather than as a
deduction from the obligation;
To limit the carrying amount of a defined benefit asset so that it does not
exceed the present value of any economic benefit available in the form of
refunds from the plan or reductions in future contributions to the plan;
Disclosure requirements
Details of disclosure Disclosed in
Amount of Long-term employee benefits Profit and Loss A/c
Amount of defined contribution plans Profit and Loss A/c
Describing the accounting policy
Amount of defined benefit plans
used and a general description
2.8 Accounting Standard 17 - segment reporting
Accounting Standard 17: Segment Reporting, defines segment in following
terms:
Standard has divided segment as follows
a) Business Segment
b) Geographical Segment
a) Business Segment
It is a distinguishable component of an enterprise providing a product or service
or group of products or services that is subject to risks and returns that are
different from other business segments.
Factors that should be considered in determining whether products or services are
related include:
the nature of the products or services;
the nature of the production processes;
the type or class of customers for the products or services;
the methods used to distribute the products or provide the services; and
if applicable, the nature of the regulatory environment, for example, banking,
insurance, or public utilities.
b) Geographical Segment
It is distinguishable component of an enterprise providing products or services in
a particular economic environment that is subject to risks and returns that are
different from components operating in other economic environments.
Factors that should be considered in identifying geographical segments include:
similarity of economic and political conditions;
relationships between operations in different geographical areas;
proximity of operations;
special risks associated with operations in a particular area;
exchange control regulations; and
the underlying currency risks
465
If there is reportable segment in the preceding period (as per criteria), same shall
be considered as reportable segment in the current year.
Under primary reporting format for each reportable segment the enterprise should
report external and internal segment revenue. Segment result, amount of segment
assets and liabilities, cost of fixed assets acquired, depreciation, amortization of
assets and other non-cash expense.
Saturn Ltd has identified the following segments: (All amounts in Rs.‘000)
External
25 2 6 20 23 23 99
sales
Inter-
segment 12 6 8 2 1 29
sales
Total
37 8 14 22 23 24 128
revenue
Segment
result
9 16 (3) (1) 6 8 35
(profit /
loss)
Segment
81 51 16 16 27 5 196
assets
467
Therefore segments Iron, Cement, Steel, Aluminium, Copper and Limestone are
reportable segments.
Workings
Accounting Standard 18: Related Party Disclosures defines Related Party and
Related Party Disclosures as follows:
Here, Key management personnel are those persons who have the authority and
responsibility for planning directing and controlling the activities of the reporting
enterprise. Relative means spouse, son, daughter, brother, sister, father and
mother.
Control aspect
Associate/Joint Venture
Ownership
Key management personnel & (e) Significant influence
469
Related party is a party which has the ability to control the other party or
exercise significant influence over the other party in making financial and/or
operating decisions.
Control means (a) direct or indirect ownership of more than 50% voting power
of an enterprise (b) control of the composition of the board of directors or any
corresponding governing authority in an enterprise, or (c) a substantial interest in
voting power and the power to direct, by statute or agreement, the financial and
operating policies of an enterprise
470
Key management personnel include those persons who have the authority and
responsibility for planning, directing and controlling the activities of the
reporting enterprise.
Following examples list out the transactions which may occur with the
related parties
Disclosure requirements
Summary
The Apex accounting body in India, the Institute of Chartered Accountants of
India, has taken the initiative in regard to standardising the Accounting
procedure.
Accounting Standards are standards which are applicable to prescribed
entities to standardize their accounting procedure so that accounts of entities
become comparable with other entities engaged in similar line of business
and lay down the principles on which accounting should be based.
The Institute of Chartered Accountants of India has so far issued 32
Accounting Standards.
Accounting policy refers to the specific accounting principles and the method
of applying those principles adopted by enterprises in the preparation and
presentation of financial statements.
Accounting policy adopted by one enterprise may be different from another
enterprise.
472
Answer to TY 3
There are basically two methods of preparing cash flow statements, (a) Direct, &
(b) Indirect. Out of these, the direct method is specifically used in the case of
accounting for insurance companies.
Question 2
Question 3
A Prudence
B Substance over form
C Materiality
D Consistency
474
Question 4
Which of the following is true with regard to a change in accounting policy?
A As a rule of thumb, all changes in accounting policies should be applied
retrospectively
B In the current year, the comparative figures of the previous year should be
adjusted to reflect the change. If this is not possible, the opening balance of
profit and loss should be adjusted as if the new policy had been applied since
the beginning
C As a rule of thumb, all changes in accounting policies should be applied
going forward only and no retrospective changes are required
D None of the above
Question 5
Which of the following items would require estimation?
(i) Bad-debts
(ii) Litigation settlement
(iii) Fair value of financial assets or liabilities
(iv) Disposal of investment
Recording the substance of the transaction comes under the concept ‘substance
over form’. According to the accrual system of accounting, expenses should be
recorded in the financial statements when there is a decrease in the economic
benefits whereas assets should be recorded when economic benefits will flow to
the entity.
475
Answer to SEQ 2
The correct answer is B.
Comparability of financial statements of different companies is an important
purpose of accounting standards.
Answer to SEQ 3
Prudence, substance over form and materiality are considerations for designing
accounting policies for an organization whereas going concern, consistency and
accrual are fundamental accounting assumptions.
.
Answer to SEQ 4
Answer to SEQ 5
Bad debts
Inventory obsolescence (inventory that is slow moving or difficult to sell)
The fair value of financial assets or financial liabilities
The useful lives of, or expected pattern of consumption of, the future
economic benefits in depreciable assets
476
CHAPTER 11
FINANCIAL ANALYSIS
Chapter Introduction
This chapter aims to provide an understanding as to why Financial Analysis is
needed for a life insurance company. You will also learn about the different tools
and techniques used for the analysis and the types of ratios used for calculation.
1. Annual Report
2. Directors Report
3. Auditors Report
4. Balance Sheet (B/S)
5. Profit and loss Account (P/L)
6. And schedules forming a part of the B/S and P/L
The main purpose of the Financial Statements is to aid in decision making. The
traditional view is that financial statements are prepared for the proprietors. But
from the last few years, this view has changed and financial statements have
become more user friendly. The users of financial statements can be divided into
two types:
478
They are the most important users of the financial statements. They can be
anyone - from a small individual investor to large companies or institutions like
nationalized banks or investment companies. They are the people who, after
studying the financial statements, select shares for buying and selling or retaining
at the correct time.
In order to monitor the growth of the company and its profitability, managers and
employees need financial statements. They use the statements to forecast future
salary with increase in perquisites, welfare activities and retirement benefits.
Thus, financial statement variables like Earnings Before Interest and Tax (EBIT)
and Profit after tax are very important. Users are also interested in knowing the
solvency position of the business, its abilities to meet challenges in future and the
growth prospects of the company.
3. Lenders/Other Suppliers
Lenders and suppliers study the financial strength of the company before giving
any loans. The financial statements provide information to lenders about the
liquidity, leverage and profitability of the company before determining the
amount of loan to be given. They require a security for the principal amount and
its repayment with interest.
4. Customers
Customers are the people to whom the company sells and maintains relations that
go on for years. The customer’s business feasibility may be dependent on the
feasibility of the business concern. Thus, customers are also interested in the
financial statements for their analysis.
479
Analysis means detailed study of the financial statements which involves careful
reading of the financial information contained and coming up with explanations
based on certain conclusions. This analysis and explanations are used by the
proprietor or by any other user group. The main aim of the financial statements is
to help the user in decision making.
Before the analysis of the financial statements, there are 3 important things that
must be known:
The purpose of the user
Part of financial statements or a particular portion to be analyzed
Method or technique to be used for analysis
The analysis may involve study of some comparable concerns at a particular time
i.e. Financial Year 1998-1999 or it may study only one particular firm over a
period of day 5 or 10 years, or it may cover both.
480
The IRDA has suggested that all Life Insurers must prepare financial statements in following manner for five years:
Miscellaneous
(A) Policyholders’ account: Total funds
Total investments
Yield on investments (%)
18 (B) Shareholders’ account:
Total funds
Total investments
Yield on investments (%)
19 Yield on total investments
20 Paid up equity capital
21 Net worth
22 Total Assets
23 Earnings per share (Rs.)
24 Book value per share (Rs.)
# Net of reinsurance
@ Net of losses
* Inclusive of interim bonuses, if any
482
Financial Statements contain many figures which cannot give any clear idea
about the financial position of the enterprise. It is the relation of a particular
figure to other figures or the change in figures from one period to another that is
important. To understand this relation and the changes, tools of financial analysis
are used. Following are the most commonly used techniques:
1. Horizontal Analysis
ABC Ltd.
Consolidated Balance Sheets
As at 31st March 2010 and as at 31st March, 2009
The Base Year in any set of data is always the first year being studied. For
example, from 2009 to 2010, ABC Ltd’s total assets increased by Rs.948 lakhs,
from Rs.4, 224 lakhs to Rs.5, 172 lakhs, or by 22.4 percent, computed as follows:
2. Trend Analysis
Data of Domestic and International net sales of ABC Ltd. together with a trend
analysis is given below:
ABC LTD.
Domestic and International Net Sales
Trend Analysis
Net Sales
[Rupees in lakhs] 2010 2009 2008 2007 2006
Trend Analysis
[in percentages]
Trend analysis uses the index number to show changes in related items over a
period of time. Two things are needed for calculating the index numbers i.e. base
year for the purpose of conversion and the index year with which to compare.
Let us calculate the Domestic Net Sales taking 2006 as the base year and 2010 as
the index year:
Thus, an index number of 129.00 means that the 2010 sales are 129.00% more
than the 2006 sales - or they are 1.290 times the 2006 sales.
ABC Ltd’s International Sales have been rising more quickly as compared to
the Domestic Sales.
Domestic Sales have hardly grown from 2006 to 2008 apart from a rise in
2010.
International Sales on the other hand have been rising substantially in every
year.
The above changes can be presented graphically also by taking ‘years’ on the
‘X’ axis and ‘percentage changes’ on the ‘Y’ axis.
3. Vertical Analysis
ABC Ltd.
Common Size Balance Sheets as at 31st March2010 and as at 31st March2009
2010 2009
Assets
Current Assets 83.9% 84.2%
Net Fixed Assets 16.1% 15.8%
Total Assets 100.00% 100.00%
Liabilities
Current liabilities 48.6% 33.8%
Secured loans 12.2% 14.5%
Total Liabilities 60.8% 48.3%
Vertical Analysis is more useful for comparing certain important elements in the
operation of business. It is also useful for identifying significant changes in the
elements from one year to the next year in comparative common-size statements.
Similarly, the common size statement can be used to draw a Profit and loss
account for each different item of expense and income. This can be presented
graphically in a pie-chart form also, and is mostly used for comparison between
companies.
4. Ratio Analysis
A ratio is the arithmetical relation between any two figures. Generally, a financial
ratio shows the inter relation between a number of items of financial information.
For example, suppose there is a direct relation between gross profit and sales
figures. Due to change in the ratio of gross profit to sales, there might be a
possibility that it would show that the business condition has changed or there
has been wrong accounting. So, in order to be accurate, there must be a study of
the basic data.
Ratios are indicators useful for:
evaluation of a company’s financial position and operations
making comparisons with results of previous years or with other companies
highlighting areas that need further investigation
analytical review
general understanding of the company and its environment
A ratio determined using at least one financial variable can be called a financial
ratio. Also, if both numerator and denominator are financial variables or if one is
a financial variable and the other is a non-financial variable, then still it is called
a financial ratio.
One variable from the Profit and Loss Statement and other from the Balance
Sheet (Mixed Ratio)
488
The above examples of ratios can be described on the basis of classification, but
normally, financial ratios are often classified according to their usage. It is
already seen that different users have different objectives, and some financial
ratios are often worked out to meet the objectives of each user group.
Hence, from the viewpoint of usage, we can have the following categories of
ratios:
i. Cash position
ii. Liquidity
iii. Working Capital /Cash flow
iv. Capital Structure or Structural Ratios
v. Profitability
vi. Debt Services Coverage
vii. Turnover
Annexure ‘A’ given in chapter 13 contains a list of different ratios that can be
worked out. But the main aim of ratios is to be used for interpretation and to
uncover new aspects of working for that business organisation.
Liquidity means the ability to convert any asset to cash within a short time
for pay out of short term liabilities. The inability to pay short term liabilities
affects its credibility as well as credit rating. It leads to commercial bankruptcy if
there is continuous default which eventually leads to sickness and dissolution.
Mostly, short term creditors and lenders are interested in knowing the liquidity
position of their financial stake.
1. Current Ratio
This ratio indicates whether the current assets will be able to generate
sufficient cash to pay off the current liabilities as and when they fall due.
Current assets
Current ratio =
Current liabilities
489
The current ratio mainly gives an idea of the company’s ability to pay back its
current liabilities i.e. short-term debt and payables with its current assets i.e.
cash, inventory and receivables.
The higher the current ratio, the more capable the company is of paying its
obligations. This is because a high current ratio depicts that the company has
more current assets as compared to its current liabilities.
Furthermore, a ratio less than 1 suggests that the company would be unable to
pay off its obligations if they fall due at that point.
The current ratio can give an idea of the efficiency of a company’s operating
cycle or its ability to turn its products into cash.
Current Assets
Current Liabilities
Creditors for goods and services + short term loan + outstanding expenses +
provision for taxation + bank overdraft + cash credit + proposed dividend +
unclaimed dividend
This ratio illustrates how the company’s liquid current assets can cover its current
liabilities. Since stocks or inventory are the least liquid of the current assets, they
are excluded.
Ratios that are ideal for a company depend upon the industry in which the
company operates. Generally a current ratio of 2:1 is considered to be
reasonable. If inventories can be quickly converted into cash then a lower
current ratio of around 1 is acceptable.
Some business sectors successfully operate with current ratios of less than one.
490
Acid test ratio i.e. quick ratio is a precise test that indicates whether a firm has
enough short-term assets to cover its immediate liabilities without selling
inventory.
Quick Liabilities mean – Current Liabilities less Bank overdraft less cash credit.
The following information is extracted from the financial statements of Ram Ltd.
20Y0 Rs
Accounts receivables 54,000
Accounts payables 14,000
Inventories 30,000
Property, plant and equipment 79,000
Bank overdraft 12,000
Cash 10,000
Short-term loan 7,600
Capital structure ratios normally focus on the long term solvency position of the
business and one of the important ratios among this is Debt- Equity Ratio.
Debt Equity ratio means long term borrowed funds whereas equity refers to
owners’ equity i.e. share capital, preference share capital and reserves.
This ratio measures the percentage return to the company on the funds it had
employed, and is a good indication of the profitability of the organization. It is
also a useful overall measure of the capability of the management.
The financial goal of the company for 2008: ROCE of 10% (minimum)
ROCE 9%
Operating profit margin 5%
Asset turnover ratio 1.8
PBIT
ROCE
Capital Emlpoyed
480
x 100
5647
= 8.50%
493
Particulars Rs
Profits after interest and taxes 500,000
Preference dividend 40,000
Ordinary share capital of Rs. 1 each 100,000
Working Note 1
Working Note 2
No. of ordinary shares = Total ordinary share capital /Face value per share
Lenders are interested in knowing the debt service coverage to judge the firm’s
ability to pay off the current interest and the installment towards repayment of
loan.
If EBIT = Rs.5.90 lakhs, Interest = Rs.50, 000.00 and Installment = Rs.5 lakhs.
4. Turnover ratios
If sales = Rs.800 lakhs, Net Fixed Assets = Rs.175 lakhs and Current Assets =
Rs.195 lakhs,
Thus we can say that for every 1 rupee of asset, the sale generated is Rs.2.16. A
higher ratio indicates that more revenue is generated per rupee of investment in
assets.
495
A Bar Diagram
B Pie Chart
C Column Diagram
D None of the above
We have already studied a number of ratios that are used for analysis and each
and every ratio used for calculation has its own significance. Let’s look at the
basic uses of financial ratios.
Long term solvency can be calculated with the help of financial ratios. When we
say long term solvency, it means the ability of the company to survive for many
years. The idea for the use of long term solvency analysis is to point out clearly
well in advance whether a company is on the road to bankruptcy.
Studies have shown that financial ratios can predict, up to 5 years in advance,
that a company may fail. Fall in profitability and liquidity ratios are the two
possible signs of business failure. Similarly, we also have indicators like debt to
equity ratio and interest coverage ratio which show whether the business is on the
road to failure.
A very good deal of work has been done in the USA to predict as to how
corporate insolvency takes place by using financial ratios. These empirical
studies are of the following types:
496
Owing to widespread sick industries in India, these studies are being proved to be
more useful. For the monitoring of sick industries (special provision) Act 1985
has been introduced. According to the Act, Board for Industrial and Financial
Reconstructions (BIFR) has been developed to find necessary diagnostics and
remedial measures.
Ratios are of great help in planning a budget for an organisation. This is because
a budget is an estimate of the present activity, based on the past activity
experience with an aim of improving. It can be used for measuring the actual
performance as against the budget activity or targets.
They can know by interpreting and comparing ratios whether there has been
wrong accounting.
Help in assessing performance of the unit being audited.
Minimises routine checking.
Helps in presenting final results.
Although ratio analysis is a widely used technique for evaluating the financial
performance of an enterprise, it is not free from limitations. Some of the
limitations are:
1. Changes in the price level affect the validity of comparison since historical
cost values may be substantially different from true values.
1. Financial ratios continuously change with the variations in the price levels; in
a dynamic economy, the price levels rarely remain constant. This is one of
the most important drawbacks of the financial ratios.
solvency can be calculated with the help of financial ratios to know the
ability of the company to survive.
A Short term
B Long term
C Cash
D None of the above
Ratios are calculated for two or more than two years and then they are
compared with other units.
Even the corporate ratios are interpreted and based on the indications
received, and corrective action is taken.
Sometimes some of the ratios are calculated monthly for observing the trend
of movement in various indices, and for taking remedial action promptly.
Fall in the ratio indicates that either large number of policies have been
issued under long term plans or more policies have been issued in the
quarterly or half-yearly mode
In order to improve the ratio, product-mix has to be changed
Part wise study will have to be undertaken for taking necessary action.
499
Fall in this ratio indicates lapse of new business. Steps should, therefore, be
taken for conservation of New Business.
(Deposits and Premium of both life insurance and pension groups schemes
business – Ratio can be calculated separately for Life and Pension and Group
Schemes)
Ratios higher than those stated above may indicate that excess provision is made
in the current year or an under provision was made in the previous year.
Thus, we saw that ratios play an important role in life insurance. Ratios help:
4. Commission Ratio
502
A 90%; 25%
B 60%; 35%
C 100%; 15%
D None of the above
503
The sales and other revenues are inflows of funds and, therefore, the sources
of funds and various expenses are outflows.
Profit being an excess of revenue over expenses, is a source of fund, whereas
loss is an application of fund.
Funds are sometimes interpreted as cash.
The most common way to define ‘funds’: as being equal to working capital
that is current assets less current liabilities.
Funds flow statements are prepared on the basis of financial data. Given below
are comparative balance sheets as at 31 st March, 1997 and as at 31st March, 1998
of PQR Ltd. The third column shows the change in respective items.
[Rs. In
Particulars 31.3. 2009 31.3.2010 Lakhs]
Net Change
Share Capital 1,000 1,000 -
Reserve Fund 3,140 3,250 + 110
Other Reserves 5,090 8,180 + 3,090
Long Term Loans 6,030 11,820 +5,790
Short Term Loans 2,000 1,600 - 400
Current Liabilities and 10,490 11,160 + 670
Provisions
Total 27,750 37,010 +9,260
[Rs. In
Particulars 31.3. 2009 31.3. 2010 Lakhs]
Net Change
Fixed Assets 16,420 26,220
Less : Depreciation 7,510 8,670
Net Fixed Assets 8,910 17,550 +8,640
Stock 5,600 7,450 +1,850
Debtors 10,090 5,960 -4,130
Cash and Bank balances 1,850 2,950 +1,100
Investments 1,300 3,100 +1,800
Total 27,750 37,010 +9,260
The above statement showing ‘net changes’ in different items of balance sheet is
presented below in the form of “Sources and Application of Funds”.
505
On the basis of the above statement, a statement of net change in working capital
can be worked out, as shown below:
i)
[Rs. In
Change in Current Assets
Lakhs]
Increase in Stock 1850
Increase in Cash and Bank Balances 1100
Increase in Investments 1800
Total Increase 4750
Less : Decrease in Debtors 4130
Net addition to current assets 620
……A
ii)
Change in Current Liabilities [Rs. In
Lakhs]
Increase in current liabilities and provisions 670
Less : Decrease in short term loan 400
Net increase in current liabilities 270
.……B
iii) Net Change [Increase] in working capital i.e. [A-B] = 350
The above statements were derived from the data given in the balance sheets.
506
In contrast to fund flow statement, cash flow statements are prepared to explain
the cash movements between two points of time.
i) In the initial years, AS-3 will be recommendatory in nature, and the standard
is recommended for use by companies listed on a recognized stock exchange
and other commercial, industrial and business enterprises in the public and
private sectors
ii) The statement deals with the provision of information about the historical
changes in cash and cash equivalents of an enterprise by means of a cash
flow statement which classifies cash flows during the period from operating,
investing and financing activities.
iii) An enterprise should prepare a cash flow statement and should present it for
each period for which financial statements are presented.
iv) A cash flow statement when used in conjunction with the rest of the financial
statements provides information that enables users to evaluate the changes in
net assets of an enterprise, its financial structure [including its liquidity and
solvency] and its ability to affect the amounts and timing of cash flows in
order to adopt to changing circumstances and opportunities.
Cash equivalents are short term, highly liquid investments that are
readily convertible into known amounts of cash and which are subject to
an insignificant risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
507
Investing activities are the acquisition and disposal of long term assets
and other investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and
composition of the owners’ capital [including preference share capital in
the case of a company] and borrowings of the enterprise.
vi) The cash flow statement should report cash flows during the period classified
as operating, investing and financing activities.
vii) An enterprise should report cash flows from operating activities using either
The direct method whereby major classes of gross cash receipts and
gross cash payments are disclosed, or
The indirect method, whereby net profit or loss is adjusted for the effects
of transactions of a non-cash nature, any deferrals or accruals of past or
future operating cash receipts or payments, and items of income or
expense associated with investing or financing cash flows.
viii) An enterprise should report separately major classes of gross cash receipts
and gross cash payments arising from investing and financing activities
subject to certain exceptions under which they are reported on net basis.
ix) The cash flows associated with extra-ordinary items should be classified as
arising from operating, investing or financing activities as appropriate and
separately disclosed.
xi) Cash flows arising from taxes on income should be separately disclosed and
should be classified as cash flows from operating activities unless they can be
specifically identified with financing and investing activities.
508
Summary
The users of financial statements can be divided into internal and external
users.
The main aim of the financial statements is to help in decision making for the
user.
Horizontal analysis gives us a better idea about working of organisation from
different viewpoints.
In the long run, Trend analysis is crucial because it shows the basic changes
in the nature of business.
A common size statement normally is a financial statement containing
monetary data expressing percent to total.
Financial ratios show the inter relation between number of items of financial
information.
Ratios are used for making comparison with results in previous years or with
other companies.
A ratio determined using at least one financial variable can be called a
financial ratio.
The inability to pay short term liabilities affects the credibility as well as
credit rating of the organisation.
The current ratio can give an idea of the efficiency of a company’s operating
cycle or its ability to turn its products into cash.
Univariate helps to find out the predictive ability of an individual.
Multi-variate considers that several ratios are simultaneously needed to
predict corporate insolvency
Ratios should only serve as a guide for taking corrective action and not as a
substitute for judgement.
A standard input- output ratio can be established to show relation between
raw materials of a specific quality.
Profit being an excess of revenue over expenses, is a source of fund, whereas
loss is an application of fund.
The cash flow statement should report cash flows during the period,
classified as operating, investing and financing activities.
510
Answer to TY 2
Answer to TY 3
Long term solvency means the ability of the company to survive for many years.
Answer to TY 4
The prefered CR ratio must be near 100% and RER should be 15%.
Answer to TY 5
Self-Examination Questions
Question 1
Question 2
2010 Rs
Accounts receivables 64,000
Accounts payables 24,000
Inventories 40,000
Property, plant and equipment 79,000
Bank overdraft 6,000
Cash 20,000
Short-term loan 9,600
A 3.10
B 3.13
C 3.03
D 2.75
Question 3
Use the above data of Amco Ltd. and calculate the quick ratio.
A 2.50
B 2.96
C 2.05
D 3.14
512
Question 4
If EBIT = Rs.6.90 lakhs, Interest = Rs.60, 000.00 and Installment = Rs.5 lakhs:
A 1.23
B 1.56
C 1.26
D None of the above.
The ‘Total Figure’ in the statement is considered equal to 100% and then each
factor of percentage is compared with the total; this is called a Common Size
Statement.
Answer to SEQ 2
Current assets
Current ratio =
Current liabilities
Answer to SEQ 3
Rs1,24,000 - Rs40,000
Rs39,600 - Rs6,000
Rs84,000
Rs33,600
=2.50: 1
Answer to SEQ 4
CHAPTER 12
Chapter Introduction
This chapter aims to provide you with an understanding of the liberalisation of
the insurance sector and finance sector in India. The chapter also explains the
Indian financial system and its components: capital market, money market,
insurance market, mutual funds and banking system.
After the liberalisation of the insurance sector in 1999, in addition to the public
sector life insurer - Life Insurance Corporation (LIC) of India - 23 more life
insurers have entered into life insurance business (as on March 2012). IRDA has
been set up to regulate and oversee the business of the insurance sector. Before
liberalisation, Life Insurance Corporation (LIC) was allowed to procure business
through traditional plans like:
Endowment plans,
Term insurance plans,
Money back plans etc.
Disposable premium for investment was not much and investment of insurance
premium was regulated through the Insurance Act, which mandated that more
than 75% of premium investment should be in Government Securities.
After liberalisation, IRDA has allowed all life insurers (including LIC) to come
out with new and innovative products with freedom to invest according to
objectives of the products. Some of the innovative products include:
unit linked insurance plans where the premium (after deducting charges) is
invested in funds as per options given by policyholders
health insurance plans
pension plans
micro insurance plans etc.
IRDA has laid down premium investment guidelines based on which the
insurance companies can invest the premium collected from policyholders.
Along with the liberalisation of the insurance market, our capital market has also
been liberalised after 1991. Before 1991, only few instruments were available for
investment and choices were limited. Hence, there was little scope of financial
management which may give better return to all stakeholders (including
policyholders).
516
Apart from various other factors, some of the public sector units became sick and
the huge investment in certain undertakings did not bring adequate returns. In
many cases, losses were incurred owing to various reasons such as:
labour unrest,
strikes,
inefficient work force,
absence of professional management etc.
In recent times, many changes have taken place in the world in respect of the
strategies for economic development.
Owing to a revolution in communication, the world has come closer and
furtherance of global trade and commerce through liberalisation in policies
has been accepted in principle by developing countries, including India.
Post 1991, reforms have been introduced and the Government of India has
adopted a policy of liberalisation and invited foreign capital for speedy
development of industries and removed a large number of restrictions on
foreign investments.
Financial management concepts have been greatly influenced as a result of
the competitive environment in industries, trade and commerce.
A Annual plans
B Three year plans
C Five year plans
D Seven year plans
518
a) Primary Market
When the company offers shares to the public for the first time, it is known as
Initial Public Offering (IPO). Subsequent offer/s made by the company to the
public is known as Follow-on Public Offering (FPO).
Primary Market
Shares offered by the company through the IPO route or FPO route are in the
primary market.
520
In the IPO and FPO method of offering shares, companies sell equity or bonds to
the public through a fixed price option or book building process. In a fixed price
option, shares are issued at a fixed price. In a book building process, a specified
price band is determined by the issuer. Final issue price is decided on the basis of
bids received at various levels within the price band.
All insurance companies are allowed to participate in the primary market. Over
the last few decades, LIC has been an active player in the primary market and has
participated in many IPOs and FPOs.
Share allotment
After the ‘issue closing date’, the allotment of shares is finalised, and the over-
subscription money is refunded.
Trading of shares
On the listing date, the trading of shares starts on the stock exchange. The
Bombay Stock Exchange and the National Stock Exchange are the two primary
stock exchanges in India. After listing, buying and selling of shares happens
through the stock exchange. This is known as the secondary market.
b) Secondary Market
Trading
Once shares / bonds are allotted to investors, trading in these securities happens
through the exchange i.e. sale and purchase happens through stock exchanges.
Brokers:
Sale and purchase of shares / bonds are allowed only through registered
intermediaries or members. These intermediaries or members are known as
brokers.
Taxation:
Securities Transactions Tax (STT) is payable on the sale and purchase of shares.
No long term capital gain tax is payable where shares are held for more than 12
months.
i) Regulator:
SEBI is the capital market regulator in India. SEBI, along with its members,
works towards orderly growth of the capital markets and ensures the smooth
functioning of the capital markets. SEBI also plays the role of a watchdog.
ii) Dematerialisation:
Since its establishment, SEBI has introduced a lot of reform measures from time
to time. SEBI has mandated that no company will be allowed to issue shares in
physical form and all shares should be in demat (electronic) form only. All
investors including institutional investors shall have a demat account before
applying for allotment of shares / bonds through the primary market or sale /
purchase of shares / bonds through stock exchanges.
iii) Depositories:
Shares / Bonds can be held in demat form with the authorised depositories. SEBI
has authorised two depositories that can hold securities in demat form for demat
account holders. These are:
National Securities Depository Ltd. (NSDL) and
Central Securities Depository Ltd. (CSDL)
522
Some companies prefer the private placement route because they don’t need to
spend a large amount for marketing the issue. All insurance companies are
allowed to purchase shares / bonds through private placement. Now companies
can also go abroad for raising capital through ADR (American Depository
Receipts) / GDR (Global Depository Receipts) / FCCB (Foreign Currency
Convertible Bonds) and list their shares on foreign stock exchanges.
Life Insurance Companies can also raise capital through markets subject to
guidelines issued by IRDA and SEBI.
523
Generally, insurance companies put their immediate money in this account. Its
maturity can be as short as one day. This is like call and notice money. Presently,
RBI does not permit insurance companies to participate in call and notice money
directly.
524
Now, after liberalisation of the economy and the insurance sector, while LIC and
private insurance companies continue to offer the above mentioned participating
plans, a lot has changed. Insurance companies have innovated and have come out
with a variety of investment plans that give the investor a lot of investment
options to choose from, based on his risk profile. For example:
in unit linked insurance plans (ULIP), the insured gets the option to
participate in the growth of capital markets
in pension plans he can get regular income (annuity) during his retirement
years
in health plans he can get himself covered against medical emergencies like
hospitalisation
in riders he has a lot of options to choose from based on his requirement
Investor classes
In India, mutual funds industry is regulated by SEBI. Mutual funds collect money
from various classes of investors like
Individuals,
High net worth individuals,
Companies
Institutions etc.
Types of schemes
a) Equity Schemes:
These schemes invest a major portion of their money in equities and equity
related securities
b) Debt Schemes:
These schemes invest a major portion of their money in fixed income securities
like bonds, debentures, fixed deposits etc.
c) Balanced Schemes:
These schemes invest a major portion of their money in a mix of equities and
debt instruments.
526
d) Gilt Schemes:
These schemes invest a major portion of their money in short term securities with
maturities of less than a year.
In this scheme, the investor can purchase units from or sell units to the fund
house at any time at the prevailing net asset value (NAV).
This scheme is open for subscription for a short period and has a fixed maturity
period of say 3 years or 5 years etc. Generally, units are sold at face value and
units are redeemed at NAV at the end of the maturity period. After closure of the
subscription period, the scheme units are listed on the stock exchange for trading.
Units can be bought and sold through the stock exchange. If an investor wants to
redeem the unit/s before the maturity period, he may have to pay a penalty called
the exit load.
Banks play a major role in channeling savings from the general public (who have
surplus investible funds) to the Government / companies who need funds for
developmental projects. In India, the banking system plays a major role in
meeting the short term, medium term and long term financial needs of the
industry. The Reserve Bank of India (RBI) is the banking regulator and has the
responsibility to ensure smooth functioning of the banking sector. The banking
system can be classified as follows.
a) Nationalised Banks
In these banks, the Government of India is the majority shareholder (more than
51% shareholding). These banks are also known as PSU banks. Examples of
nationalised banks include:
State Bank of India and its subsidiaries
Punjab National Bank
Bank of India
Bank of Baroda
Andhra Bank
Bank of India etc.
b) Private Banks
c) Foreign Banks
These banks are headquartered outside India and have operations in India.
Examples of foreign banks include:
Standard Chartered Bank
HSBC Bank
Citibank
Royal Bank of Scotland
Barclays Bank
Bank of America
d) Co-operative Banks
These banks are established by groups of people and are registered with the
Registrar of co-operative societies. Examples of co-operative banks include:
Saraswat Co-operative Bank
Rupee Co-operative Bank
Cosmos Co-operative Bank
Ratnakar Co-operative Bank
529
These banks have been set up with an objective to ensure sufficient institutional
credit for agriculture and other rural sectors. The RRBs are jointly owned by the
Government of India, the concerned State Government and the Sponsor Banks.
They collect money from the people in the form of deposits and lend them to
farmers for agricultural and allied activities. Examples of regional rural banks
include:
Chhatisgarh Gramin Bank
Haryana Gramin Bank
Parvatiya Gramin Bank
Pragathi Gramin Bank
Sharda Gramin Bank
Manipur Rural Bank
NHB is the regulator for housing finance companies (HFCs) in India. NHB
controls the activities of HFCs like HDFC, LIC Housing Finance, Dewan
Housing Finance etc. and also provides them with low cost finance. Its basic
function is to operate as a principal agency to promote housing finance
institutions both at local and regional levels and to provide financial and other
support to such institutions and for matters connected therewith or incidental
thereto.
530
Collecting deposits:
Giving loans:
These deposits are lent in the form of loans to corporates (business loans,
working capital loans, overdraft, equipment financing loans term loan etc.) and to
individuals (personal loan, housing loan and education loan, vehicle loan etc.).
They also sell third party products like insurance and mutual funds to boost their
fee income.
The financial management function plays a very important role in every sector of
the economy and a professional finance manager can play a vital role in this era
of cut throat competition where the policyholder is the king. The finance
manager has to be very vigilant, efficient, opportunistic and enterprising to pick
up best deals and at the same time, enforce financial discipline. Insurance
companies through their professional finance managers can make best use of
scarce resources available at their disposal and help in bringing the required
speedy economic development.
A 1981
B 1991
C 2001
D 1971
531
Summary
Today, there are 24 life insurance companies (including LIC) doing life
insurance business in India.
Post-Independence in 1947, the political leaders who were greatly influenced
by ideas of socialism and democracy adopted a model of mixed economy for
the economic development of the country.
Immediately after independence, the Planning Commission was established
and it was assigned the role of preparing five year plans.
At the time of Independence, the Government of India established most of
the core industries, where huge capital was required. For example SAIL,
BHEL, ONGC, NTPC etc. were set up.
In 1991, the Government took a decision to deregulate the Licence Raj to
boost industrial growth.
Following is the structure of the financial system in India: capital market,
money market, insurance market, mutual funds, banking system.
Capital market is a place where companies (privately owned or Government
owned) can raise money (capital).
When a company issues shares for the first time, it is done through the IPO
process in the primary market.
Once the shares are listed, the trading (buying and selling) of shares happens
through the secondary market.
The BSE and the NSE are the two active stock exchanges in India.
SEBI is the stock market regulator in India.
NSDL and CSDL are SEBI authorised depositories.
Money market securities are instruments with maturity of not more than one
year.
A mutual fund is a professional collective investment scheme that pools
money from investors with a common objective; to invest it in stocks, bonds,
money market instruments and any other securities as notified by SEBI.
Investment schemes offered by mutual funds include: equity schemes, debt
schemes, balanced schemes, gilt schemes, money market schemes etc.
Banks play a major role in channeling savings from the general public (who
have surplus investible funds) to the Government / companies who need
funds for developmental projects.
The Reserve Bank of India (RBI) is the banking regulator and has the
responsibility to ensure smooth functioning of the banking sector.
The banking system in India includes: national banks, private banks, foreign
banks, co-operative banks, regional rural banks etc.
532
Answer to TY 2
Self-Examination Questions
Question 1
A Primary Market
B Secondary Market
C Intermediary Market
D Post Listing Market
Question 2
A Allotment of shares
B Allocation of shares
C Provisioning of shares
D Handing out of shares
533
Question 3
Money market securities are instruments with maturity of not more than .
A 3 months
B 6 months
C 1 year
D 3 years
Question 4
In which of the following insurance plans does the insured get the option to
participate in the growth of capital markets?
Question 5
Which of the following plays a significant role in meeting the credit needs of
agriculture?
A NABARD
B NHB
C NIA
D SIDBI
534
Answer to SEQ 2
Answer to SEQ 3
Money market securities are instruments with maturity of not more than one
year.
Answer to SEQ 4
In a unit linked insurance plan (ULIP), the insured get the option to participate in
the growth of capital markets.
Answer to SEQ 5
CHAPTER 13
Chapter Introduction
This chapter aims to provide an understanding about the different concepts of
financial management and their application to the insurance industry. You will
learn how the insurance industry applies these concepts to perform better and
provide the best returns to policyholders.
With the introduction of foregin players in the insurace industry who develop
innovative products, perform better marketing of products and ensure strong
distribution skills, private companies are attracting more Indian customers as
compared to the government ones.
In order to determine the solvency margin, insurers need to follow some basic
principles of cash management called Safety/Profitabilty/ Liquidity (SPL).
2. Risk Management
A ship carrying valuable goods can sink, or the goods might get damaged in
transit. To manage this risk, an insurance policy can be taken to protect the goods
or to recover the damage.
The life insurance company invests the premium received from the policyholders
in various classes of assets like:
Real estate
Capital Market Operations
Loan to policy holders
a) Asset Risk
As life insurers hold investments in various assets, they are subject to different
types of asset risk.
539
b) Realization risk
When the asset value is dependent on the performance and operation of the
business, the insurer anticipates the return on investment, which includes the cash
rate to compensate for the realization of additional risk. In a life insurance
company, the insurer has to analyze the risk and must be able to separate the
return from the investment.
The insurer has to mitigate the risk involved with the investment. Normally, the
Life Insurance Companies offer products that are hybrid in nature, like:
i) Insurance
ii) Investment
540
The insurance company must be able to separate the insurance portion from
the investment products.
The capital protection plan objective is to protect capital so that the investment is
safe and secure. Thus, the risk varies according to the nature of the product.
We have seen that concentration risk involves putting all money in one asset,
thus the insurer has to be careful with the investment and must keep
sufficient funds in cash or equivalents like call money or short term FD.
The insurer must estimate the portfolio to avoid market risk and should
reshuffle any assets where he sees any shrinkage in the asset.
The insurer must obtain credit rating for those companies where it decides to
put money so as to avoid any credit risk.
Finally, the insurer must recover the assets from the debtors as and when
due.
What is ALM?
to manage risk rather than to eliminate it with a certain structure which includes
self-imposed limits.
ALM is very important and vital for proper management of finances in order to
enable the organisation to meet its future needs of cash flow and capital. The
insurer must have sufficient long term assets to meet its long term liabilities. For
insurance companies, the ALM focal point is to match the liability to the asset,
with the primary goal of minimising interest risk.
ALM helps the insurer to maintain a good balance for effective competition and
to meet legitimate objectives for growth, profit and risk. It helps to forecast
changes in economic value over a range of likely and adverse scenarios.
Insurers should have prior knowledge of sufficient assets that must be available
to match liabilities for new businesses.
The value of future cash flows must be in such a manner that it is consistent with
the market prices and should take into consideration the distribution of future
asset and liability cash flows to decide the exposure of ALM risk.
4. Cash Management
The operations of the life insurance company are spread all over and are multi-
level e.g. Branch office, Regional office and Head office. Collection of premium
is done at the lowest level i.e. the branch or business center. After the premium is
collected, it is sent to the head office. Some insurance companies have given the
Branch office power to make payments to policyholders and manage expenses at
their level, whereas some have centralized their power at the head office.
Some insurance companies have decentralized the payment at the Branch Office
Level, after they have assessed the need for payment of expenses (to
policyholders and others). After allocating funds for this, if there is any surplus, it
should be transferred to the higher office as soon as possible. In some branches,
they have the facility for only collections and not payments. Accordingly, the
total deposits with the bank must be reported to the controlling office on a daily
basis. After the controlling office has been reported about the cash, it is then
542
transferred immediately. The funds should not remain idle in the bank account as
no interest will be earned on them.
Transfer of all surplus funds should be made within the minimum possible time
and the funds must be available to insurance companies for investment on real
time basis. Funds are usually transferred thorough RTGS or Net Banking.
5. Capital Management
In order to have better returns, the insurance company must make optimal
utilization of its capital.
Accounting Ratios
Summary
Financial concepts are used by insurance companies to get attractive returns
for the policy holders in the face of tough competition.
Due to introduction of foreign companies in the industry, there has been
increase in competition.
Solvency and liquidity are two different things. Solvency means the ability of
an organisation to cover its liabilities with the use of the organisation’s
assets. Liquidity refers to the cash flow in an organisation.
Risk management refers to minimising the likely damages.
ALM is used for sound decision making and taking actions with respect to
assets and liabilities.
ALM helps to forecast changes regarding economic value.
RTGS or Net Banking methods are used for transfer of funds collected by the
controlling office.
The insurance company must make optimal utilisation of its capital.
544
The introduction of foreign companies in the inurance industry has given new
products, and policyholders are provided with attractive rates of interest which
has increased the level of competion.
Answer to TY 2
Self-Examination Questions
Question 1
When the asset value is dependent on the performance and operation of the
business, and the rate of investment includes the cash rate to compensate for the
additional risk, this is called
A Concentration Risk
B Market Risk
C Realization Risk
D Liquidity Risk
Question 2
A Liquidity
B Solvency
C Asset Liabilty Management
D None of the above
545
Question 3
A Credit
B Capital
C Market
D Concentration
Answer to SEQ 2
Answer to SEQ 3
CHAPTER 14
Chapter Introduction
Taxes form an important source of revenue to the Government. This is a major
source of revenue generation. The Government has to fund various activities of
development and for this purpose it requires revenue which is generated through
taxation.
This chapter aims to provide you with an understanding of the taxation process.
a) Direct tax
b) Indirect tax
If tax is levied on the price of goods or service, then it is called indirect tax.
Service tax, value added tax etc. are examples of indirect taxes.
The Father of Economics, Adam Smith, has laid down the following four basic
principles in order to build a good taxation system:
a) Equitable
This principle aims at equality and social justice to people. There should be equal
treatment of similarly situated tax payers i.e. taxes levied should be directly
proportional to the income.
548
b) Certainty
In short, there should be consistency and stability in the prediction of tax payer’s
bills and amount of revenue collected over time.
c) Convenience
Taxes should be readily and easily assessed, collected and administered. Under
this principle, the convenience of the tax payer must be taken into account while
deciding the mode and timing of payment of taxes.
d) Economical
This principle requires that the tax administration is economical i.e. cost of tax
collection should be lower than the amount of tax collected. In short, compliance
and administration of taxes should be minimal in terms of cost.
Additional features
The above mentioned canons of taxation are also considered the original canons
of taxation. In view of the increased complexities in governance, modern
economists have come up with additional criteria which should also be complied
with while devising a tax system.
a) Adequacy
A tax should have the ability to produce sufficient and desirable amount of
revenue to the taxing authority i.e. the tax system should have the ability to yield
enough revenue without resorting to deficit financing. This is also called the
canon of productivity.
549
The tax system should be elastic, i.e. the tax system should be capable of
reallocating resources to achieve various specific social and economic objectives.
For example, during a liquidity crunch when the government needs more income,
the taxation system should be elastic enough to generate additional income
through increase in the tax rates.
c) Neutrality
The tax system should not encourage inefficient allocation of resources by being
so extreme that tax payers make counterproductive economic decisions.
d) Simplicity
e) Diversity
Tax revenues should be collected from various sources rather than from one
source. This is because diversified sources of revenue would ensure that the
government is not dependent heavily on one source.
550
In this learning outcome, we will discuss the features of Income Tax with respect
to companies carrying on life insurance business.
Rule 1 of Section 115 B says that Profit and Gains of life insurance business shall
be computed separately from profit and gains of any other business.
Profits and gains of life insurance business will be taxed at the special rate of
12.5% as per section 115B. Both policy holders’ and shareholders’ profit should
be taxed at 12.5%, as combined results represent profits from life insurance
business.
Profits and gains from ‘Other than life insurance business’ would be taxed at the
normal tax rate.
552
Rule 2 says that Profit and Gain shall be taken to be the annual average of the
surplus which is calculated by adjusting the surplus or deficit disclosed by the
actuarial valuation made in accordance with the Insurance Act 1938 (4 of 1938)
in respect of the last inter valuation period ending before the commencement of
the assessment year, so as to exclude from it any surplus or deficit included
therein which was made in any earlier inter-valuation period.
Section 44 of the I-Tax Act 1961 [under Chapter IV D – “Profits and Gains
of Business or Profession] exempts an insurance business of any kind from the
operation of the sections dealing with specified heads of income as well as those
of section 199 which deals with credits for tax deducted at source, and provides
that the profits and gains of such a business, from all sources, are to be computed
in accordance with the Rules contained in the First Schedule to the I-Tax Act
1961. The principle is applicable even to mutual associations and co-operative
societies carrying on insurance business.
Insurance Business
In the First Schedule, Part A deals with life insurance business, and Part B deals
with other insurance business.
553
In the case of a person who carries on or at any time in the previous years carried
on life insurance business, the profits and gains of such person from that business
shall be computed separately from his profits and gains from any other business.
The profits and gains of life insurance business shall be taken to be the annual
average of the surplus arrived at by adjusting the surplus or deficit disclosed by
the actuarial valuation made in accordance with the Insurance Act, 1938 [4 of
1938], in respect of the last inter-valuation period ending before the
commencement of the assessment year, so as to exclude from it any surplus or
deficit included therein which was made in any earlier inter-valuation period.
Where for any year an assessment of the profits of life insurance business is
made in accordance with the annual average of a surplus disclosed by a valuation
for an inter-valuation period exceeding twelve months, then in computing the
income-tax payable for that year, credit shall not be given in accordance with
section 199 for the income-tax paid in the previous year, but credit shall be given
for the annual average of the income-tax paid by deduction at source from
interest on securities or otherwise during such period”.
Section 115B of the Income Tax Act 1961 which deals with tax on profits and
gains of life insurance business is quoted below :-
115B. [(1)] Where the total income of an assessee includes any profits and gains
from life insurance business, the income-tax payable shall be the aggregate of –
ii) the amount of income-tax with which the assessee would have been
chargeable had the total income of the assessee been reduced by the amount
of profits and gains of the life insurance business.
554
Provided that where the assessee makes during the said previous [years] any
deposit of an amount of not less than two and one-half per cent of the profits and
gains of the life insurance business in the security fund, the amount of income-
tax payable by the assessee under the said clause (i) shall be reduced by an
amount equal to two and one-half percent of such profits and gains and,
accordingly, the deposit of thirty-three and one-third per cent required to be made
under this sub-section shall be calculated on the income-tax as so reduced.
Profits and gains of life insurance business are taxed at the rate of as per
section 115B.
A 10%
B 12.5%
C 8%
D 12%
556
1. Introduction
Section 192 of Income Tax Act 1961 (IT Act) provides that every person
responsible for paying any income which is chargeable under the head ‘Salary’
shall deduct income tax on the estimated income of the assessees under the head
salary. The deduction has to be made at the time of payment of salary and
average rate of income tax has to be applied for deduction of tax. It should be
kept in mind that income tax will be deducted only when the estimated salary
exceeds the maximum amount not chargeable to tax.
According to Section 192, the employer is required to deduct tax at source on the
amount payable at the average rate of income tax. This is to be computed on the
basis of rates in force for the financial year in which payment is made.
Individual only
Resident
Resident Indians up individual of the
to 60 years of age age of eighty
years or above
Where total income
(i) does not exceed Nil Nil
Rs.200,000/-
Where the total income
10% of the amt in
(ii) exceeds Rs.200,000/- but Nil
excess of Rs.200,000/-
does exceed Rs.500000/-
Where the total income Rs.30000/- + 20% of
20% of the amt in
exceeds Rs.500000/- but the total amount by
(iii) excess of
does not exceed which total income
Rs.500,000/-
Rs.10,00,000/- exceeds Rs.500000/-
Rs.1,00,000 +
Rs.1,30,000 + 30% of
30% of the amount
Where the total income the amount by which
(iv) by which total
exceeds Rs.10,00,000/- total income exceeds
income exceeds
Rs.10,00,000/-
Rs.10,00,000/-
Note
For senior citizens of more than 60 years but less than 80 years of age, the
threshold limit is Rs.250000.
In addition to the above, ‘Education cess @2% and secondary and Higher
Education cess @1% on income tax shall be chargeable.
558
With effect from 1.6.2002, employers have the option of paying tax on the non-
monetary perquisite (discussed later) given to an employee. Section 192(1A) and
section 192(1B) of the Income Tax Act enable the employer to make payment at
his option of the entire tax or a part of the tax due on non-monetary perks on
behalf of the employee.
According to section 200 of the IT Act, the person responsible for deduction of
tax from the payment made to an employee is also required to deposit the tax so
deducted in a Government Account within the prescribed time and in the manner
prescribed vide Rule 30.
Payment of tax deducted at source (TDS) has to be normally made within a week
of the last day of the month in which the deduction is made.
However, vide Rule 30(1) (ii) (b), Assessing officials can in special case with
prior approval of Joint CIT allow payment of TDS quarterly i.e. 15 th June, 15th
Sept, 15th Dec and 15th Mar.
It should be kept in mind that payment can be made through internet (e-TDS) /
Cheque / Debit / Credit Card / Demand Draft or through Cash.
In case of payment made by cheque, the date of encashment of the cheque will be
the date of payment of tax.
Every person deducting tax at source is required as per Section 203 to furnish a
certificate to the payee to the effect that tax has been deducted along with certain
other particulars. The certificate, usually called the TDS certificate, has to be
furnished within a period of one month from the end of the relevant
financial year.
559
With effect from 1.4.2005, every employer responsible for deducting tax is
required to file quarterly statements of TDS for quarters ending on 30 th June, 30th
Sept, 31st Dec and 31st March in each financial year which is to be delivered to
the prescribed authority [Director General of Income Tax (System)] or the
persons authorized by such authority (NSDL).
In quarterly statement of TDS, the deductor has to quote his TAN and PAN
numbers. In addition to this, the employer should mention the PAN of all
employees compulsorily.
Lately, all corporate employers have to furnish their return through electronic
media.
A The employer
B The employee
C Neither the employer nor the employee
D Either the employer or the employee
560
4. Ram is provided with a motor car owned by the company. Ram uses the car
exclusively for personal use. The cubic capacity of its engine is 1.3. During
2010-11, the company incurred an expenditure of Rs. 45,000 on its running
as well as maintenance. Furthermore, the company paid a remuneration of
Rs. 2,000 per month to his driver. Ram paid the company Rs. 12,000 for the
use of the car.
5. If the car was used for both personal as well as official use; the value of the
perquisite would be Rs. 32,400 [(Rs. 1800 + Rs. 900) x 12].
6. Ram took a housing loan of Rs. 100,000 from the company on 1 April 2010.
The loan was taken for four years. The interest paid to the company was Rs.
6,000.
The taxable value of the perquisite = Rs. 2,000 [i.e. interest payable at the
prescribed rate (Rs. 100,000 x 8%) Less: interest (if any) actually paid by the
employee (Rs. 6000)]
565
Rent
50% paid
Resident Basic HRA Rent HRA
of HRA less
of salary paid paid exempt
salary 10% of
salary
A Kolkatta 25,000 6,000 7,500 12500 6,000 5000 5000
B Goa 37,000 4,500 4,400 14800 4,500 700 700
From the above mentioned salary, employees are entitled to get deductions under
various sections. Brief detail is given below.
Amount of
Section Details
deduction
Life Insurance Premium- Self, Spouse
and Children
Deferred Annuity- Self, Spouse and
Children
Contribution to Recognized Provident
Fund, Public Provident Fund
Deposit into selected post office
scheme such as NSS, NSC, and CTD
etc.
Repayment of Housing loan
80C,
Tuition Fees.
80CCC and Rs. 1,00,000/-
Fixed Deposit of scheduled bank if it
80CCD
is more than 5years
Contribution of ULIP OF LIC Mutual
Fund and investment in ELSS
schemes of Mutual Fund
Payment of Premium for annuity plan
of LIC or any other insurer (80 CCC)
Deposit made by Central Government
servant in his pension account to the
extent of 10% of his pension
80CCD.
This deduction is allowed for the payment
80D
of Mediclaim Insurance to General
567
Relief Fund; or
the National Children’s Fund; or
the Indira Gandhi Memorial Trust,
or
the Rajiv Gandhi Foundation,
Loan can be taken by the tax payer for pursuing his own education or education
of his spouse / child.
569
If an employee gets salary for more than 12 months then to take tax rate benefit,
he can claim relief u/s 89 of the Income Tax Act. Employer will take cognizance
of it and give relief from tax while deducting tax at source.
Finally, from the Assessment year 2011-12, if the employee has income from
salary and tax has been deducted from salary as per rules and no tax is payable by
him / refundable to him, he need not file an income tax return.
Sham is the manager of Beta Insurers. His salary for the year 2011-12 was Rs.
820,000 per annum. He is provided with a house which is leased by Zeta at a rent
of Rs. 120,000 per annum. What is the value of the taxable perquisite?
A 123,000
B 120,000
C 82,000
D 61,500
TAN is a unique number allotted to the deductor of tax at source for the purpose
of identification of every deductor.
Section 203A (2) casts a statutory responsibility on the deductor to quote TAN
in the following places once it has been allotted:
In all challans for the payment of any sum in accordance with the provisions
of Section 200
With effect from 1.6.2001, the deductor of tax at source is required as per section
139A (5B) to quote the PAN of the person from whose income TDS has been
deducted in:
Under section 139 A of the Act, every person if his total income or the total
income of any person in respect of which he is assessable under the Act during
any previous year exceeded the amount which is not chargeable to tax, and who
has not been allotted a permanent account number (PAN), shall apply to the
Assessing Officer for the allotment of Permanent Account Number.
571
Jasmine owns a house property which is used by him throughout the previous
year 2010-11 for his residence.
The annual value of the property is Rs. 1,50,000.
Expenses incurred are as follows:
Repairs: Rs. 2,000, municipal taxes: Rs. 20,000, insurance Rs. 3,000, interest on
borrowed capital Rs. 1,50,000.
Compute the income from house property.
A Nil
B (Rs. 150,000)
C (Rs.25,000)
D (Rs.175,000)
Section 44AB of the Income-tax Act, 1961 deals with “Audit of accounts of
certain persons carrying on business or profession”.
The Finance Act 1984 has made a provision in the Income-tax Act 1961, in the
form of Section 44AB, making it obligatory for a person carrying on business to
get his accounts audited with effect from the Assessment year 1985-86 before the
‘specified date’ by an accountant if the total sales turnover or gross receipts in
business for the accounting year or years relevant to the Assessment year 1985-
86 or any subsequent Assessment year exceed or exceeds Rs. 40 lakhs.(Rs100
Lakhs with effect from A.Y. 2013-14) A person carrying on profession is also
required to get his accounts audited before the “specified date” if his gross
receipts in profession for an accounting year or years relevant to any of the
aforesaid assessment years exceed Rs. 10 lakhs.(Rs. 25Lakhs with effect from
A.Y. 2013-14) Such persons should also obtain before the ‘specified date’ a
report of the audit in the prescribed form. For this purpose, the Central Board of
Direct Taxes has prescribed under Rule 6G, Forms 3C A – 3 CE containing
forms of audit report and particulars to be furnished therewith.
The provisions of Section 44AB of the Income-tax Act, 1961 are applicable to
All Life Insurance Companies including Life Insurance Corporation of India
575
Service tax has been introduced for the first time in the year 1994-95 by the then
Finance Minister (Now Prime Minister) Dr. Manmohan Singh. One of the
purposes of levying service tax was to generate a new avenue of taxation and to
bring more people in the service tax net.
It will not be out of place to mention that Service Tax is a part of the Finance
Act; Chapter V of Finance Act 1994 deals with the imposition of service tax.
For the first time in 2002, Service Tax was imposed on Insurance Auxiliary
Service concerning life insurance – detailed discussion is given in the following
paragraphs.
Similarly, Service Tax was imposed on Life Insurance Service vide Finance
(No.2) Act with effect from 10 th Sept 2004.
576
Hence, from the above we can see that service providers are insurance agents,
actuaries and insurance consultants. In the case of insurance consultants, the
service is provided mainly to insurance companies (insurers), while in the case of
insurance agents, the service is provided to both the insurer and the policyholder.
Service tax is liable to be paid by the insurance auxiliary service provider, except
in the case of insurance agents. Insurance agents normally do not charge the
policy holder. Hence, there cannot be any service tax on nil payment service.
However, agents provide service on behalf of insurance companies, and they get
commission on a periodic basis. In the case of an insurance agent, it has been
provided in the service tax rules that the concerned insurance company who has
appointed the agent will be liable to pay service tax.
In simple words, we can say that Life Insurance Companies are liable to pay
service tax on commission (including other remuneration to agents); this is called
input service tax.
Hence, we can say that - that portion of service which pertains to the risk element
is liable to service tax. This levy will not be applicable to such premium of the
existing policies which were paid before the new levy comes into force.
However, option has been given to life insurers that in case of composite policies
risk plus saving) they can pay 1% (now Increased to 1.5% from financial 2011-
12) of total premium towards discharge of service tax liability.
Now, w.e.f 1.4.2011, a unit linked insurance plan has also been brought under the
net of service tax. Earlier, only mortality rates and fund management charges
were taxed. Now policy allocation charges and administration charges on ULIP
would also come under the service tax net.’
The service tax shall be paid to the credit of the Central Government:
i) By the 6th day of the month, if tax is paid electronically through internet
banking, it has been provided that the assessee who has paid service tax of
Rs.50 lakh in the current financial year shall deposit the service tax liable to
be paid by him electronically, through internet banking.
578
ii) In other cases, by the 5 th of the month following the calendar month in which
payment is received.
However, service tax for the month of March has to be paid by 31 st March.
Service tax on life insurance services are called output services and are allowed
to take credit against input services like service tax on payment to Insurance
Agents and service tax paid on other services like service tax on telephone,
mobile bills etc.
Hence, a Life Insurance Company should keep proper record of service tax
payable on out front services and service tax paid on input services.
Summary
The Father of Economics, Adam Smith, has laid down the four basic
principles which would help to build a good taxation system.
Income Tax on life insurance companies is not considered a normal business
income. Calculation of tax on insurance companies is done in accordance
with the provisions of Section 44 read with the First Schedule of the Income
tax 1961.
Profits and gains of life insurance business will be taxed at the special rate of
12.5% as per section 115B.
Payment of tax deducted at source (TDS) has to be normally made within a
week of the last day of the month in which the deduction is made.
The TDS certificate has to be furnished within a period of one month
from the end of the relevant financial year.
If an employee has income from salary and tax has been deducted from
salary as per the rules and no tax is payable by him / refundable to him, then
he need not file an income tax return.
Life insurance companies are liable to pay service tax on commission
(including other remuneration to agents), and it is called input service tax.
Service tax on life insurance services are called output services and are
allowed to take credit against input services like service tax on payment to
Insurance agents and service tax paid on other services like service tax on
telephone, mobile bills
A life insurance company should keep proper record of service tax payable
on out front services and service tax paid on input services.
580
Answer to TY 2
Profits and gains of life insurance business will be taxed at the special rate of
12.5% as per section 115B.
Answer to TY 3
With effect from 1.6.2002, employers have the option of paying tax on the non-
monetary perquisite given to employees.
Answer to TY 4
Answer to TY 5
Answer to TY 6
Answer to TY 7
Self-Examination Questions
Question 1
Question 2
Tax revenues should be collected from various sources rather than from one
source. This relates to which canon of taxation?
A Adequacy
B Neutrality
C Simplicity
D Diversity
582
Question 3
The deduction of Income Tax made on any interest or dividend payable to the life
insurance corporation in respect of any securities or shares owned by it is at the
rate of:
A 5%
B 7.5%
C 12.5%
D 0%
Question 4
Swanand has taken a loan of Rs. 70,000 for higher studies for his wife on
1.10.2011. On 31.3.2012, he has repaid Rs. 20,000 (which includes Rs.3,000
towards interest). Furthermore, his son has repaid Rs.10,000 (which includes an
interest of Rs.1,000) on the same date.
Question 5
Grand insurers will have to get a tax audit conducted on its business if:
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
Under section 80E, Swanand can claim a deduction for interest paid on loan
taken for pursuing Higher Education. Loan can be taken by the tax payer for
pursuing his own education or education of his spouse / child. The deduction is
available for a maximum period of eight years or till the principal amount along
with the interest is liquidated.
Answer to SEQ 5
According to the provisions of Section 44AB of the Income-tax Act, 1961, which
are applicable to all Life Insurance Companies, tax audit is applicable where the
total sales turnover for an accounting year exceeds Rs.60 lakhs.However for
financial year 2012-13, limit is Rs. 1 Crore.
584
CHAPTER 15
Chapter Introduction
This chapter aims to provide an understanding of the Anti Money Laundering
Guidelines and the PMLAACT. You will also learn about the insurance
regulation regarding Know Your Customers, reporting obligation for insurance
companies and the customer identification procedure.
Money laundering means bringing illegally obtained money into the mainstream,
legal economy. Money launderers, from dishonest traders to terrorists, aim to
deposit their illegally-obtained money in financial institutions and banks. The
goal of a large number of criminal acts is to generate income which can be used
for illegal purposes, causing harm to society, which enables the criminals to
enjoy the illegitimate income without jeopardising their source. Sales of illegal
arms, smuggling, embezzlement and insider trading can produce large gains and
create the incentive to “legitimise” the illegitimate gains made through money
laundering.
Money laundering is the act of changing the appearance of money that comes
from illegitimate sources so that it appears to be legitimate money.
The word money laundering has two aspects: MONEY + LAUNDREING. The
laundry is a place where dirty clothes are taken to be washed. Similarly, money
laundering is also the process by which dirty money / black money / illegal
money is converted into legal money. To put it more precisely, we can say that
money laundering is a process where illegal or ‘dirty’ money is put through a
cycle of transactions, so that it comes out ‘cleansed’ at the other end as ‘legal’ or
‘clean’ money.
586
Anil obtained money from smuggling. In order to clean this money, he went to an
antiques shop and bought an antique piece of furniture for Rs.1,20,000 in cash.
He then sold this piece of furniture for Rs. 1,00,000 (being quite prepared to
suffer the apparent loss of Rs. 20,000). This time, Anil asked for a cheque that
could then be paid innocently into a bank account, making the money look
legitimate.
The process of money laundering can be broadly classified into three stages viz.
placement, layering and integration:
i) Placement
This is generally the first stage. In this stage, the launderer inserts the illegitimate
money into a legitimate financial institution through purchase of art, jewellery, or
a series of monetary instruments (cheques, money orders) etc. This is also often
done by depositing cash in the bank.
The introduction of illegal money into the financial system can be done by
breaking up large amounts of money into less conspicuous smaller sums that
are then deposited directly into a bank account.
Techniques like “smurfing”, where small amount deposits are made every
day in various financial institutions, in such a way that it does not attract
attention of legal / enforcement authorities.
587
ii) Layering
While transferring funds, instead of ‘straight’ transfers from one point to another,
a complex series of transfers are made. This is called ‘layering’ of transactions.
One transaction forms a layer upon another, ultimately concealing the source of
funds, the nature of funds and their ownership.
After the funds have entered the financial system, the launderer engages in a
series of conversions or movements of the funds to separate them from their
source. The funds might be channelled through the purchase and sales of
investment instruments, or electronically transferred through a series of accounts
at various banks across the globe. Layering involves moving the money through
various financial transactions to change its form and make it difficult to follow.
Layering may involve:
The recent case of money laundering that alleged illegal gratification of about Rs.
550 crore related to the 2G spectrum allocation scam involved a lot of people
without any explanation given for it. This clearly shows how big is the process of
money laundeing.
A Smurfing
B Shell companies
C Integration
D None of the above
588
The KYC process involves identifying, validating and verifying the customer’s
information so as to ensure that the customer is genuine and legitimate and does
not have any fraudulent intentions. The KYC process involves collecting the
customer’s photograph, identification proof and address proof and verifying the
same.
The insurance companies have to collect and verify the following proofs in
compliance with the KYC requirements for individuals and others:
1. Photographs
2. Proof of Identity
3. Proof of Residence
(Refer to detailed documents required for proof of residence and identity given in
Annexure I)
3. To take all necessary steps to identify the beneficial owner and all measures
to verify their satisfaction so as to establish who the beneficial owner is.
Insurers have to monitor all the KYC norms for their customers. KYC is needed
for both the new customers as well as for existing customers. Such data is used to
monitor the policy for possible abuse or illegal use. This is one of the objectives
of KYC. KYC deficiencies can lead to various business and legal risks. If an
insurance company gets unknowingly used for money laundering, such
involvement can lead to substantial risk and loss of reputation of the company.
When a new contract is issued to new customer, KYC should be done before the
issue of the new insurance contract. This requirement should be complied with in
all life insurance contracts as specified.
KYC in the case of existing customers should be carried out based on the limits
fixed for new ones on all contracts/relevant transactions in the case of the
existing polices.
The AML/CFT requirements will not be applied to the existing customers paying
premiums less than Rs. one lakh per annum. But KYC norms are compulsory to
those policy holders who pay premium of Rs. one lac or more per annum.
590
With the verification of identity of the customer at the time of initial issuance of
contract which includes obtaining a recent photograph, KYC should be carried
out at the claim payout stage and when any further top-up payments are
inconsistent with the customer’s known profile. Any change which is
inconsistent with the normal and expected activity of the customer should attract
the attention of the insurer for further ongoing KYC processes and action should
be considered as necessary.
1. Customer Profile:
Customer’s risk profile can be categorised into high risk and low risk customers.
Low risk customers are individuals and entities whose identities and source
of funds can be verified easily e.g. salaried employees, people belonging to
lower income group, Government departments and Government owned
companies and Regulators and statutory bodies etc.
High risk customer includes customers who carry an inherently higher than
average risk to the insurance company e.g. Non-residents, High net worth
individuals, Firms with sleeping partners , trusts, charities etc.
2. Product profile:
Vulnerable products like single premium products, ULIPs, policy features like
top-ups, partial withdrawals, and free-look period etc. are high risks in product
profiles. Vulnerable areas like frequent free-look cancellations, assignments by
policyholder to a third party not related to him will have to attract more attention
and detailed checks from AML perspective.
591
A Non-residents
B High net worth individuals
C Companies having close family shareholding or beneficial ownership
D None of the above
b) The advisor and/or employee shall obtain income proofs as in Annexure III,
to establish his need for insurance cover.
592
The insurer must see that mere documentation of income proofs, however, does
not constitute establishing ‘source of funds’. Insurers should take appropriate
measures commensurate with the assessed risk of a customer and product profile
as part of their due diligence measures which may include:
conducting independent enquiries on the details collected /provided by the
customer where required
referring to a trustworthy database: public or other, etc.
Every insurance company provides its customers a period within which they can
get back to the insurer with questions regarding their Life Insurance Policy,
which is called Free look Period.
The feature of free look period is highly prone to misuse by launderers. They
place criminal proceeds into a contract and then take them back within the free-
look period on the pretext of not being happy with terms and conditions of the
policy. The money comes out of the insurance company and therefore, loses its
original identity and appears to come from a legitimate source.
Free look cancellation means the customer the has right to terminate the policy
without any further charges or fines when the necessary questions are not
answered reasonably or a Life Insurance Policy has been missold or if he does
not agree with the Terms and conditions as mentioned in the Policy Documents.
593
Nothing is charged except for the mortality charge for those 15 days
and medical charges and stamp duty charges are only deducted.
A mere simple transaction as Free look Cancellation is a simple
process.
The normal cancellation terms and conditions and deductions of the
Life Insurance Policy are not applicable for Free look cancellation.
The insurer needs to give special attention especially where clients do free look
cancellation more than once.
A customer has a right to cancel his Life Insurance Policy when his questions
are not answered or the policy is missold to him. This is called:
In order to confirm that the premium is paid out of clear, recognizable source of
funds, the insurance company is advised not to accept premiums in cash above
Rs. 50, 000. They are further advised to accept the remittance of lower cash
transactions.
For integrally related transactions, premium amounts greater than Rs.50, 000
in a calendar month should be examined more closely for possible angles of
money laundering.
All cash transactions where forged or fake currency notes or bank notes have
been used as genuine and where any forgery of a valuable security or a document
has taken place facilitating the transactions should be reported within 7 days of
identification to FIU-IND.
Records are to be retained in such a way that they should be easily accessible.
Cash transactions where fake currency notes or bank notes have been used as
genuine or where any forgery of a valuable security has taken place have to be
reported to FIU-India within .
A 7 days
B 6 days
C 17 days
D 3 days
a) Appointment
The Principal Compliance Officer should ensure that the Board approved
AML/CFT programme is being implemented effectively, including
monitoring compliance by the company’s insurance agents with their
obligations under the programme.
He /She should ensure that employees and agents of the insurance company
have appropriate resources and are well trained to address questions
regarding the application of the programme in light of specific facts.
Summary
Money laundering is the act of changing the appearance of money that comes
from illegitimate sources so that it appears to be legitimate money.
The progress of money laundering can broadly be classified into three stages
viz. placement, layering and integration.
KYC process is meant to weed the bad customers out and to protect the good
ones.
Implementation of KYC should not mean denial of insurance services to the
public.
AML / CFT guidelines place the responsibility of a robust programme on the
insurance companies for guarding against insurance products being used to
launder unlawfully derived funds or to finance terrorist acts.
Records of transactions reported to FIU will have to be retained for 10 years
beginning from the date of occurrence of transaction.
Records of training imparted to staff in the various categories detailed above
should be maintained.
600
Answer to TY 1
Answer to TY 2
Answer to TY 3
Free look cancellation means the customer has the right to terminate the policy
without any further charges or fine.
Answer to TY 4
Answer to TY 5
A responsibility to act with honesty requires trust and being authentic and
truthful.
601
Self-Examination Questions
Question 1
In which year was the Financial Intelligence Unit (FIU) set up in Delhi?
A 1999
B 2002
C 2004
D 2006
Question 2
Records of customer identification date will have to be retained for a period of:
A 10 years
B 15 years
C 11 years
D 20 years
Question 3
Cash transactions above Rs.10 lakh per month have to be reported to FIU-IND by
the insurance company by .
Question 4
Question 5
Question 6
A Integration
B Smurfing
C Layering
D None of the above
Answer to SEQ 1
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
Answer to SEQ 5
Answer to SEQ 6
ANNEXURE I
Features Documents
Legal name and any other names used i. Passport
ii. PAN Card
iii. Driving License
iv. Voters identity card
v. Letter from a recognized
vi. Personal identification and
certification of the employees of
the insurer for identity of the
prospective policyholder.
Public authority (as defined under section 2 (h) of the Right to Information Act,
2005) or Public Servant (as defined in section 2 ( c) of the “The Prevention of
Corruption Act 1988”) verifying the identity and residence of the customer.
605
Features Documents
Proof of residence i. Telephone bill pertaining to any
kind of telephone connection like
mobile, landline wireless etc
provided it is not older than six
months from the date of insurance
contract.
ii. Bank Account statement wherein
his Permanent/Present residential
address is available provided it is
not older than six months as on the
date of acceptance.
iii. Letter from any recognized public
authority
iv. Electricity Bill
v. Ration Card
vi. Valid lease agreement along with
rent receipt which is not more than
three months old as a residence
proof
vii. Employer’s certificate as a proof of
residence (certificates of employers
who have in place systematic
procedures for recruitment along
with maintenance of mandatory
records of its employees are
generally reliable.)
Proof of both identity and residence Written confirmation from the banks
regarding identification and proof of
residence
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Features Documents
Name of the Company i. Certificate of incorporation and
i. Principal place of business Memorandum and Articles of
ii. Mailing address of the company Association
iii. Telephone/fax number ii. Resolution of the Board of
Directors to open an account and
identification of those who have
authority to operate the account.
iii. Power of Attorney granted to its
managers, officers or employees to
transact business on its behalf.
iv. Copy of PAN allotment letter
Features Documents
i. Legal name, i. Registration Certificate if registered
ii. address, ii. Partnership deed
iii. name of all partners and their iii. Power of Attorney granted to a
addresses, partner or an employee of the firm
iv. telephone numbers of the firm and to transact business on its behalf
partners iv. Any officially valid document
identifying the partners and the
persons holding the Power of
Attorney and their addresses
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Features Documents
i. Names of trustees, settlers, i. Certificate of Registration if
beneficiaries and signatories registered. Power of Attorney
ii. Names and address of the founder, granted to transact business on its
the managers/directors and the behalf
beneficiaries. ii. Any officially valid document to
iii. Telephone/Fax numbers of the Trusts identify the trustees, settlers,
and Foundations and trustees, beneficiaries and those holding
settlers, beneficiaries and signatories. Power of Attorney,
founders/managers/directors and
their addresses
iii. Resolution of the managing body of
the foundation/ association
ANNEXURE II
VULNERABLE PRODUCTS
i. Unit link products which provide for withdrawals and unlimited top-up
premiums
ii. Single Premium products, where the money is invested in lump sum and
surrendered at the earliest opportunity
iii. Free look cancellations - especially the big ticket cases
ANNEXURE III
ANNEXURE IV
ILLUSTRATIVE LIST OF SUSPICIOUS TRANSACTIONS
ii. Cash based suspicious transactions for payment of premium and top ups over
and above Rs. 5 lakhs per person per month. It should also consider multiple
DDs each denominated for less than ` Rs. 50,000/-
ix. Borrowing the maximum amount against a policy soon after buying it
CHAPTER 16
Chapter Introduction
This chapter aims to provide you with an understanding of the implementation of
IFRS 4 for insurance companies. You will also learn about the key features of
IFRS 4 with respect to an insurance contract.
As per the directives issued by the Ministry of Corporate Affairs, all insurance
companies are required to apply International Financial Reporting Standards
(IFRS), w.e.f. 1st April 2012. Presently, Indian Insurance Companies prepare
their accounts as per IRDA (Preparation of financial statements and auditor’s
report) Regulations 2000.
IFRS
The Institute of Chartered Accountants of India (ICAI) has also issued Indian
Standards which are in convergence with IFRS, and is actively promoting IFRS.
It has recently issued an exposure draft of the new Accounting standard AS39, “
Insurance Contracts”, along the lines of IFRS 4 (phase I). All listed entities,
including banks and insurance companies, are required to adopt IFRS.
The insurance contract project of IASB has been split into 2 phases:
Phase I:
This phase was concluded in 2004, when IFRS 4 for insurance contracts was
published by IASB. At the end of this phase, it was decided to retain many of the
existing international insurance contract accounting practices.
It is important to note that IFRS 4 has been issued as a short term means to fill
the gap in IFRSs.
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Phase II:
To have uniformity with other countries, India has agreed to adopt International
Standards for preparing financial statements. In view of these international
developments, the Indian Ministry of Corporate Affairs has also committed to
comply with the IFRS provisions by 2012.
As per IFSR 4, an insurance contract is a contract under which one party (the
insurer) accepts significant insurance risk from another party (the policyholder)
by agreeing to compensate the policy holder if a specified uncertain future event
(the insured event) adversely affects the policy holder.
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To make accounts comparable, the financial statements for 2012-13 of all listed
insurance companies will have to be prepared in compliance with IFRS 4
Insurance Contracts.
With the adoption of IFRS 4 Insurance Contracts, the financial statements will be
more transparent and comparable across the world. It is also believed by various
accounting bodies and regulators that it will bring enhanced disclosure and
greater consistency in insurance accounting.
Objective of this new IFRS is to move towards fair value accounting (i.e.
recording both assets and liabilities at the “amount for which an asset could be
exchanged or a liability settled) in place of historical accounting.
Under IFRS 4, all assets and any profits or losses flowing through the revenue
account may be allowed under fair value measurement. Fair value can be
measured reliably if:
The variability is in the range of reasonable fair value estimates and is not
significant for the estimate
The probabilities of the various estimates within the range can be reasonably
assessed and used in estimating fair value
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g) Treatment of investment
Held to maturity (HTM): Debt instruments which the entity intends to hold
to maturity.
Available for sale (AFS): Investment marked to market with changes
recorded in reserves.
Held for trading: Marked to market with changes recorded in the income
statement
Loans and receivables: Non derivative financial assets.
Given the nature of insurance company liabilities, most investments are liable to
be categorised as ‘available for sale’ with the associated volatility in
shareholders’ equity.
Under IFRS, debt instruments, which the entity intends to hold to maturity, are
categorised as:
A Held to maturity
B Available for sale
C Held for trading
D Loans and receivables
Summary
As per the directives issued by the Ministry of Corporate Affairs, all
insurance companies are required to apply International Financial Reporting
Standards (IFRS), w.e.f. 1st April 2012.
International Financial Reporting Standards (IFRS) has been prepared by the
International Accounting Standard Council (IASC).
The main objective of IFRS 4 is to specify accounting for insurance contracts
issued by insurers. It also specifies accounting for reinsurance contracts
issued or held by an entity.
As per IFSR 4, an insurance contract is a contract under which one party (the
insurer) accepts significant insurance risk from another party (the
policyholder) by agreeing to compensate the policy holder if a specified
uncertain future event (the insured event) adversely affects the policy holder.
With the adoption of IFRS 4 Insurance Contracts, the financial statements
will be more transparent and comparable across world.
Under IFRS 4, if an insurer changes its accounting policies for insurance
liabilities, it may reclassify a few or all of its financial assets as at ‘fair value
through profit or loss”.
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Answer to TY 2
Under IFRS, debt instruments which the entity intends to hold to maturity are
categorised as held to maturity.
A IRDA
B ICAI
C IASC
D IASB
Question 2
Question 3
A Revenue statement
B Income statement
C Profit and loss statement
D Balance sheet
Question 4
Which of the following is categorised under loans and receivables under IFRS?
A Debt instruments
B Equity
C Non derivative financial assets
D Investment products
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
Non derivative financial assets are categorised under loans and receivables under
IFRS.