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.