accounting treatment of goodwill at the time of admission

8/13/2019 Accounting Treatment of Goodwill at the Time of Admission

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Accounting treatment of goodwill at the time of admission

When a new partner enters in partnership firm, the old partner sacrifices his share for him , so it is the

duty of new partner to give goodwill in cash or in any other way to old partner . There are following

method with this new partner give his share of goodwill to old partners .

1st method

Private distribution of goodwill

Under this method , new partner gives his share of goodwill to old partners personally .So there is no

need to record it to the books of firm . No journal entry will pass .

2nd method

Goodwill is given in cash form by new partner

Under this method , old partner bring his share of goodwill in cash form in the firm and it is taken by

old partner in their sacrifice ratio . For this following journal entry pass in the books of firm

Cash / Bank Account Debit xxxxxxxxx

To Goodwill / Premium Account xxxxxxxxxx

Goodwill account debit xxxxxxxx ( share of new partners goodwill )

To old partners capital account xxxxxxx ( divide in sacrifice ratio )

3rd method

when new partner bring goodwill in cash in business and taken by old partner and then withdraw by

old partner

Above two entries will pass as same as in second method but third new entry will pass

Old partners capital account Debit xxxxxxxxxxx

To cash / bank account xxxxxxxx

4th method
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when new partner do not bring goodwill in cash form

If new partner do not bring goodwill in cash in firm , then following entry will pass for the adjustment

of goodwill .

New partners capital account debit xxxxxxxx (share of goodwill )

To old partners capital account xxxxxxxxx (division in sacrifice ratio)

5th method

If partial in cash form of goodwill

Part of cash goodwill

Cash account dr. xxxxxx

To goodwill / premium account xxxxxxxx

Goodwill account debit ( cash goodwill) xxxxxxxxx

New partner account debit ( not in cash goodwill ) xxxx

To old partner capital account in sacrifice ratio xxxxxxx

6th method

If goodwill already exits in balance sheet of old partner , then it must be transfer to old partners

capital account in old ratio . Other method is same above from 1 to 5 method .

Entry passed for transferring of old goodwill

Old partners capital account debit xxxxxxx

To goodwill xxxxxxx

7th method

If new partner brings other asset as goodwill of his share of goodwill . Then following entry will pass

Asset account debit xxxxxx

To goodwill account xxxxxxxx

Goodwill account debit xxxxxxxxx

To old partners capital account in sacrifice ratio xxxxxxxxxx


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Admission of a Partner in Partnership

When a new partner joins a partnership the old partnership is dissolved and a new partnership is

formed. Accounting for admission of new partner depends on the nature of arrangement between the

existing partners and the new partner. Such an arrangement can take any of the following forms:

a. The new partner brings in new assets

b. The new partner purchases interest in partnership from existing partners at book value

c. The new partner pays a bonus for the partnership's goodwill; and

d. The new partner receives a bonus for the partnership's negative goodwill.

Accounting in each of the situation is discussed separately below:

New partner brings additional assets

When the new partner brings in new assets, the assets are debited at the value agreed by the

partners for the purpose and the partner's capital account is credited for the total value of thoseassets.

Example 1

Pluto and Sedna were partners in Kuiper Space Consulting. Their respective capital balance was $45

million and $25 million. In 2005 they agreed to admit Eris who agreed to contribute a very specialized

telescope worth $20 million.

The admission through introduction of new assets is recorded by the following journal entry:

Telescope 20,000,000

Eris Capital Account 20,000,000

The new partner purchases his share from existing partners at book value.

New partner purchases interest in partnership from existing partners at book value

When the new partner purchases interest from existing partners at book value, the transaction is

recorded by crediting the capital account of the new partner and debiting the capital account of

existing partner(s). The transaction is reported in the books for the partnership at the book value of

the share transferred and it has nothing to do with the price which the new partner has paid to the

existing partner(s).

Example 2

Refer to Example 1 and assume that Eris purchased 25% of share of Pluto in KSC for $15 million and

45% share of Sedna for $10 million.


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For the purpose of accounting for the above transaction, we have to work with book values of the

transferred shares. The consideration at which the transfer is made between Pluto, Sedna and Eris is

not relevant because it is the partners' personal transaction. We just need to debit Pluto's capital

account by $11.25 million (25% of $45 million) and Sedna's capital account by $11.25 million (45% of

$25 million) and credit Eris capital account by $22.5 million ($11.25 million worth of book value

purchased from Pluto and $11.25 million worth of book value purchased from Sedna). From looking at

the transaction, we see that Pluto sold the share at profit but Sedna sold it at a loss. But all this is not

relevant for accounting purpose in the given arrangement.

New partner pays a bonus for goodwill

When a partnership has good reputation and a profitable client base, new partners are

normally required to pay a hefty bonus for goodwill i.e. they introduce assets in excess

of the book value of the share they get in the firm. In such a situation, the bonus

(which equals the assets they introduce minus the book value of the share they get in

the partnership) is credited to the existing partners' capital accounts.

Example 3

Refer Example 1 and assume that Eris brings in cash worth $40 million but in return it gets a capital

share of only $25 million. Any payment bonus representing goodwill is shared equally by Pluto and

Sedna.

The $15 million representing excess of assets introduced over the book value of the share represents

the bonus paid to the existing partners. This bonus is credited to Pluto's and Sedna's capital accounts

in a ratio agreed in the partnership agreement. (In their mutual profit sharing ratio if no such

provision exists the agreement). It is journalized as follows

Cash 40,000,000

Eris Capital 25,000,000

Pluto Capital ($15 million/2) 7,500,000

Sedna Capital ($15 million/2) 7,500,000

New partner receives a bonus for negative goodwill

Every partnership is interested in recruiting influential partners that could prove key in business

development. Existing partners might be willing to offer a bonus to a new partner i.e. they might offer

him a share in the book value of the partnership's equity which is in excess of assets contributed by

him. When this is the case, the existing partners share the bonus paid either in the accordance with

the partnership agreement or in their profit sharing ratio or equally. The transaction is accounted for

by debiting each partners' capital account by their respective shares of bonus paid and crediting the

total bonus amount to the new partner's capital.


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Example 4

Refer Example 1 and assume that Eris brings in cash worth $40 million but in return it gets a capital

share of $60 million. Any exchange of bonus is shared equally by Pluto and Sedna.

The $20 million representing excess of the Eris's share in partnership capital over his contribution

represents the bonus he receives for the 'negative goodwill'. The bonus is born by Pluto and Sedtna

equally and transaction is journalized as follows:

Cash 40,000,000

Pluto Capital ($15 million/2) 7,500,000

Sedna Capital ($15 million/2) 7,500,000

Eris Capital 60,000,000

Admission of a Partner* How can a New Partner be Admitted:-According to section 31(1) of Indian Partnership Act 1932, a person can be admitted as a newpartner only with the consent of all exiting partners.

* A new partner is needed into the business due to the following reasons:-1. When more capital is needed for the expansion of the business.

2.

When a competent and experienced person is needed for the efficient running of the business.3. To increase the goodwill and reputation of the business by taking a reputed and renownedPerson into the partnership.

4. To encourage a capable employee by taking him into the partnership.

* Following Adjustments are needed at the time of the admission of a newpartner :-1. Calculation of new profit sharing ratio.2. Accounting treatment of goodwill.3. Accounting treatment for revaluation of Assets and Liabilities.4. Accounting treatment of reserves and accumulated profits.5. Adjustment of capitals on the basis of new profit sharing ratio.

* Calculation of New Profit Sharing Ratio:

1. When only the ratio of new partner is given in the question, then in the absence of any instructions.It is presumed that the old partner will continue to share the remaining profits in the same ratio inwhich they were sharing before the admission of a new partner.


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2. The new partner purchases his share of profit from the old partners equally. In such cases thenew profit sharing ratios of the old partners will be as certained by deducting the sacrifice made bythem from their existing share of profits.

New Profit Ratio = Old Ratio - Sacrifice

3. The new partner purchases his share of profit from the old partners in particular ratio. In suchcases the new profit sharing ratio of the old partners will be calculated after deducting the sacrificemade by a partner from his existing share of profit.

New Profit Ratio = Old Ratio - Sacrifice


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When the old partners surrender a particular fraction of their share in favour of the newPartner then.,

Surrendering Share = Surrendered Share XOld Ratio.New Ratio = Old Ratio - Surrendering Share.

Sacrifice Ratio = Old Ratio -New Ratio.

*Accounting Treatment of Goodwill on the Admission of a Partner :

1. When the amount of goodwill (premium) is paid privately.:- No Entry

2. When the new partner brings his share of goodwill (premium) in cash:

a.) When the amount of goodwill/ premium brought in by the new partner is retained inthe business:-

i.) Cash/ Bank A/c Dr.To goodwill A/c

ii.) Goodwill A/c Dr ( in sacrifice ratio)To Old partners capital A/c

b.) When goodwill/premium brought in by the new partner is withdrawn by the old partners:-i.) Old Partners capitalA/c Dr.

To Cash / Bank A/c

* When goodwill already appears in the books and new partners brings hisshare of goodwill/premium in cash:-

First of all the existing goodwill account will have to be written off. For this purpose old partners

capital accounts are debited in old ratio and goodwill account is credited.

Old partners capitalA/c Dr.To goodwill A/c ( in old ratio)

Remaining entries remains same for bring goodwill in cash.

* When the new partner does not bring his share of goodwill/premium incash:-

New partners currentA/c Dr. (from his share ofgoodwill)

To old partners capital A/c (in sacrifice ratio)

* When goodwill already appears in the books and new partner does notbring his share of goodwill/premium in cash:-

i.) Old partners capitalA/c Dr.


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To goodwill A/c (in old ratio)

ii.) New partners currentA/c Dr.To old partners capital A/c (in sacrifice ratio )

* When new partner brings in only a part of his share of goodwill:-

i.) Cash/bank A/c Dr.To goodwill A/c

ii.) Goodwill A/c Dr.New partners current A/c Dr.

To Old partners capital A/c (in sacrifice ratio)

* Revaluation of assets & liabilities :-Revaluation account :-

Account which is prepared to record changes in the value of assets & liabilities at timeof admission, retirement, death and change in profit ratio of existing partners. Proformaof Revaluation Account is given below :-

Revaluation Account

Particulars Amount Particulars AmountTo Decrease in value of assets

To Increase in value of liabilitiesTo Unrecorded liabilities

To Profit on revaluationtransferred to partners capitalaccounts (in old ratio)

By Increase in value of assets

By Decrease in value of liabilitiesBy unrecorded assets

By loss on revaluationtransferred to partners capitalaccounts (in old ratio)

Partners Capital Account

Particulars A B C Particulars A B CTo drawings

To interest on

drawings

To profit & loss (Share

of loss)To revaluation A/c

(share of loss)To balance c/d

By balance b/d

By cash/bank A/c

By interest on capital

By salary

By commissionBy P&L appropriation

A/c (share of profit)By revaluation A/c(share of profit)


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i.) For decrease in the value of assets & increase in the value of Assets /unrecorded Assets:-

1. Revaluation A/c Dr.To assets A/c (decrease

)

2. Assets A/c Dr.To revaluation A/c (increase)

3. Unrecorded assets A/c Dr.To revaluation A/c

ii.) For increase / decrease of liabilities or unrecorded liabilities :-1. Revaluation A/c. Dr.

To liabilities A/c (increase )2. Liabilities A/c Dr.

To Revaluation A/c (decrease)

3. Revaluation A/c DrTo unrecorded liabilities A/c

iii.) Revaluation A/c shows profit or loss :-1. Revaluation A/c. Dr. (in profit)

To Old partners capital A/c (in old

ratio)

2. Old partners capital A/c. Dr. (in loss)To revaluation A/c (in old

ratio)

* Accounting treatment of reserves and accumulated profits or losses :-i.) For distributing reserves and accumulated profits among old partners in old ratio -

General reserve A/c Dr.Reserve A/c Dr.P&L A/c {cr. Balance} Dr.

To old partners capital a/c / current a/c.

ii.) For distributing accumulated losses among old partners in old ratio-

Old partners capital A/c Dr.To P&L A/c { Dr. balance}

iii.) For distributing surplus of specific funds:-

Workmens compensation fundA/c Dr.


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Investment fluctuation fund A/c Dr.To Old Partners Capital a/c. / Current a/c.

* Adjustment of old partners capital accounts on the basis of new partnerscapital:-

i.) If the existing capital of any partner is less then his newly calculated capital:-Bank A/c / Partners Current a/c. Dr.

To Old Partners Capital A/c.

ii) If the existing capital of any partner is more than his newly calculated capital :Old Partners Capital A/c. Dr.

To Bank A/c. / Partners Current A/c

.

accounting treatment in case of retirement of partner

A Partner has the right to retire from the firm after giving due notice in advance.

A new partnership comes into existence between the remaining partners.

*A retiring partner is entitled to get the following:1) Share in goodwill;Goodwill of the firm is valued and the retiring partners share of goodwill is

credited to his capital account.

2) Share in Reserves:Reserves are the undistributed profits and it is also credited to the capital

account of retiring partner.3) Share in revaluation of assets and liabilities:Assets and liabilities are revalued on the date of

retirement and retiring partners share of profit is credited or the loss is debited to his capital account.

*Accounting problems:1) Calculation of new profit sharing ratio and gaining ratio of the continuing partners.

2) Treatment of goodwill.

3) Accounting treatment for revaluation of assets and liabilities.

4) Accounting treatment of reserves, accumulated profits and losses.

5) Accounting treatment of joint life policy.

6) Payment to retiring partner.7) Adjustment of capitals in proportion to profit sharing ratios.

*Calculation of new profit sharing ratio:

.1) If the new profit sharing ratios of the remaining partners are not given in the question ,it will be

assumed that the remaining partners continue to share profits and losses in the old ratio.


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2) Sometimes the remaining partners purchase the share of retiring partner in some specified

proportion .In such cases the fraction of shares purchased by them is added to their old share and

the new ratio is calculated as follows:-

New ratio = old ratio + gain

*Calculation of Gaining Ratio:- Meaning of Gaining Ratio: Gaining ratio is the ratio in which the remaining partners will pay the

amount of goodwill to the retiring partners.

- Calculation of Gaining Ratio:

1) If the new profits sharing ratios of the remaining partners are not given in the question, it will be

assumed that the remaining partners continue to gain in the old ratio.

2) If the new profit sharing ratio of the remaining partners is given in the question, gaining ratio is

calculated by deducting old ratio from the new ratio.

Gaining Ratio = New RatioOld Ratio*Difference between sacrificing Ratio and Gaining Ratio:

Basis Sacrificing Ratio Gaining Ratio1) Meaning: The ratio in which the old

partners surrender a part of

their share in favour of a new

partner.

The ratio in which the

remaining partners acquire

the outgoing partners share.

2)When calculated Calculated at the time of the

admission of a new partner.

Calculated at the time of the

retirement or death of a

partner.

3)Formula for calculation Sacrificing Ratio=Old Ratio-

New Ratio

Gaining Ratio=New Ratio-Old

Ratio

4) Purpose New partners share of goodwillis divided between the old

partners in sacrificing ratio.

Goodwill paid to retiringpartner is paid by the

remaining partners in their

gaining ratio.

*Accounting Treatment of Goodwill:1) Remaining partners capitalA/c Dr. (In gaining ratio)

To Retiring/Deceased partners capital A/c ( with his share of goodwill)


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2) When the goodwill A/c is already appearing in the books:

i) All partners capitalA/c Dr.( in old ratio )

To Goodwill A/c (goodwill existing in the books)

ii) Remaining partners capitalA/c Dr. (in the gaining ratio)

To Retiring/Deceased partners capital A/c

*Adjustment of Accumulated profits and reserves:

1) For distributing reserves and accumulated profits-General Reserve A/c Dr.

Reserve Fund A/c Dr.

Profit and loss A/c (cr.) Dr.

To All partners capital or current A/c (in old ratio)

2) For distributing accumulated losses:All partners capital or currentA/c Dr. (in old ratio)

To Profit and loss A/c

3) For distributing surplus of specific funds:Workmen compensation fund A/c Dr.

Investment fluctuation fund A/c Dr.

To All partners capital or current A/c (in old ratio)

*Adjustment of joint life policy on retirement of a partner:

1) when premium paid has been considered as revenueexpenditure:

- Joint life policy A/c Dr. (surrender value on the date of retirement)To All partners capital A/c (in old ratio)

2) when remaining partners decide not to show Joint life policy inbooks:

Remaining partners capitalA/c Dr. (in new profit sharing ratio)

To Joint life policy A/c

3) when premium paid has been considered as capitalexpenditure: No further treatment required

if remaining partners decide not to show Joint life policy in books-

Remaining partners capital A/c (in new ratio)

To Joint life policy A/c


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Payment to retiring partner

a) If the amount is paid in cash or by cheque to retiring partner:Retiring partners capital A/c Dr.

To cash/Bank A/c (His share paid off)

b) If the amount is not paid in cash, the amount due to him will be transferred to his loan A/c:

Retiring partners capitalA/c Dr.

To Retiring partners loan A/c

* Death of a partner :On the death of a partner, the amount payable to him is to be paid to his legal representatives

following amounts will be his capital account:

1) The amount standing to the credit of his capital A/c.

2) His share of the increase in the value of goodwill of the firm.

3) Interest on capital, if provided in the partnership deed.

4) His share of profit on the revaluation of assets and liabilities.

5) His share of undistributed profits or reserves.

6) His share of life policy.

7) His share of profit upto the date of his death.

Following amounts will be debited to the account of the deceasedpartner for ascertaining the amount due to his legalrepresentatives:

1) Drawings.

2) Interest on drawings.3) His share of loss on the revaluation of assets and liabilities.4) His share of undistributed loss, such as debit balance of profit and loss A/c.5) His share of the reduction in the value of goodwill.

*Calculation of profit : If the death of a partner occurs on any day during the year ,the executors of the deceased partner will also be entitled to the share of profits earned by the firm

from the beginning of the year till the date of his death.

Two methods to ascertain profit:A) On Time Basis: In this method , we have to take into consideration the profit of the last year

and the time for which he remained a partner during the current year.

Firms Profit = Average Profit XNumber of months


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12Share of deceased person in profit = Firms profit X Share of deceasedperson

B) On Turnover or sales Basis:= Profit of pervious year/Sales of previous year X Sales of current year

* Individual life policy:- Instead of taking only one joint life policy, the firm may take individual policies on the lives of

partners.

Accounting Treatment :(1) When surrender values are not appearing in thebooks,

For amount received from the insurance company on maturity or death of a partner,

Insurance company A/c Dr.

To life policy A/c

Life policy A/c Dr.

To All partners capital A/c (in old ratio)

For recording the deceased partners share in the surrender value of surviving partners policies,

Surviving partners capitalA/c Dr.(in gaining ratio)

To Deceased partners capital A/c

(2) When surrender values are already appearing in the books,

For amount received from the insurance company on maturity or death of a partner,

Insurance company A/c Dr.

To life policy A/c

Life policy A/c Dr.(amount received minus surrender value

Appearing in the balance sheet)

To All partners capital A/c (in old ratio)

> Entry for recording the surrender value of surviving partners policies will not

be passed in this case since they are already appearing in the balance sheet.

Death of a partner

A partnership will come to an end immediately whenever a partner dies although the firm may continue with thereaming partners by purchasing the share of the deceased partner. The matters which require consideration in caseof death of partner and their accounting treatment are th same as in case of retirement of partner thus when a partnerdies it means compulsory retirement and his representatives or the executors of his estate are entitled to all the rightswhich have been stated in chapter of the retirement of partner.


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Difference between two situation retirement and death of partner

(i) Retirement of a partner is usually planned and made effective form the closing date of an accounting year butdeath of a partner may occur any time without notice during the year.

(ii) The payment of retiring partner share will be received by him but the payment of deceased partner share will be

received by his legal heirs.

Calculation of share of profit upto date of death

The representatives of deceased partner will be entitled to his share of profits accrued upto date of death. To avoidthe necessity of preparing final accounts on the date of death it is frequently provided in the partnership deed, that inthe event of the death of a partner his share of the accruing profits upto the date of depth is to be arrived by any oneof the following two methods:

(i) On the basis of time

(ii) On the basis of turnover

On the basis of time: if the time basis is used the profit will be assumed to have uniformity over the year. According tothis method profit may be estimated by any one of the following two methods:

(a) On the basis of last year profit in this case last year profit is given in the question and on this basis the profit ofthe period between the date of preparing last final accounts to the date of death is calculated after that proportionshare of outgoing partner will be calculated.

(b) On the basis of average profit: in certain cases partners may agree to calculated deceased partner share of profiton the basis of average profit. This is worked out as follows:

Take the total profit to the required number of past years.

Calculate the average profit

Total profit + no of years,

Reduced average profit for the period upto date of death;

Find out the share of profit of the deceased partner.

Formula deceased partner share of profit = previous year profit or average profit X time till death/12 / 365 X deceasedpartner proportion of profit

(iii) On the basin of turnover (or sales) if profit till the date of death are to be calculated on the bias of turnover onsuch arrangement last year profit and sales are given together with the sale of the current year upto the date of deathof the partner the profit is ascertained proportionately and share of profit of deceased partner is calculated.

Deceased partner share of profit = last year profit/ last year sale X sales till death x deceased partner profit share

Accounting treatment of outgoing partner share in profit

The outgoing partner share in the profit may be readjusted in either of the following ways:

(a) Through profit & loss suspense accounts: this method is used only when the new profit sharing ratio of continuingpartners does not differ from their old profit sharing ratio. In this case, the following entries will be passed.

(i) In case of profit

Profit & loss suspense A/c Dr. (share of profit)

To outgoing partners capital A/c


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(ii) In case of loss

Outgoing partner capital A/c Dr. (Share of profit)

To profit & loss suspense A/c

(b)Through capital transfer: this method is used only when the new profit sharing ratio of continuing partners differs

from their old sharing ratio. In this case the following entries will be passed.

(i) In case of profit

Gaining partners capital A/c Dr. (gaining ratio)

To outgoing partners capital A/c (share of profit)

(ii)In case of loss

Outgoing partner capital A/c Dr. (Share of loss)

To gaining partners capital A/c (gaining ratio)

It shield be remembered that if partner is retired during the year, the above rules will also be applicable for calculating

his share of profit.

Example: You are given the balance sheet of mohit shoran and Rahall who are partners sharing privets in the ratio of2 : 2: 1 as on march 31, 2007.

Balance sheet

Liabilities $ Assets $

Creditors 40,000 Goodwill 30,000

Reserve fund 25,000 Fixed assets 60,000

Capitals Stock 10,000

Mohit 30,000 Sundry debtors 20,000

Sohan 25,000 Cash at bank 15,000Rahul 15,000 70,000

1,35,000 1,35,000

Shoran died on June 15, 2007 according to the deed his legal representatives are entitled to

(i) Balance in capital account:

(ii) Share of goodwill valued on the basis of thrice the average of the past 4 years profits.

(iii) Share in profits up to the date of death on the basis of average profits for the past 4 years.

(iv) Interest on capital account @ 12% p.a.

Profits for the years ending on March 31 of 2004, 2005 2006, 2007 respectively were $15,000, $ 17,000, $ 19,000

and $ 13,000.

The firm has taken a joint life policy of $ 1, 25,000 the annual premium being charged to profit & loss account every

ear, shoran legal representatives were to be paid the amount due. Mohit and Rahall continued as partner by taking

over shoran share equally work out the amount payable to shoran legal representatives.


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Fire insurance

A fire insurance is a contract under which the insurer in return for a consideration (premium) agrees toindemnify the insured for the financial loss which the latter may suffer due to destruction of or damage toproperty or goods, caused by fire, during a specified period. The contract specifies the maximum amount ,agreed to by the parties at the time of the contract, which the insured can claim in case of loss. This amountis not , however , the measure of the loss. The loss can be ascertained only after the fire has occurred. Theinsurer is liable to make good the actual amount of loss not exceeding the maximum amount fixed under thepolicy.

A fire insurance policy cannot be assigned without the permission of the insurer because the insured musthave insurable interest in the property at the time of contract as well as at the time of loss. The insurableinterest in goods may arise out on account of (i) ownership, (ii) possession, or (iii) contract. A person with alimited interest in a property or goods may insure them to cover not only his own interest but also theinterest of others in them. Under fire insurance, the following persons have insurable interest in the subjectmatter:-

Owner

Mortgagee

Pawnee

Pawn broker

Official receiver or assignee in insolvency proceedings

Warehouse keeper in the goods of customer

A person in lawful possession e.g. common carrier, wharfinger, commission agent.

The term 'fire' is used in its popular and literal sense and means a fire which has 'broken bounds'. 'Fire'which is used for domestic or manufacturing purposes is not fire as long as it is confined within usual limits.In the fire insurance policy, 'Fire' means the production of light and heat by combustion or burning. Thus,fire, must result from actual ignition and the resulting loss must be proximately caused by such ignition. Thephrase 'loss or damage by fire' also includes the loss or damage caused by efforts to extinguish fire.

The types of losses covered by fire insurance are:-

Goods spoiled or property damaged by water used to extinguish the fire.


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Pulling down of adjacent premises by the fire brigade in order to prevent the progress of flame.

Breakage of goods in the process of their removal from the building where fire is raging e.g.damage caused by throwing furniture out of window.

Wages paid to persons employed for extinguishing fire.

The types of losses not covered by a fire insurance policy are:-

loss due to fire caused by earthquake, invasion, act of foreign enemy, hostilities or war, civil strife,riots, mutiny, martial law, military rising or rebellion or insurrection.

loss caused by subterranean (underground) fire.

loss caused by burning of property by order of any public authority.

loss by theft during or after the occurrence of fire.

loss or damage to property caused by its own fermentation or spontaneous combustion e.g.exploding of a bomb due to an inherent defect in it.

loss or damage by lightening or explosion is not covered unless these cause actual ignition whichspread into fire.

A claim for loss by fire must satisfy the following conditions:-

The loss must be caused by actual fire or ignition and not just by high temperature.

The proximate cause of loss should be fire.

The loss or damage must relate to subject matter of policy.


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The ignition must be either of the goods or of the premises where goods are kept.

The fire must be accidental, not intentional. If the fire is caused through a malicious or deliberateact of the insured or his agents, the insurer will not be liable for the loss.

Types of Fire Insurance Policies:-

Specific policy:- is a policy which covers the loss up to a specific amount which is less than thereal value of the property. The actual value of the property is not taken into consideration whiledetermining the amount of indemnity. Such a policy is not subject to 'average clause'. 'Averageclause' is a clause by which the insured is called upon to bear a portion of the loss himself. The mainobject of the clause is to check under-insurance, to encourage full insurance and to impress uponthe property owners to get their property accurately valued before insurance. If the insurer hasinserted an average clause, the policy is known as "Average Policy".

Comprehensive policy:- is also known as 'all in one' policy and covers risks like fire, theft,burglary, third party risks, etc. It may also cover loss of profits during the period the businessremains closed due to fire.

Valued policy:- is a departure from the contract of indemnity. Under it the insured can recover afixed amount agreed to at the time the policy is taken. In the event of loss, only the fixed amount ispayable, irrespective of the actual amount of loss.

Floating policy:- is a policy which covers loss by fire caused to property belonging to the sameperson but located at different places under a single sum and for one premium. Such a policy might

cover goods lying in two warehouses at two different locations. This policy is always subject to'average clause'.

Replacement or Re-instatement policy:- is a policy in which the insurer inserts a re-instatementclause, whereby he undertakes to pay the cost of replacement of the property damaged ordestroyed by fire. Thus, he may re-instate or replace the property instead of paying cash. In such apolicy, the insurer has to select one of the two alternatives, i.e. either to pay cash or to replace theproperty, and afterwards he cannot change to the other option.

TYPES OF FIRE INSURANCE POLICIES

The principal types of fire insurance policies are given. below:

1. Valued policy

When the agreed value of the subject matter is mentioned in the policy is named as valued policy.

This value may not necessarily be the actual value of the property. In the event of toss by fire the

insurer pays the admitted value of the property.


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2. Unvalued policy

An unvalued policy in one in which the value of the subject matter is not declared at the time of

policy taken. But in case of loss the value is computed by assessment. This is also called an open

policy.

3. Specific policy

In case of specific policy, the property is insured for a definite sum. If there is loss, the stated amount

will have to be paid to the policyholder. But the actual value of the subject matter is not considered in

this respect. For examples if a policy is taken for Rupees 20,000 upon a building whose actual value

is Rs.1,00,000 and afire occurs causing the amount of loss Rs.20,000. The insurance company will

pay the whole amount of loss of Rs.20,000 irrespective of the fact that the building was insured for

one-fifth of its value.

4. Average policy

An average policy is one which contains the average clause. This clause required the insurance

company to pay only that portion of the loss which is borne by the insured amount to the actual value

of the subject matter of the insurance. For example a value of the property is Rs.1,00,000. It is

insured for Rs.60,000 (60% of the total value) and the amount of loss is Rs.60,000. The insurance

company will not pay Rs.60,000 to the policyholder but will pay Rs.36,000 (60% of Rs.60,000).

5. Floating policy

A floating policy is that which covers the fluctuating risk of several goods lying in different localities

for supply to various markets. Such a policy is usually taken out under one sum and one premium by

the businessman whose goods are lying at docks and warehouses.

6. Stock declaration policy

This policy is taken for covering the stock where great fluctuations in the value can happen

throughout the contract period. On such policy 75% of the premium has to be deposited in advance.

The maximum liability of insurance company is specified in the policy by the insured. At the end of

year the average stock and final premium is calculated.

7. Loss of profit policy

Such type of policy covers the loss of profit which sustains as a result of fire. This policy is also

known as consequential loss policy.

8. Standard fire policy

This policy is issued for compensation of all direct loss or damage caused by lighting and burning.

Such policy also covers damages by earthquake, hair flood, explosion, cyclone and riot.

9. Reinstatement policy


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Under this policy insurance company pays more than the actual value of the property destroyed by

fire in order to cover the cost of replacement of the said property. It is also called as Replacement

Policy. This type of policy is not very common in these days.

10. Schedule Policy

A schedule policy is one which insures many properties under collective terms and conditions,

Details of the properties and their respective rates of premium are listed in one policy only for the

convenience of the insured.

11. Sprinkler leakage policy

This type of policy covers the loss of building as a result of the damage by he

leakage of liquid or water.

12. Excess policy

This policy is issued for the stock of merchandise whose value is constantly fluctuating. In such case

it is not suitable to take one policy for certain sum. So the insured takes an ordinary policy for

minimum value of the stock and excess policy for excess value of the stock. The actual value of the

stock will be reported periodically

13. Maximum value with Discount policy

Under this policy one third discount of the premium paid is refundable to the insured at the maturity

of the policy. This policy covers the risk for maximum amount.


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The Fire Insurance Claims Process: A Step by Step Review

The claims process is generally referred to as the time that a policyholder notifies his or her insurer

of the occurrence until the problem has been fixed. Here's the basic process:

Reviewing your policywhat to look for and where to find it. The very first thing policyholders should

do is review their insurance policy to determine how much and what type of coverage they have,

what is covered, what is excluded and to determine how their claim must be filed and any deadlines

that might apply. Much of this information can be found on the declaration's page of the policy which

is usually located at the very beginning of the policy. If you can't locate your policy, contact your

broker or insurance company immediately to obtain a copy.

When to contact your insurance company. You should contact your insurance company as soon as

possible to notify them of the type of loss you've suffered. In fact, they may requireyou to contact

them within a certain amount of time after a loss has occurred. Your policy will detail this information,

including whether that notification must be in writing.

What information your insurance company will need to start the claims process. Your insurance

company may require you to submit certain information / documentation to start the claims process.

That generally consists of a statement from you on what happened and the extent of damage you

suffered. They may require more and you, as a policyholder, have a duty to provide them with

whatever information / documentation they needas long as it is reasonable. Be thorough in all of

your documentation as you won't be reimbursed for something that has not been documented.

What your insurance company should do. Once you've notified your insurance company of your loss

and provided the information needed to start the claim, your insurer will generally assign the case to

a claims representative who will analyze your policy to determine what type of policy you have, your

policy limits, what is covered, what is excluded, your deductibles and any other information that

might be needed.

Once completed, the claims rep will send you a letter that details that information. California law

requires insurance companies to send that letter within 30 days after being notified of the loss. If you

do not agree with your insurer's analysis of your policy, it's important to contact them immediately

and resolve those issues.

When both parties are in agreement, the claims rep will either pay the claim or decide to investigate

the claim depending on the size and circumstances surrounding the claim. If an investigator is hired,

he or she will come to your home to do the investigation and will prepare a report for the insurance

company detailing what they found. Assuming that the insurance company doesn't suspect fraud, a

plan will be put in place to obtain cost estimates for rebuilding or repairing your home.

Payment process. Payment processes will differ depending on the type of loss you have. For a small

loss, your insurer may simply write you a check. For a larger loss, your insurer may advance some


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of the costs needed to rebuild or repair your home throughout the process. It's important to ask your

claims adjuster how the payment process will occur in your situation, and more importantly, to get

that in writing.

A note of caution: Cash checks from your insurance company carefully. Make sure that you are not

signing away any rights by cashing the check. If the check has a notation that it is 'payment in full'

(when it isn't) or that by cashing the check, the policyholder waives any rights, don't cash it until you

understand the consequences.

Time line. While the time line for every claim differs depending on the nature of the claim, most

claims can generally be completed within a few months. That may not be the case with the Southern

California fires as there is likely to be a shortage of investigators and adjusters. In extreme cases like

this, the process could take several months. It's important to keep in close contact with your claims

representative to make sure that your claim doesn't fall through the cracks and that you'll be able to

get back into your home as soon as possible.

What are the procedure for effecting fire

insurance?The procedure for effecting fire insurance.

The term fire denotes a condition of burning or visible flame accompanied by heat. Fire insurance

contract is an important and popular form of insurance for the business world. A fire insurance

contract is an agreement whereby one party in return of a consideration, undertakes to indemnify

the other party against financial loss suffered by the insured as a result of damage or destruction ofthe insured property by fire. A claim for the loss by fire can be entertained if there must be actual fire

and the fire must be accidental but not intentional.

A fire insurance policy covers actual fire losses and any of the following losses consequent upon fire:

i. Damages caused to property because of collapse of roof or side wall due to fire.

ii. Damages caused to property by sprinkling of water to put out the fire.

iii. Damages caused to property at the time of removing it in the hot haste from the building under

fire. All losses caused due to efforts in extinguishing fire.

iv. Damages by lighting are not covered under fire policy but if lighting cause ignition of fire, it will

be included in the policy of fire insurance.

v. It does not cover losses due to explosion but if it causes actual ignition which ultimately spreads

into fire, it will be covered by fire insurance policy.
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A fire insurance contract is a contract of indemnity and as such the insured cannot claim more than

the actual amount of losses. The property so covered under fire insurance policy must be clearly

described. Property held in trust are not covered under fire insurance policy.

When a house is insured under fire insurance policy, it does not cover household goods. The

following steps are observed while effecting fire insurance policy:

I. Filling up Proposal Form:

A person desiring of taking a fire insurance policy has to select and contact a fire insurance office. He

will obtain a proposal form from the office and fill up the proposal form. While filling up the

proposal form of principles of good faith must be observed and he has to fill up the form with utmost

good faith.

II. Associating Evidence of Responsibility:

The insurer will ascertain that the proposer is a respectable person and is undertaking the policy in

utmost good faith. This consideration should be viewed before accepting the proposal. Since the

insurance policy covers a high degree of moral hazards, these considerations are to be kept in mind.

III. Survey of the Property:

The proposed property to be insured is surveyed by an expert called the surveyor. The surveyor

inspect the property and estimate the degree of risks involved in such property. On the basis of the

surveyor's report the insurer accepts or rejects the policy.

IV. Accepting Proposal and Issuing of cover note:

After the receipt of surveyor's report, it is scrutinized to see whether risks is acceptable or not. When

the insurer is satisfied with regard to the report of the surveyor, he accepts the proposal and gives

intimation to the proposer accordingly. The rate of premium is decided and on acceptance of

appropriate premiums a cover note is issued. A cover note is an interim policy till the final policy is

issued. A cover note serves as an evidence of insurance when losses to property are caused before the

issue of final policy but after the issue of cover note.

V. Issue of Final Policy:

After the issue of cover note, policy document is prepared. It is duly stamped document which

contains terms and conditions of the insurance. The policy serve as an evidence of insurance between

the insured and the insurer.

MEANING OF FIRE INSURANCE

The term fire in a fire insurance is interpreted in the literal and popular sense. There is fire when

something burns. In other words fire means visible flames or actual ignition.Simmering/ smolderingis not considered fire in Fire Insurance. Fire produces heat and light but either of them alone is not

fire. Lightening is not a fire but if it ignitessomething, the damage may be due to fire.

Under section 2(6A) Insurance Act 1938, the fire insurance business is defined as follows: Fire

insurance business means the business of effecting, otherwise than independently to some other


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class of business, contracts of insurance against loss by or incidental to fire or other occurrence

customarily included among the risks insured against in fire insurancepolicies.

Example: The following are the items which can be burnt/

damaged through fire:

Buildings

Electrical installation in buildings

Contents of buildings such as machinery, plant and

equipments, accessories, etc.

Goods (raw materials, inprocess, semifinished, finished,

packing materials, etc.) in factories, godowns etc..

Goods in the open

Furniture, fixture and fittings

Pipelines (including contents) located inside or outside

the compound, etc.

The owner of abovementioned properties can insure against

fire damage through fire insurance policy which provides

accounting treatment of goodwill at the time of admission

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