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Insurance Policy Method

This method attempts to remove the drawbacks of the Sinking (Depreciation) Fund Method in respect of fluctuation in interest rates and values of securities. Under his method, arrangements are made with any General Insurance Company which will pay the required amount at the end of a fixed period (say 5 or 10 or 15 years) in return for annual premium for fixed period. Interest on investment is not a part of this method and hence no question of its reinvestment. In respect of accounting treatment, following entries are passed every year: The two accounts, namely, Depreciation Fund Account and Depreciation Fund Policy Account are balanced every year.

(i)    On payment of premium

Depreciation Fund Policy Account    Dr.    (with annual premium equal to depreciation)
    To Bank Account

(ii)    For charging depreciation    
Depreciation Account            Dr.    (with annual premium equal to depreciation)
    To Depreciation Fund Account

On the expiry of the stipulated period, the insurance company will pay the agreed amount which is credited to Depreciation Fund Policy Account. This account will then show a credit balance which will be transferred to Depreciation Fund Account. The asset account is closed by transfer to Depreciation Fund Account. It is needless to state the Depreciation Account is transferred to Profit and Loss Account at the end of each accounting period.

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