Stock valuation and insurance claim

Stock valuation and insurance claim

Insurance is an agreement between the insured and insurer, whereby the insurer in return for a premium agrees to compensate the insured in case of a loss. The amount insured and on which the insurance is paid is referred to as sum insured.

Over-insurance

Over-insurance is the situation where the sum insured is higher than the actual value of the item insured. Example, when the sum insured is higher than the value of stock that were present prior to the accident. When stocks are over-insured, the insurance claim equals the actual value of stock destroyed i.e., actual loss.

Under-insurance

Under-insurance is the situation where the sum insured is lower than the actual value of the item insured. Example, when the sum insured is lower than the value of stock that were present prior to the accident. When stocks are under-insured, the insurance claim will be determined based on an average clause. An average clause is a clause in an insurance policy that requires the insured to bear a portion of the loss if the item was under-insured.

Insurance claim calculation (average clause)

If there is an average clause, the insurance claim will be calculated as follows:

Insurance claim = (Sum insured × Actual loss) / Stock value at the date of accident

Loss of stock calculation

Loss of stock can be determined by using the following formula:

Details	Amount (TZS)
Amount of stock on the date of accident	xx
Less: Amount of salvaged stock	xx
Amount of stock loss	xx

No average clause

If there is no average clause, then the insurance claim will be the lower of the actual loss and sum insured.

Example

Juma prepares accounts on 30th September, each year. On 31st December, 2020 fire destroyed the greater part of his stock. The following information was collected from his books:

Details	Amount (TZS)
Stock on 1st October, 2020	3,600,000
Purchases from 1st October – 31st December, 2020	8,500,000
Sales from 1st October – 31st December, 2020	11,800,000

The rate of gross profit is 33½% on cost. Stock to the value of TZS 300,000 was salvaged. Insurance policy was for TZS 2,500,000 and claim was subject to average clause.

Additional information:

1. Stock at the beginning was calculated at 10% less than cost.
2. Purchases include the purchase of the plant for TZS 500,000

Solution

1. Calculate the value of stock as at the date of accident

Statement of stock as at 31st December, 2020

Details	TZS	TZS
Opening Inventory (W1)	11,800,000
Add: Purchases	2,950,000
Less: Purchases of Plants (Capital Expenditure)	-4,000,000
Cost of Goods Available for Sale		8,500,000
Less: Cost of Sales	-500,000
Sales	12,000,000
Less: Gross Profit (W2)	-8,850,000
Closing Stock		3,150,000

2. Calculation of stock loss (amount of stock destroyed by fire)

Amount of Stock on the Date of Accident: 3,150,000 Less: Amount of Salvage Stock: -300,000 Amount of Stock Loss: 2,850,000

3. Calculation of insurance claim (using average clause)

Insurance Claim = (Sum Insured / Stock Value at the Date of Accident) × Actual Loss Insurance Claim = (2,500,000 / 3,150,000) × 2,850,000 Insurance Claim = 2,261,905

Alternative: Statement of insurance claim

Details	TZS	TZS
Opening Inventory (W1)	11,800,000
Add: Purchases	2,950,000
Less: Purchases of Plants (Capital Expenditure)	-4,000,000
Cost of Goods Available for Sale		8,500,000
Less: Cost of Sales	-500,000
Sales	12,000,000
Less: Gross Profit (W2)	-8,850,000
Closing Stock		3,150,000
Less: Amount of Salvage Stock	-300,000
Cost of Goods Destroyed by Fire	2,850,000
Insurance Claim		2,261,905

Workings

W1: Determining the cost value of stock

Given that 90% of the stock is valued at 3,600,000: Cost Value of Stock = (3,600,000 / 90) × 100 Cost Value of Stock = 4,000,000

W2: Determining the amount of gross profit

Given a 33.33% markup on cost, we first convert this into the gross profit margin:

Gross Profit Margin = (33 / 133) × 100 = 25%

Gross Profit = 25% × 11,800,000 Gross Profit = 2,950,000