SUSPENSE ACCOUNTS; NUMBERED ACCOUNTS; ADJUSTMENT OF FIRE LOSSES
SUSPENSE ACCOUNTS
Definition of Suspense Accounts—General Purpose
Any account which is used as a place of temporary record for items
pending a determination of their final status or allocation may be
called a suspense account. The definition points out the general
purpose for which such accounts are opened. It frequently becomes
necessary to record items on the books as soon as the transactions
giving rise to them have taken place. At the time, the information
needed to determine their final place of record may be lacking. Stock
certificates may find their way into the secretary’s office with the
name of the party to whom transferred omitted; cash may be received
through the mails with the identity of the sender not disclosed;
provision must be made for bad debts before it is known what accounts
will prove uncollectible—these and similar items call for record before
their final status is determinable.
When cash is either short or over, the Cash Short and Over account
serves as a temporary adjustment account. Discrepancies between the
book record and the physical inventory of cash due to various causes
are temporarily thrown into this account until further information
discloses the cause. When it becomes evident that such information
cannot be secured, any balance is usually treated as a profit and loss
item at the end of the fiscal period. Similarly, discrepancies between
the bank’s cash record and that of the business may be thrown into an
account called “Bank Adjustments” or some other similar title, to show
the nature of the items there recorded. The Petty Cash account, between
the periods of its adjustment by means of a replenishing check, is in
the nature of a suspense account. Only when an analysis of the petty
cash expenditures and the replenishing check are recorded on the books
is Petty Cash an asset account. Failure to locate an error in the trial
balance is sometimes recorded on the books through the medium of a
Trial Balance Adjustment account so as not to carry the difference over
into the trial balance of succeeding months. Where such an account is
set up it is a suspense account pending the finding of the error.
Again, it may sometimes become necessary to adjust arbitrarily a
difference between a controlling account and the total of the ledger
which it controls pending the finding of the discrepancies between
the two. Thus, an Accounts Receivable Control may not accord with the
sum total of the customers’ accounts carried in the sales ledger, and
it may be deemed advisable to accept the subsidiary ledger record
as correct rather than the figures of the controlling account. The
adjusting item is usually incorporated in the controlling account but
is in the nature of a suspense item pending the allocation of the
difference. As mentioned above, a cash receipt from an unidentified
customer must be recorded in a suitably named suspense account.
Similarly, unclaimed wages which have been charged on the books to the
proper ledger account and credited to cash must be carried until they
are called for or until their record may with reasonable certainty be
closed on the books. Unclaimed dividends must also be held in suspense
until such time as a definite settlement of their disposition may be
determined. Advances to subsidiaries when recorded as a charge in open
account against the subsidiary are frequently of the nature of suspense
items. The subsidiary may settle the account by payment of cash, by
payment of its bonds or stock, or the account may not be settled and it
then becomes necessary to write it off as a bad debt.
Similarly, purchase invoices and other like items in dispute may be
booked as suspense items under suitable titles. However, in cases of
this kind it is more usual to hold the invoices until some basis of
settlement is reached before recording them on the books. If the fiscal
period closes with these items still unsettled, it will be necessary to
bring them on the books as contingent liabilities.
The Reserve for Depreciation may be looked upon as a suspense account.
The credit entries therein which serve the several purposes explained
elsewhere, are in the nature of items belonging to asset accounts which
are held in suspense pending the final disposal of all or some part
of the asset. This final disposition may take place either because of
sale, loss by fire, or the discard of the asset on account of complete
depreciation. At such a time it becomes necessary to transfer the
portion of the reserve belonging to the asset finally disposed of as a
credit to the asset account in order to clear that account of the asset
values therein shown.
Reserve for Doubtful Accounts as a Suspense Account
In like manner the Reserve for Doubtful Accounts is a suspense account
because at the close of the fiscal period it becomes necessary to
make an estimate of the probable amount of uncollectible items in
order to appraise correctly the value of outstanding claims against
customers. This estimate must be carried as a credit in the Reserve for
Doubtful Accounts because at that time it is not known definitely to
what particular customers’ accounts it applies. During the following
periods, as the information becomes definite as to what accounts are
absolutely uncollectible, the credit held temporarily in the reserve
account is transferred to the particular customer’s account which has
proved uncollectible. Thus, we often speak of charging an uncollectible
customer’s account against the reserve, which is another way of saying
that we transfer from the reserve a portion of the credit held there
in suspense, to the customer’s account after it has been determined to
what customer’s account it belongs.
Use of Suspense Ledger
In an effort to keep closer track of doubtful accounts and notes
receivable, such accounts are frequently transferred to what is known
as a suspense ledger. A fundamental misunderstanding seems to exist
with regard to the meaning of such a transfer. A business man often
points with pride to the fact that he has transferred a number of
items from his regular customers ledger to a suspense ledger, implying
thereby a policy of conservatism in the value at which he carries his
customers’ accounts on his books. As a matter of fact, the transfer
to the suspense ledger in no sense changes the valuation at which the
accounts are carried on the books. Separation of the doubtful items
from those considered good provides a convenient basis for analysis
according to which, at the end of the fiscal period, it will be
possible to make a much more accurate and intelligent estimate of the
probable loss from uncollectible items. Aside from that and another
fact of importance, namely, that by keeping all such accounts in a
suspense ledger it becomes much easier to watch them closely, nothing
is to be gained by the use of a suspense ledger. As to the proper
method of handling this ledger, it is best to carry in conjunction
with it a separate control on the general ledger supplementary to
the customers ledger controlling account. This would be effected at
the time of removing an individual account to the suspense ledger,
by transferring the same item from the customers ledger controlling
account to the suspense ledger controlling account.
The form of the suspense ledger is somewhat different from that of the
regular ledger in that provision is made for gathering information
as to the efforts made to collect the items and the result of those
efforts. A loose-leaf or card ledger serves the purpose best. While
the form is not standardized, such information as the report of the
mercantile agency at the time of granting the original credit; the
agent in whose hands the account is placed for collection; the date of
placing the claim in his hands; his report on his efforts to collect
the account; the lawyer to whom the account is given in case suit is
brought; the attorney’s report; the name and address of the trustee or
receiver in case the customer has gone into bankruptcy; the date of
filing a claim with the trustee; the judgment secured; the particulars
as to settlement; and provision for additional remarks—all this
information is of value and provision should be made to record it. It
may also be sometimes desirable to make use of a suspense journal where
information in addition to that for which provision has been made on
the ledger account can be collated and kept for reference.
Accounts Receivable Hypothecated
In connection with the handling of accounts receivable it may be
well to draw attention to the growing practice of discounting open
accounts receivable in much the same way in which notes receivable
are discounted. In recent years a group of non-professional bankers
have initiated this kind of financing. It may sometimes happen that
a merchant exhausts his credit with his regular banker and is unable
to raise further necessary funds in the usual way. By applying to the
so-called commercial credit companies or these non-professional bankers
it is frequently possible for him to discount his _new accounts_ as he
creates them through current sales to customers and so secure funds
for tiding him over a temporary stringency. The practice, however, is
looked upon in business and regular banking circles as evidence of
the financial instability of the merchant and his probable bankruptcy
in the near future. The cost of raising funds in this way is almost
prohibitive excepting in cases of dire need and it is not resorted to
by business houses whose financial condition is sound.
The practice works out somewhat as follows. A merchant desiring to
discount his accounts turns over to the credit company with whom he has
made the arrangement, the invoices of all accounts to be discounted as
evidence of the sales just made to customers. The credit company on the
strength of these invoices advances anywhere from 70% to 80% of their
face value, thus maintaining a margin of safety of from 20% to 30%. The
charge made is called commission rather than interest, and varies from
2% to 5%. To protect the credit company, frequently such invoices, as
they go out to customers, bear a notation to the effect that payment of
the bill is to be made to the credit company and not to the merchant
selling the goods. An obvious and serious objection to this practice is
that it gives the customer information as to the method of financing
to which the seller has been reduced. In view of this objection a few
bankers are willing for payment to be made as usual to the merchant,
who must in turn transfer the identical item or the merchant’s own
check for an equivalent amount to the banker. A periodical settlement
with the banker secures from him a statement and return of the moneys
held by way of margin. The accounts as settled are paid in full to
the banker who has previously furnished, say, 70% of their face value
in cash to the merchant. The banker thus holds 30% more money than he
has furnished to the merchant, and as these margins accumulate it may
sometimes happen that the banker is loaning the merchant the latter’s
own money. Consequently, it becomes imperative for the merchant to keep
careful record of all accounts discounted with, and of their payment
to, the banker so that he can protect himself by requiring a settlement
as may be shown necessary.
Accounting for Accounts Receivable Discounted
The accounting procedure in keeping track of these items is very
similar to that for notes receivable discounted. Inasmuch as the
practice does not involve an outright sale of the accounts to the
banker, a contingent liability is created in case the customer does
not pay his account, which the merchant will have to make good to the
banker just as in the case of notes receivable unpaid at maturity. The
bookkeeping record of discounted accounts may be considered under four
aspects:
1. At the time of discount.
2. At the time of the banker’s report of customers’
payments.
3. At the time an account is charged back by the
banker because of inability to collect.
4. At the time of final settlement with the bankers.
1. At the time a group of accounts is discounted the charges are to
Cash for the amount of cash received, to Commissions Paid on Discounted
Accounts for the amount of commission, and a charge to the Bankers or
to a Bankers’ Margin account for the margin. The credit offsetting
these debits is to an account called Customers’ Accounts Discounted.
No further entry is necessary until the banker’s report of customers’
payments.
2. At the time an account is reported as paid by the banker, the
contingent liability thereon as carried in the Customers’ Accounts
Discounted account has ceased to exist and a reversing entry becomes
necessary, Customers’ Accounts Discounted is charged, and the
customer’s account is credited.
3. When an account is not collected and is charged back by the
banker, the contingent liability as carried under Customers’ Accounts
Discounted becomes a real liability which has to be settled by payment
to the banker of the amount of the cash originally advanced by him at
the time of discount. At such a time the entry made will be a debit to
Customers’ Accounts Discounted offset by credits to Cash and to Bankers
or Bankers’ Margin account, as the case may be.
4. At the time of final settlement with the bankers, all that remains
to be done is for them to pay over the balance of cash in their hands
belonging to the merchant. This balance of cash is reflected by the
amount of margins which they have demanded at the time of discount.
Hence, on the merchant’s books the transaction will be recorded as a
debit to Cash and a credit to Bankers or Bankers’ Margin account.
In order to keep close track of all accounts under discount it is
advisable and almost necessary to make use of what may be termed a
“discounted accounts register.” Every account, as discounted, should be
given a number and entered in numerical sequence in the register. As an
account is paid by the customer and reported by the banker it should be
there shown as paid. The banker at the time of final settlement must
render an accounting for all the accounts not shown as canceled by
the register, either in cash or by a return of the claim against the
customer.
NUMBERED ACCOUNTS
Allotment of Numbers to Accounts
The allotment of a series of numbers to a certain kind of accounts not
only classifies them in an orderly manner by grouping them according to
their resemblances and separating them according to their differences,
but the notation also greatly facilitates locating them and saves much
time and effort in indicating them on vouchers, journal entries, etc.
Another advantage is that posting records may be checked as to their
general correctness by an official who has only a general knowledge
of the system. As an illustration, if the asset accounts have the
general classification of 1 and the expense accounts have the general
classification of 9, it needs only a cursory survey of voucher, or
ledger posting data, to see whether an expense item has been charged to
a capital account or vice versa.
The framework of the classification should be so constructed that
any account, new or old, not already included in the scheme, can
be inserted without disturbing the general order. If this is done,
the system can never become obsolete in the sense of becoming
impracticable, because changes can be inserted in their appropriate
place as soon as they occur.
The different schemes or symbols which have been developed from time
to time are the Dewey decimal system with its variations; the mnemonic
system; and a combination of the two. The Dewey decimal system is
undoubtedly the most complete and highly perfected in theory of any,
and, as the name indicates, is a combination of figures and periods
giving a symbol of almost unlimited expansion. The use of figures and
symbols offers an infinite number of possible combinations, but the
straight decimal system is in no way practical for general use, chiefly
because a voluminous key is necessary even to interpret the symbol.
The mnemonic system, as its name indicates, was devised for the
purpose of supplying a symbol which would be suggestive and which would
indicate the object that it was intended to identify. The mnemonic
symbol consists of a combination of letters and figures with the
occasional use of a period or a dash. In order to classify completely
any object in a large system, according to general classifications and
special subdivisions, it is sometimes necessary to use five, six, or
seven letters to identify one particular piece of machinery. In this
case also, the use of a key becomes a necessity. The mnemonic system
pure and simple is more often used for identifying machinery and tools
or other stock, kept in a factory stock room. It is adapted also to the
filing of correspondence.
The two advantages claimed for the mnemonic over the Dewey system are:
1. The letters of the alphabet are used and so give
opportunity for a more rational classification
than the ten possible groups of the decimal system.
2. A system consisting of letters may be made more
easily mnemonic, each letter being, as a rule, the
initial of the term symbolized, and may be recalled
to mind more easily than a number arbitrarily
chosen for that purpose.
The following example shows how easily a machine can be located and
described. If:
M is used for machine
L for lathes
C for core ramming machines
P for power machines
R for ramming machines
then:
ML would immediately suggest a lathe
MCR a core ramming machine
MPR a power ramming machine
Etc.
Where there are several styles of the same type of machine, numerals
may be added, as MPR₁, MPR₂, etc.
A combination of these two systems which has been applied to large
institutions is characterized by grouping all departments which perform
the same class of service under one letter of the alphabet, and then
numbering their functions. Frederick A. Parkhurst[72] has outlined a
very useful system which may be used in a manufacturing or other plant
somewhat as follows. Group A with subdivisions would include:
1A Accounting Room 1B Sales Department
2A Cost Department 2B Order Department
3A Credit Department 3B Stenographic Department
4A Billing Department
5A Filing Department
[72] “In Symbols.”
Each department of the factory has an arbitrary letter allotted to it
and is always referred to in all records by this letter and number.
The Interstate Commerce Commission uses a numerical system of numbering
accounts by first grouping each class under “general accounts”;
then under each group of general accounts, special accounts called
“primary accounts” are numbered consecutively. These accounts have
been analyzed so minutely that not much leeway is given for inserting
new accounts and for this reason the method is not so elastic as a
good classification requires. Thus, Operating Revenue accounts are
classified generally into:
I Transportation—Rail Line
II Transportation—Water Line
III Incidental
IV Joint Facility
The primary accounts under these general subdivisions are numbered as
follows:
Transportation—Rail Line from #101 to #116
Transportation—Water Line from 121 to 128
Incidental from 131 to 143
Joint Facility from 151 to 152
Operating Expense Accounts are classified under the following general
accounts:
I Maintenance of Way and Structures
II Maintenance of Equipment
III Traffic
IV Transportation—Rail Line
V Transportation—Water Line
VI Miscellaneous Operations
VII General
VIII Transportation for Investment—Cr.
The primary accounts under these are numbered from 201 to 462.
Another numerical method which can be used for general businesses and
which corresponds somewhat to the above is arranged as follows:
100 to 700 Assets and Deferred Charges
800 to 1100 Capital Stock, Liabilities, Reserves, and Surplus
1500 to 2500 Profit and Loss Accounts
The even hundred accounts are the controlling accounts in the general
ledger. The details are carried in subsidiary ledgers and are numbered
consecutively from 101 to 199, etc.
This system also is not so elastic as one constructed on the theory of
the Dewey decimal system, which may be expanded indefinitely without
disarranging the system as a whole. First of all the general ledger
accounts may be classified into nine fundamental groups as follows:
1 Asset Accounts
2 Investments and Treasury Securities
3 Prepaid Items
4 Liabilities
5 Accrued Items
6 Valuation Reserves
7 Capital and Surplus
8 Income
9 Expense Accounts
These general groups may be further subdivided indefinitely into groups
of nine, keeping in mind continually that the process of division
should be from general to special and that the progress should be
gradual.
1 Asset Accounts
11 Fixed Assets
111 Land
1111 Used and Useful in Operation
11111 Details in Subsidiary Books
1112 Held for Speculative or Investment Purposes
11121 Details in Subsidiary Books
11122
112 Buildings
113 Machinery
114 Tools
115
116
117
118
119
12 Current Assets
121 Cash in Bank
1211 Local Bank
1212 New York Bank
1213 Chicago Bank
122 Petty Cash Fund
123 Notes Receivable
124 Accounts Receivable
125 Merchandise
1251 Inventories
1252 Purchases Raw Material
1253 In Process
1254 Finished Goods
1255
1256
126
127
128
129
8 INCOME ACCOUNTS
81 Sales
811 Merchandise
8112 By Departments, etc.
812 Consignments
8121 Details in Subsidiary Records
9 EXPENSE ACCOUNTS
91 Manufacturing
911 Prime
9111 Wages
9112 Freight
912 Manufacturing Expenses
92 Selling Expenses
921 Salaries
9211 Details in Subsidiary Records
922 Traveling Expenses
923 Commissions
924 Advertising
925 General Selling
93 Administrative Expenses
94 General Expenses
All accounts under 100 are general ledger accounts, and accounts over
100 are accounts kept in subsidiary records.
From this outline it is apparent that even though each series is
limited to nine as in the Dewey decimal system, it may be indefinitely
expanded to include a large number of accounts, and will be elastic
enough to accommodate any number of future additions to the system.
It also classifies accounts so definitely that errors in posting are
very rare. A skilled bookkeeper would not be likely to post an income
account in any account beginning with 9 for instance.
If this system is used by a large corporation or holding company which
operates branches or factories in different sections of the country,
all forming part of the general system, letters of the alphabet may
be allotted to each factory or branch in addition to the numerical
classification. By this means the accounts of each branch may be
kept separate on the books of the head office, but the corresponding
expense accounts will have the same numbers and may be incorporated
in the head office books or balance sheet without any difficulty.
This illustrates the principle of grouping all accounts belonging to
the same classification and separating all accounts which belong to
different units of the same organization.
In establishing a special system of classification for any purpose
whatever, the main points to be kept in mind are that the following
requirements shall be fully met:
1. To enumerate all the kinds of information which
may be classified.
2. To group these items into a limited number of classes.
3. To give each class a definite and unchanging symbol.
4. To provide for expansion of the classification under
each group, and symbolize each subdivision by
an addition to the symbol for the group.
If these general rules are observed, the notation may be numerical or
alphabetical, whichever serves the purposes noted above, and also is
most easily memorized without the use of an elaborate key to interpret
the system.
ADJUSTMENT OF FIRE LOSSES
The Insurance Contract
A fire insurance policy is a contractual engagement, modified by the
conditions stated, to pay or replace, in part or in whole, any loss
through fire, covering the property specified for a definite period.
The amount to be paid cannot exceed the face value of the policy. The
main points covered in the policy are the parties, the property, the
risk, the amount, the term, the premium, and the conditions governing.
There are three ways in which the contract may be terminated, namely:
by expiration, cancellation, or forfeiture. Generally the contract
holds good until noon of the day named as the date of expiration.
Therefore, if a fire should break out in the forenoon on that day but
the greater part of the damage were caused after the noon hour, the
whole loss would be covered according to the terms of the policy. The
policy can be canceled immediately by the insured by giving notice to
the insurance company. The latter, however, must give notice and wait
five days before the cancellation will be effective.
In case of cancellation, the premium cost for the expired term is
usually higher proportionately than for the whole term; what is known
as the “short rate” becoming effective. The causes for the forfeiture
of the policy are many and various. Among the reasons are concealment
or misrepresentation, or fraud in connection with taking out the policy
or in substantiation of claims for losses incurred. Some of the parts
of the agreement relative to occupancy, vacancy, change in title, use
or allowance of dangerous substances may be the cause. Then again,
neglect of the clauses as to the maintenance of an adequate sprinkler
system, making provisions for watching the building, etc., may lead to
forfeiture.
Requirements in Case of Loss
When a loss occurs the first thing necessary is to give at once a
written notice to the insurance company and to endeavor to protect the
property from further damage. The next step is to separate the damaged
and the undamaged movable property, and to put these two classes in
order so as to facilitate checking up. Then follows the making out
of an inventory giving accurate details concerning the kind, the
amount, the cost, and the damage claimed in respect to the goods.
Upon the arrival of the adjuster of the insurance company, adjustment
may be made immediately, or it may be a protracted affair, depending
on conditions. The insured is required by the terms of the policy to
submit a sworn proof of loss within 60 days. This proof must enumerate
the facts and beliefs of the insured regarding the origin and time of
the fire, the interest the insured has in the property, together with
the interest, if any, held by others, the cash value of each item, the
sum total of the loss sustained, the encumbrances on the property,
other insurance, whether valid or not, a copy of all descriptions and
schedules of all the policies, any change in title, use, occupation,
location, possession, or exposure of the property since the issuance
of the policy. It is also required to state by whom and how the
insured building was occupied at the time of the fire. Sometimes the
insurance company may require that this proof be verified by plans or
specifications of the building, machinery, or fixtures that have been
destroyed or damaged. At its option, it may request a certificate from
an impartial magistrate or notary public substantiating the correctness
and honesty of the claims presented. It is further required that the
insured keep himself ready to exhibit any remains of the property in
question. He may also be required to submit to an examination under
oath and produce at the option of the insurance company any books of
account, bills and other vouchers, and permit copies or extracts to be
made from them.
Determination of Value of Loss
The insurance policy gives no hard and fast rule regarding the
determination of value. The usual phraseology is: “This Company shall
not be liable beyond the actual cash value of the property at the time
any loss or damage occurs and the loss or damage shall be ascertained
or estimated according to such actual cost value, with the proper
deduction for depreciation, however caused, and shall in no event
exceed what it would then cost the insured to repair or replace the
same with material of like kind and quality.”
The insurance company has accordingly the option of using the lower of
two bases of settlement, viz.: (1) actual cash value at the time of
the fire; or (2) what it would cost the insured party to replace the
property lost. The price which governs, cost or selling, will depend
upon the nature of the property. As a general rule, it is the cost
price. For goods which cannot be readily or advantageously reproduced,
like cereals and cotton, the adjustment basis is the local open market
price prevailing immediately before the fire. In adjusting values,
adequate depreciation allowance is made not only for ordinary wear and
tear, but also for losses incidental to changes of fashion, demand, etc.
Adjustment of Differences
Whenever there is a dispute regarding the standards applicable in
the adjustment or a disagreement regarding the method by which the
standards are applied, one or the other of the parties generally
invokes the provisions of the policy for an appraisal. In accordance
with the terms of the policy, the insurer and insured may each appoint
an appraiser who in turn selects an umpire. This official does not
act except when called on for a decision if the appraisers disagree
on some point. The appraisers proceed to make a joint appraisement
of the damage caused and the value of the loss. If this appraisal
is incorporated in a written award and signed by the appraisers, it
is binding on both parties, and will be upheld by the courts. This
provision is applicable to total and partial losses, but is limited to
questions of value and damage. The appraisers are generally experts,
but may call in any other person to give testimony. They are not bound
by any legal rules of evidence, but may determine their own procedure.
After the value of the loss has been arrived at, by agreement or
appraisal, the liability as modified by the conditions or limitations
comes up for consideration. There are generally a number of these
clauses present in every policy although they are not always in
force. One of these is the pro rata or the contributing clause. In
the standard policy this clause reads as follows: “This Company shall
not be liable under this policy for a greater proportion of any loss
... than the amount hereby insured shall bear to the whole insurance,
whether valid or not, or by solvent or insolvent insurers covering
such property.” The apportionment of the loss on this basis is often a
complicated affair.
Effect of Coinsurance Clause
Another limitation clause is the “coinsurance,” sometimes called the
“average clause” or “reduced rate” clause. The object of this clause is
to make the relation between value and insurance somewhat more stable
and to adjust the rates in accordance with the ascertained probability
of big and small losses. The assumption is that partial losses to
the property will also be partial losses to the insurance company.
Rates can be adjusted in the light of the ascertained probability
of the respective occurrence of slight and serious losses, and on
the assumption that partial losses to the property will also be only
partial losses to the insurance company. This clause does not operate
to reduce the insured’s recovery if either the loss or insurance equals
or exceeds the named percentage of value. Where applied, it does so
only after any apportionment under the contribution clause has been
determined.
The effect of the coinsurance clause is usually to make the insured a
coinsurer with the company for the difference between an amount limited
in the policy and the face of the policy. The limiting amount is
usually 80%, though it may be any other agreed per cent. The clause in
the policy may read somewhat as follows:
“In consideration of the premium for which this policy is issued, it is
expressly stipulated that in event of loss this company shall be liable
for no greater proportion thereof than the sum hereby insured bears
to eighty per cent of the cash value of the property described herein
at the time when such loss shall happen, nor more than the proportion
which this policy bears to the total insurance.”
Thus, in order to make the insured a coinsurer, in the event of loss
the company’s liability is limited to that proportion which the sum
insured bears to 80% of the cash value of the property described in the
policy at the time of loss. Where the loss or the insurance equals or
exceeds 80% of the value, the clause has no effect; when both are less,
the insured and the insurer bear the loss in certain proportions. A few
illustrations will show the way in which the liability of the company
is determined. In the case of an 80% coinsurance clause, the formula by
which the liability can be determined is derived as follows:
A = the sum insured, i.e., the face of the policy
B = the amount of the loss
C = the cash value of the property at the time of the loss
L = the liability of the company
Then, in accordance with the provisions of the coinsurance clause,
A AB
L = ----- × B or ----
.8C .8C
Three applications of the formula will be illustrated. In the first,
both the face of the policy and the amount of loss are less than 80%
of the cash value of the property. In the second, the policy carries
80% of the value of the property but the loss is less than 80% of the
property value. In the third, while the face of the policy is less
than 80%, the loss is more than 80% of the property value. From the
formula, it is evident that where A is 80% of C, the formula reduces to
B; and where B is 80% of C, it reduces to A. It must be borne in mind,
however, that the insurance company is never liable for more than the
amount insured, i.e., the face of the policy, nor for more than the
amount of the loss.
Face of Cash Value Amount of Liability of
Policy of Property Loss Insurance Company
“A” “C” “B” “L”
(1) $3,000 $5,000 $2,500 $1,875
(2) 4,000 5,000 2,500 2,500
(3) 3,000 5,000 5,000 3,000
Applying the formula in:
AB 3,000 × 2,500
(1) ----- = --------------- = 1,875
.8C .8 of 5,000
AB 4,000 × 2,500
(2) ----- = --------------- = 2,500
.8C .8 of 5,000
AB 3,000 × 5,000
(3) ----- = --------------- = 3,750
.8C .8 of 5,000
It will be noted in (3) that, inasmuch as the policy is $3,000, only
$3,000 can be collected.
When the amount of the liability has been determined, the insurance
company has three options:
1. Payment may be made in cash within 60 days
after the completion of the proof of loss.
2. It may rebuild or replace the property. Notice of
such intention must be given within 30 days from
the filing of proof.
3. It may pay the “sound” value, i.e., the actual cash
value of the property and dispose of what remains
of it for its own account.
In most cases the first method is followed.
Method of Record-Keeping to Facilitate Ready Adjustment
Under the standard contract the insurance company must make adjustment
within 60 days after the report of the loss. Where no differences exist
or only such differences as are capable of easy adjustment between
the company and the insured, payment of the loss is usually made
without any delay because of the advertising value in the community
of a quick adjustment of fire losses. Most of the differences which
cause delay in the making of adjustments result from the inability of
the insured to prove satisfactorily the amount of his loss. Failure
to prove loss usually results from a slipshod manner of keeping the
records and a loss of the supporting vouchers. The standard policy
provides that the insurance company may require the production of
original bills and vouchers to establish the cost of the property
destroyed. Where these are not obtainable the process of adjustment
may be delayed until data on which to figure the original cost can
be secured which is satisfactory both to the insurance company and
the insured. Accordingly, in order to secure adjustment of fire
losses without delay, the record of all assets should be supported by
original vouchers. Where the asset account is a group account, i.e.,
one composed of numerous pieces of property, a subsidiary ledger or
register, or inventory record as it is sometimes called, should be
carried, in which appear the details of the group account. If, then,
the assets covered by the group account are only partially destroyed,
it is then possible readily to determine the cost value of the portion
destroyed by comparison with the portion left. In the case of machinery
and tools, furniture and fixtures, delivery equipment, etc., the use
of such a register is particularly advantageous. If the voucher system
of account-keeping is in use, there will be supporting data for all
charges to asset accounts and an examination of these will make it
possible to determine the legitimacy of all such charges.
Another point to be kept in mind if ready adjustment is desired is
to make sure that the policy covering particular property makes a
sufficiently definite statement of the property covered so as to
indicate clearly the exact property to which the policy applies.
Oftentimes policies are taken out on buildings with the description
so indefinitely worded that it becomes very difficult, where there
are many buildings, to know just what is covered by any particular
policy. Where policies are taken out covering new equipment as it
is purchased, and at some future time the equipment is moved from
building to building, the problem of allocating the policy with the
property covered by it becomes particularly difficult. To surmount
these difficulties it may be wise even to draw up charts and maps of
all buildings and their equipment, indicating on the insurance policies
the particular pieces of property covered by them as shown on the map.
As mentioned above, clear, businesslike records kept by the insured
and properly supported by original data will always make for speedy
adjustment of fire losses.
Adjusting Entries for Fire Losses
To make the books record properly the loss suffered by fire, it is
necessary to set up a special account called “Fire Loss.” To that
account will be charged the full amount of the loss, including any
expenses incurred in connection therewith and also the portion of
the unexpired insurance premium which is canceled by the fire. This
account will be credited with the amount of insurance received or
allowed by the insurance company. Stated otherwise, to the account
will be transferred the book value of all property destroyed and all
expenses in connection with the fire. After the account is credited
with the amount of insurance received, the balance shows the net loss
suffered by the fire and will be closed directly into surplus so as not
to affect the results of the current period’s operations. As a rule,
at the time of the loss of a fixed asset, depreciation has accrued
from the close of the last fiscal period and this must be taken into
consideration in making the adjustments on the books. The amount of
such accrued depreciation must be charged to the current period’s
Depreciation account because the period must bear its proper proportion
of the expense. The offsetting credit to such charge will be made
directly to the asset account rather than to its Depreciation Reserve
account. The depreciation applicable to the asset destroyed which has
accumulated in the past must now be transferred as a credit to the
asset account. After such transfer and entry in the asset account
of the accrued depreciation, the balance of the asset account shows
the appraised value of the asset as at the time of the fire. If this
appraised value is accepted as the true value by the insurance company,
no further adjustment is needed and this becomes the figure or amount
which is transferred to the Fire Loss account. If, however, settlement
is made on a lesser valuation, in strict theory, the difference between
the book value of the asset and the value accepted as the basis
for settlement should be charged to surplus as an adjustment item
occasioned by insufficient depreciation charges in former periods.
Usually, however, no cognizance is taken of such adjustment and the
total book value of the destroyed asset is charged to Fire Loss account.
If the loss is complete or the insurance company makes a settlement
of the total amount of the policy, the policy is canceled and all
unexpired premiums applicable to it are used up and constitute an
additional loss occasioned by fire. The amount of such unexpired
premiums is therefore charged to Fire Loss account. If settlement
is not made for the total amount of the policy, the amount of the
settlement is indorsed on the policy in order to show the amount of
insurance still in force for which the company is liable. The due
proportion of the unexpired premium will be charged off to Fire Loss
account. This proportion will be represented by the ratio of the amount
of the settlement to the face of the policy.
In the case of loss of stock-in-trade by fire it is very necessary
to have available as the basis for determining the value of the
merchandise destroyed the inventory record as at the close of the
previous fiscal period. The record of all purchases, purchase returns,
sales, and sales returns from then until the time of the fire, and
the records of previous years, should also be available in order to
determine the average rate of gross profit. If such rate of gross
profit is not available, there must be a rate agreed upon by the
insured and the company as the basis for settlement. The method of
determining the value of the goods on hand at the time of the fire by
means of the data just mentioned is explained in full in Volume I, page
506, under the head of “Book or Estimated Inventories.” Here also, as
in the case of fixed assets, clear, businesslike records lead to a
speedy adjustment of the loss.