IC-46

GENERAL INSURANCE ACCOUNTS PREPARATION AND

REGULATION OF INVESTMENT
(WITH KEYNOTES)

Acknowledgement:

This course based on new syllabus has been prepared with the assistance of:

Ratan Chandra Guria,

A.R. Sekar

Reviewed by
V.C. Jain

Peer Reviewed by

K.E. Kalyanasundaram

G – Block, Plot No. C-46, Bandra Kurla Complex, Bandra (E), Mumbai – 400 051.

i
 GENERAL INSURANCE ACCOUNTS PREPARATION AND
REGULATION OF INVESTMENT

IC-46

Revised Edition- 2023

ALL RIGHTS RESERVED

This course material is the copyright of Insurance Institute of India

(III). This course is designed for providing academic inputs for
students appearing for the examinations of Insurance Institute of India.
This course content may not be reproduced for any commercial purpose, in part
or whole, without prior express written permission of the Institute.

The contents are based on prevailing best practices and not intended to give
interpretations or solutions in case of disputes, legal or otherwise.

This is only an indicative study material. Please note that the questions in the
examination shall not be confined to this study material.

Published by: Secretary General, Insurance Institute of India, G- Block, Plot C-

46, Bandra Kurla Complex, Bandra (E) Mumbai – 400 051 and Printed at

Any communication regarding this study material may be addressed to

ctd@iii.org.in

ii
 PREFACE
This course is designed for the use of candidates appearing for the Associateship
(Non-Life) examination of the Insurance Institute of India.

The course gives an overview of the General Insurance Financial Accounting and
Investment Regulations in five chapters subdivided into twenty units presented
in a logical manner. This covers, inter alia, Accounting Principles, Standards,
Processes and Methods of Finalisation of accounts applicable to business entities
in general as well as Methods, Processes and Techniques of Non-life Insurance
Financial Accounting separately. Besides, Investment Accounting & Regulations,
Internal Audit processes and techniques, Statutory Audit requirements and
salient aspects of International Financial Reporting Standard –IFRS 4 having
impact on the presentation of financial statements and Disclosure of Accounting
Information of Non-life insurance companies have been dealt with distinctly in
order to get the students familiarized and equipped with the latest knowledge
in the subject. Discussions in almost all the units have been accompanied by a
number of examples explaining the intricacies of financial accounting. The
subject matter has also been accompanied by the relevant extracts of the
financial statements published in the Annual Reports of The New India
Assurance Company Limited in appendix 1 to demonstrate and explain the
complexities and technicalities in preparation, presentation and analysis of
financial statements of a non-life insurance company. It has been the endeavor
of the Institute to provide a unified and integrated study material in Financial
Accounting, Audit and Investment Accounting & Regulation to enable the
students to obtain comprehensive knowledge on the subject in one go. The
study material has been prepared and presented in such a manner that a
student who has no prior knowledge of the fundamentals of financial accounting
can prepare and analyze financial statements of general insurance business
without any difficulty after his thorough study of this study material.

Although the course covers the syllabus prescribed for the examination, it is
desirable that candidates should supplement their knowledge by additional
reading materials such as recommended Text Books, relevant Regulations issued
by IRDAI, Office Manuals on Accounts, Audit and Investments. The books
recommended here are 1) Financial Accounting by R. L. Gupta & V.K. Gupta, 2)
Financial Accounting by S. N. Maheshwari, 3) Advanced Accounts by M. C.
Shukla, T. S. Grewal & S. C. Gupta and 4) Financial Management & Insurance
Accounting by K.C. Mishra and R. C. Guria (National Insurance Academy)

In today’s competitive insurance business, finance, accounting & investment

have assumed critical significance. Financial Accounting has become all the
more important today in the business world in view of use of cross-border
capital and foreign investment in insurance business requiring implementation
iii
of International Financial Reporting Standards and stringent disclosure norms for
protection of the interests of various stakeholders of the insurance. Sound
knowledge on Financial Accounting, Financial Statement Analysis, Investment
Accounting with Regulations, Internal Audit Procedures, Statutory Audit
Requirements and standards, Regulatory and Statutory requirements for
Disclosures are very essential in insurance business management. The
candidates therefore should keep themselves abreast of the latest trends in the
market, which are constantly changing. More importantly, this being a practical
paper, requires the students to obtain comprehensive theoretical knowledge
and thorough practice from this Study Material as also from the recommended
books to attain proficiency and confidence in preparation and presentation of
Non-life Insurance Financial Statements and Accounting Analysis.

To enhance the learning and to make it rich, each chapter in the study text has
specific learning outcomes listed at the beginning of the chapter and a summary
at the end of the chapter followed by self-test questions and answers. Within
the study text there are a number of features like case studies, extensive use of
examples, diagrams, tables, MCQs, tips etc. to add life to learning and to make
it interesting for the candidate.

To supplement the study text, key notes have been provided. Key notes include
topics presented in the same order as the study text and aid revision by giving
clear, visual emphasis to key points. Key notes are quite handy as they are
portable and concise, ideal for last minute revision on the move.

Although sufficient care has been taken in publishing the study material, the
possibility of errors, omissions and discrepancies cannot be ruled out. Should
there be any discrepancy, error or omission noted in the study material, the
Institute shall be liable for issue of necessary corrigendum in the study material.
The Institute would welcome suggestions to improve the quality of the present
course of materials. The candidates are recommended to collect and study
specimen forms used in offices. This will provide a practical basis for their
studies. Suggestions for improvement are most welcome.

iv
 CONTENTS
Chapter Page
Title
No. No.
Accounting Scope, Concepts, Principles and
Chapter 1
Standards
Unit-1 Financial Accounting – Meaning And Scope 1
Unit-2 Accounting Concepts, Principles and Convention 18
Accounting Standards – ‘As’ And ‘Ind As’
Unit-3 40
- Objectives And Interpretation
Unit-4 Accounting Policies 52
Accounting Process, Methods & Control and
Chapter 2
Finalisation of Accounts
Unit-5 Accounting Process 60
Unit-6 Accounting Methods, Procedures and Control 75
Unit-7 Depreciation Accounting 100
Unit-8 Bank Reconciliation Statement 123
Introduction To Company Accounts (Based On The
Unit-9 137
Companies Act 2013)
Non-Life Insurance Business Accounting Methods,
Chapter 3
Techniques & Process
Unit-10 General Insurance Accounting Process & Techniques 164
Unit-11 Insurance Accounting Regulations 189
Unit-12 Preparation & Presentation of Financial Statements 232
Unit-13 Reinsurance Accounting 279
Accounting Methods & Process of Special
Chapter 4
Accounting Transactions
IRDAI (Investment) Regulations(Based On IRDAI
Unit-14 322
(Investment) Regulations 2016
Unit-15 Investment Accounting 340
Annual Reports, Audit & International Financial
Chapter 5
Reporting Standards
Unit-16 Annual Reports (Based on Companies Act 2013) 359
Unit-17 Statutory Audit in General Insurance Business 367
Unit-18 Internal Audit in General Insurance Business 402
Chapter 6 Indirect Taxation
Unit-19 Goods & Services Tax 429

v
 CHAPTER 1

ACCOUNTING SCOPE, CONCEPTS, PRINCIPLES

AND STANDARDS

UNIT-1

FINANCIAL ACCOUNTING – MEANING AND SCOPE

Chapter Introduction

This chapter aims to provide you with an understanding of basic financial

accounting.

a) Give a brief introduction to the concept of financial accounting and

explain its meaning.
b) Describe the objectives and functions of accounting.
c) Discuss the limitations of financial accounting.
d) Identify the books of accounts.

1
1. Give a brief introduction to the concept of financial accounting and
explain its meaning.
[Learning Outcome a]

1.1 Introduction

The term ‘accounting’ is a derivative of the word ‘account’ which, as per

Chambers 21st Century Dictionary means, among other things, “an explanation,
especially of one’s behaviour”. Each activity in our everyday life must have
some accountability. Similar is the case with economic activity that constitutes
the fulcrum of our economic life. Financial Accounting is thus concerned with
the accountability of economic activities or activities related to finance. It
shows the methods and techniques to account for the financial activities for
preparation of meaningful information for those who are concerned with those
activities in any capacity.

Every aspect of economic activity requires proper recording of all transactions

and financial events to obtain adequate financial information as an aid to
decision making. Financial Accounting has been developed to serve this
purpose, which has universal application for recording transactions and events
with a view to presenting suitable information in the matter of decision-making.

Every business enterprise has to maintain books of account in a systematic

manner for recording all such financial transactions. Such financial transactions
include purchases and sales of goods / services, payment of wages, payment of
administrative expenses, receipts of other income, introduction of capital,
purchase of plant / machinery, distribution of profits, payment of taxes and so
on.

Financial accounting methods followed by business houses depend on the types

of business and the statutes or business laws applicable to them. There are two
systems of recording transactions ‘single entry system’ and ‘double entry
system’. A sole proprietor may maintain his books and accounts on a single
entry basis that generates incomplete records only, while a company registered
under the Companies Act is required to maintain accounts on double entry
system for preparation of its financial statements and for mandatory disclosure
of information to the stakeholders of the company.

Single entry system is a scribbling way of preparing accounts, like the

transactions noted in a petty shop. ‘Double Entry’ system is being practiced
universally at present barring a few small traders and shopkeepers.

Financial Accounting is required not only by business enterprises, but also by

Government Departments.

2
A Municipal Corporation has to maintain books of accounts for recording
financial transactions to account for sources and utilisation of funds.

Financial transactions on sources of funds generally include receipts of govt.

grants, collection of municipal taxes, raising funds from public or financial
institutions etc. while financial transactions for utilisation of funds include
payments for expenses incurred for road development and repairs, maintenance
of sanitation and cleanliness of the municipal wards, municipality upkeep and
public welfare, establishment and staff welfare etc. All such financial
transactions are required to be recorded in the books of accounts in accordance
with the accounting standards, accounting policies and procedures applicable to
municipalities.

Financial accounting in financial institutions like banks, insurance companies

and others are special in nature and type, as they are required to follow
regulatory norms and requirements of statutes over and above compliance with
the provisions of the Companies Act, 2013 and the accounting standards issued
by The Institute of Chartered Accountants of India (ICAI). Accounts of these
business organisations are popularly called ‘Form Accounts’ in financial
accounting parlance. The Financial accounting of banks is based on RBI
regulations and the provisions of the Banking Regulation Act, 1949, in addition
to compliance with the relevant provisions of the Companies Act, 2013 and the
Indian Accounting Standards as referred to above.

Insurance accounting is a systematic and analytical process of financial

accounting that requires compliance with the requirements of the Companies
Act 2013, the provisions of the Insurance (Laws) Amendment Act 2015, the
directives contained in the IRDAI Regulations on accounts and the Accounting
Standards (AS) issued by the ICAI (or the requirements of the relevant IFRS
which will be applicable to the insurance sector also very soon).

Insurance accounts are very specific in nature, in consideration of legal

requirements and also considering the information requirement for different
classes of stakeholders like policyholders, shareholders, financial institutions,
reinsurers, co-insurers, regulators, the Government and the society at large.

Financial accounting methods followed by business houses depend on:

A The type of business

B The statutes
C Business laws applicable to them
D All of the above
3
1.2 Meaning of Accounting

Accounting is the process of recording and reporting of financial transactions

including the origination of the transaction, its recognition, processing and
summarisation in the financial statements.
The New York State Society of CPAs

The American Institute of Certified Public Accountants (AICPA) has defined

accounting as “an art of recording, classifying and summarising in a significant
manner and in terms of money, transactions, and events which are, in part at
least of financial character and interpreting the results thereof”.

Accounting is thus the process of recording, classifying, summarising, analysing

and interpreting financial transactions and communicating the results thereof to
the interested parties.

The very basic unit of accounting is a ‘transaction’ that differs from a general
event or an occurrence. An event which is measurable in terms of money and
which changes the financial position when it occurs gives rise to a transaction.
To put in the form of a corollary, it can be said that all transactions are events
but all events are not transactions.

Transactions are recorded first in the primary books of accounts known as

Journals including Cash Book and then transferred to Ledgers in the form of
Ledger Accounts.

A ledger is an Account head-wise collection of records, where each account

head is presented in a tabular format showing an opening balance, chronological
transactions shown as a debit or credit entry, and a closing balance. It is shown
for a defined period, say, from 1st April, 2020 to 31st March, 2021.

‘Trial Balance’ is a summary of all ledger balances as on a particular date

which reflects the financial performance and state of affairs (financial position)
of the entity.

4
Which of the following are users of financial statements?

A Financial analysts
B Tax authorities
C Shareholders
D All of the above

2. Describe the objectives and functions of accounting.

[Learning Outcome b]
There are two prime objectives of financial accounting:

1. to report on the financial position of an entity (e.g. a business, an

organisation); and
2. to show how the entity has performed (financially), particularly over an
accounting period. The most common measurement of "performance" is
profit.

2.1 Objectives of accounting

The idea and objectives of accounting may well be appreciated with reference
to the concept of joint stock company operations where management is
separated from ownership.

A joint stock company or public limited company is treated as an artificial

juridical person having a separate identity and perpetual succession. A number
of interested parties are involved in such a joint stock company. To protect
various stakeholders including shareholders, investors, financiers, customers,
suppliers, employees, regulators, the Government and the society at large,
there must be proper financial accounting for every joint stock company. Thus,
financial accounting has the social responsibility to communicate results and
information to the society.

Let us now elaborate on these objectives for better understanding.

1. Recording of financial transactions

Recording refers to the actual writing of the transactions that take place in
words and figures so that reliable information regarding the position of the
business can be made available at any point of time. The books where this
information is recorded are known as the ‘books of original entry’. The
transactions are recorded in the books of accounts on the basis of documents
such as invoices, receipts, vouchers, bank statements, etc.
5
The recorded transactions are then classified, summarised and analysed
logically for the purpose of preparation of financial statements in accordance
with legal and regulatory norms or provisions. The two end products of financial
accounting being Profit & Loss Account and Balance Sheet reveal profitability on
one hand and financial soundness on the other.

Therefore, transactions need to be summarised in a structured manner in order

to understand an entity’s financial position and performance at the end of a
period.

2. Ascertainment of results of recorded transactions

The ultimate objective of accounting is preparation of financial statements, i.e.

Balance Sheet, Profit & Loss Account and other peripheral statements.

 Profit and Loss Account is prepared to ascertain the net result i.e.
operating surplus or loss from the aggregate of all financial transactions
effected by the enterprise for a particular period – say, a year.

 While Profit & Loss Account is prepared in a commercial organisation to

determine the result being either profit or loss, Income and Expenditure
Account is prepared for the same purpose for a non-profit seeking
organisation, the term being either surplus or deficit.

 In General Insurance business, such results are determined by Revenue

Accounts followed by Profit and Loss Account.

3. Assessment and analysis of financial health of the enterprise

A businessman is concerned not only with the profitability of the business

operations, but also with the growth and solvency of the entity. For this
purpose, a balance sheet, the final and conclusive part of financial statements,
is prepared to ascertain the financial position consisting of the total assets and
liabilities, net worth and net working capital of the organisation.

There are various tools and techniques to analyse the financial position of a
business as on a particular date such as Ratio Analysis, Fund Flow Analysis, Cash
Flow Analysis and others depending on the purpose of the analysis and the
parties who seek to analyse.

In insurance business, a lot of emphasis is directed towards solvency and

liquidity apart from net worth in measuring financial health.

Solvency is the capacity to pay liability and borrowings. The regulator may
not allow an insurance company to do business, or specific line of business
6
without the requisite solvency ratio which is computed with reference to RSM
(Required Solvency Margin) and ASM (Available Solvency Margin).

 RSM is determined with reference to the nature and volume of business

operations and the incurred claims on such business operations.

 ASM is calculated with reference to Net Worth being excess of ‘Admissible

assets over liabilities’ in both the policyholders’ funds and the shareholders’
funds. (explained in detail in the later part)

Liquidity is the readiness of an entity to honour its expected and unexpected

commitments in time.

4. Communicating results to stakeholders for decision making

Accounting as a language of business communicates the financial results and

required information of the enterprise to various stakeholders by means of
financial statements. Such financial results and information on the financial
health of the enterprise help the interested group of stakeholders to take
various rational, financial and investment decisions with respect to the
enterprise. In the case of certain categories of companies, publication of
periodic operational results is mandatory as per the provisions of the relevant
statute. An insurance company prepares, presents and publishes an annual
report every year containing the financial statements as required by the
Insurance Act, the IRDAI Regulations and other statutory provisions.

The Annual Report also contains Directors’ report, Management Report and
Audit Reports providing financial results, financial health and other particulars
for the information of all stakeholders.

In insurance business, a lot of emphasis is directed towards ____________ and

____________ apart from net worth in measuring financial health.

A Profitability, revenue
B Expenditure, revenue
C Solvency, liquidity
D Profit and loss account, balance sheet

2.2 Functions of Accounting

Functions of accounting stem from objectives of accounting, as discussed above.

7
The American Institute of Certified Public Accountants (AICPA) has regarded
accounting as a service activity. Its functions are “to provide quantitative
information, primarily financial in nature, about economic entities, that is
intended to be useful in making economic decisions, in making choices
among alternative courses of actions”.

Accounting includes several branches like Financial Accounting, Managerial

Accounting, Cost Accounting, Government Accounting etc.

Here, we will concentrate on the main functions of financial accounting.

1. Performance Measurement: Financial accounting measures and determines

the past performance of the business entity and the current financial
position or the state of affairs through the financial statements. In general
insurance business, financial performance being profitability, solvency and
liquidity of the insurer is measured by Revenue Accounts, Profit &Loss
Account, Balance Sheet and Receipts & Payments Accounts (Fund Flow/Cash
Flow statements).

2. Forecasting and Trend Analysis: Accounting results and past performance

analysis help in forecasting the future performance or trend analysis of
profitability and solvency of the enterprise based on the past data.

3. Providing Data for Decision Making: Accounting also provides various

financial information and data for the users of the financial accounting
statements, helping them in rational decision making in respect of the
enterprise.

4. Evaluation and analysis: financial information, data and results contained in

the financial statements enable intra-company and inter-company
comparison and analysis for making informed decisions for the stakeholders
of the enterprise.

5. Accounting Control: financial accounting also aids in exercising accounting

control as well as administrative control through maintenance of various
books, records and registers. For example, Premium Register, Co-insurance
Register, Claim Register, Advance Register etc. in insurance business play
very important roles in accounting control and administrative control.

6. Government Regulations and Taxation: financial accounting and financial

statements provide the required information and particulars to various govt.
departments and regulators for their assessment and collection of various
taxes, revenues and fees.

8
In general, financial accounting helps to determine the reasonableness of the
cost for which funds are arranged and the manner in which such funds are
employed to exploit maximum returns.

3. Discuss the limitations of financial accounting.

[Learning Outcome c]

Following are the major limitations of financial accounting.

1. Financial Accounting permits alternative treatment

Financial accounting allows scope for alternative treatment of the same

transactions in certain cases based on accounting concepts, policies, principles
and assumptions that might be followed by different accountants. Accounting
follows GAAP - Generally Accepted Accounting Principles.

As there exists more than one principle for the treatment of any particular
item, treatment may vary from one entity to another depending upon their
concept and accounting policy. Thus, complications may crop up from this
flexibility, specifically in the matter of comparability of financial statements of
different organisations.

The closing stock of a business house may be valued by any of the methods such
as FIFO (First-in- First-out), LIFO (Last-in-First-out), Weighted Average Price,
Average Price, Standard Price etc. As per Accounting Standard-2 issued by ICAI
only two methods i.e. First in First Out and Weighted Average are permitted.

If two different entities follow different methods of stock valuation, their

accounting results are not directly comparable.

However, in General Insurance accounting in India, the scope of alternative

treatment by different insurers has been reduced with the introduction of
mandatory observance of IRDAI regulations in regard to recognition of income
and expenditure, valuation of investment and assets, determination of liability
etc. Yet, such regulations are not applicable to insurance companies in other
countries implying lack of feasibility of comparison with the financial
statements of companies in those countries. This type of difficulty is expected
to be curtailed, if not eliminated, with the implementation of IFRS.

9
2. Financial Accounting is influenced by personal judgments

Estimates are required to be made to record certain events or transactions.

Such estimates are influenced by personal judgment in many cases.
Consequently, it becomes very difficult to maintain uniformity and accuracy in
estimation, and thus, objectivity suffers.

In general insurance accounting, estimation of liability for outstanding claims

greatly differs in view of opinions and personal judgment of surveyors, stage of
survey, availability of relevant information and examination as also perception
of the underwriter concerned. Thus the so-called 'Convention of objectivity' is
not truly observed in estimation of liability for outstanding claims due to the
fact that estimates are influenced by personal judgments.

3. Financial Accounting ignores important non-monetary information

Financial accounting does not take into account transactions of non- monetary
nature such as efficiency of employees, input-output analysis, R&D application
and results and the like.

4. Financial Accounting does not provide timely information.

The publication of results on a particular date takes time, due to compilation of

data, analysis and presentation. Thus, the information available shall always be
of the past period only and the present live status is not available for the
public.

5. Financial Accounting does not provide technical details

The information supplied by the financial accounting and financial statements,

do not provide such information product-wise, leaving other incidental
information for collection from other sources.

In general insurance business, Miscellaneous Revenue Account may reveal a net

result being either operating surplus or operating loss of all the products
covered under the Miscellaneous Department, which may include more than 100
products.

Though much of such details are taken care of through Segment reporting,
complete details are not reported in the case of motor insurance regarding
class-wise vehicles.
10
6. Financial Accounting does not disclose the present value of the business

In financial accounting, the financial position of the business as on a particular

date is shown by a statement known as 'Balance Sheet'. In a Balance Sheet, the
assets are shown on the basis of the "Continuing Entity Concept” (i.e. going
concern basis). Thus, it is presumed that the business will have a relatively
longer life and will continue to exist indefinitely. Hence, the asset values are
'going concern values’ based on historical cost.

The 'market value’ or ‘realisable value' of each asset is not ascertainable from
the financial statements for management decisions.

7. Financial Accounting does not provide classification of cost

Financial accounting does not classify costs into direct and indirect, fixed and
variable, controllable and uncontrollable, normal and abnormal etc. It only
allocates expenditure into two categories: as Capital and Revenue. A capital
expenditure is an expense for a long term benefit, normally for a period more
than a year, whereas a revenue expenditure is to manage the day to day
activities.

Because of such limitations, management decisions cannot be taken without the

application of Management Accounting that gathers information available from
both financial accounting and cost accounting.

In general insurance, financial statements are prepared and presented for a

period of __________, which are audited.

A One year
B Two years
C Half year
D Quarter year

4. Identify the books of accounts.

[Learning Outcome d]

Accounting entries are recorded in the ‘Books of Accounts’. Under double entry
book keeping, each individual financial transaction is recorded at least through
two different ledger accounts within the financial accounting system.

Books of accounts broadly include Journals and Ledgers.

11
Journals are termed the ‘Primary Books of Accounts’. When an accounting
transaction relating to a business is entered in the accounting records for the
first time, these records are called books of prime entry or books of original
entry. Books of prime entry are the books in which transactions are recorded for
the first time. These are also called basic / primary / original accounting books.

An example of a journal entry is as below.

Description Debit / Credit Amt. Rs. Amt. Rs.

Bank charges Dedit (Dr.) 1,000
Bank account Credit (Cr.) 1,000

Ledgers are denoted as Final Books of Accounts. Ledgers incorporate individual

‘Accounts’ under which details of such transactions related to a particular
account are available. These ledger accounts display the balance as on a
particular date, implying the net amount of all transactions accounted under
them.

 Ledgers include Cash Book also as it, like any other ledger account, displays
cash or bank balance as on a particular date. Besides, all cash transactions
are primarily recorded in the cash book. The Cash Book includes Bank Book
also. Hence, cash book is called both a journal and a ledger.

Fixed Assets (ledger)

Date Description Debit Credit

01.04.2020 Opening balance 1,00,000
15.05.2020 Purchase of furniture 50,000
20.12.2020 Sale of furniture 30,000
31.03.2021 Closing balance 1,20,000

The following table summarises the differences between journal and ledger:

Journal Ledger
Books of prime entry Books of final entry
As soon as transaction originates it Transactions are posted in the ledger
is recorded in the journal after they have been recorded in the
journal
Transactions are recorded in the Transactions are classified according to
order of occurrence i.e. strictly in their nature and are grouped in the
a chronological order concerned accounts
Debit and credit amounts of a Debit and credit amounts of a
12
 transaction are recorded in transaction are recorded on two
adjacent columns different sides of two different accounts
Journal is not balanced Every account in the ledger is balanced
at the appropriate time
Final accounts can't be prepared Ledger is the basis of preparing the final
directly from the journal accounts

Sec 128 of the Companies Act 2013 deals with the Books of Accounts to be kept
by a company and such books shall be kept on accrual basis and according to
the double entry system of accounting. Such books shall be kept for not less
than 8 financial years immediately preceding the present financial year.

In general insurance companies, books of account maintained at operating

offices are different from the books of account maintained at the Head office
level.

At present, books of account are maintained through computer systems as the

manual system of financial accounting has been almost discarded. Some of the
books of accounts maintained at the operating office level of a general
insurance company are as below.

 Collection Register
 Payments Register
 Cheque Dishonoured Register
 Petty Cash Register

 Premium Register
 Refund Premium Register
 Cover Note Control Register
 Co-insurance Register
 Claims Disbursement Register
 Claims Intimation Register
 Outstanding claims Register
 Claims Recovery Register
 Salvage Register

 General Ledger
 Sub-Ledger
 Assets Register
 Policy Stamps Register
 Revenue Stamps Register

13
As per Sec.128 of the Companies Act, 2013, books of accounts are to be kept for
a period of ____________ financial years.

A 7
B 8
C 9
D 10

Summary
 Accounting is the process of recording, classifying, summarising, analysing
and interpreting the financial transactions and communicating the results to
its users.
 All transactions are events but all events are not transactions.
 The main objective and function of accounting is to report on the financial
position of the entity and highlight its performance for an accounting
period.
 In insurance business, the balance sheet is the basis for ASM while Revenue
Accounts provide the required information for the computation of RSM.
 In general insurance companies, books of account maintained at the
operating offices are different from the accounts maintained at the head
office level.

Answers to Test Yourself

Answer to TY 1
The correct option is D. Financial accounting methods followed by business
houses depend on the types of business and the statutes or business laws
applicable to them.

Answer to TY 2
The correct option is D. The users of financial statements include the
shareholders, investors, employers, suppliers, trade creditors, customers,
lenders, regulators, Government Authorities, tax authorities, financial analysts,
etc.

Answer to TY 3
The correct option is C. In insurance business, for measuring the financial
health, a lot of emphasis is directed towards solvency and liquidity, apart from
the net worth.

14
Answer to TY 4
The correct option is A. In general insurance, financial statements are prepared
and presented for a period of one year, which are audited. However, for a listed
company, the accounts are to be audited on a limited review basis every
quarter.

Answer to TY 5
The correct option is B. The Companies Act, 2013, under Sec.138, prescribes
that the books of accounts of accounts are to be maintained for a period of not
less than 8 years, immediately preceding the present financial year.

Self-Examination Questions

Question 1

For a municipal corporation, financial transactions on sources of funds generally

include:

A Collection of municipal taxes

B Amount incurred for road development and repairs
C Sale of goods
D Amount spent on public welfare

Question 2

Which of the following accounting system of recording transactions is being

practised universally?

A Single entry system

B Double entry system
C Balance sheet method
D Profit and loss account method

Question 3

Insurance accounting requires compliance with the requirements of the

Companies Act __________, the provisions of the Insurance Act ________ and
the directives contained in the _________ Regulations.

A 1938, 1956, AS
B 1956, 2000, IFRS
C 2013, 2015, IRDAI
D 1938, 2002, ICAI

15
Question 4

In general insurance business, financial results (profitability) are determined by

the _____________.

A Revenue account & Profit and loss account

B Balance Sheet
C Income and expenditure account
D Receipts and Payments account

Question 5

The ‘realisable value' of each asset is not ascertainable from the financial
statements for management decisions because of which of the following
limitations of financial accounting?

A Does not provide technical details

B Does not provide classification of cost
C Does not disclose present value of the business
D Does not help in price fixation

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is A. Options B and D indicate utilisation of funds. Option C
indicates revenue income.

Answer to SEQ 2
The correct option is B. In practice, the ‘Double Entry’ system is being applied
universally at present, barring a few small traders and shopkeepers. A sole
proprietor may maintain his books of accounts on a single entry basis, which
generates incomplete records only.
Answer to SEQ 3
The correct option is C. Insurance accounting is a systematic and analytical
process of financial accounting that requires compliance with the requirements
of the Companies Act, 2013, the provisions of The Insurance (Laws) Amendment
Act 2015 and the directives contained in the IRDAI Regulations on accounts and
the Accounting Standards (AS) issued by ICAI or the requirements of the relevant
IFRS which will be applicable to the insurance sector also very soon.

16
Answer to SEQ 4
The correct option is A. In General Insurance business, financial results are
determined by Revenue Accounts followed by Profit and Loss Account.

Answer to SEQ 5
The correct option is C. The 'market value’ or ‘realisable value' of each asset is
not ascertainable from the financial statements for management decisions
including those related to internal reconstruction or external reconstruction like
merger, amalgamation and others as financial statements are based on the
historical cost and do not disclose the present value of the business.

17
 CHAPTER 1

ACCOUNTING SCOPE, CONCEPTS, PRINCIPLES

AND STANDARDS

UNIT-2

ACCOUNTING CONCEPTS, PRINCIPLES AND

CONVENTION
Chapter Introduction

Financial statements of different entities in a particular industry should be

prepared on a uniform basis to communicate proper financial information
regarding financial accounting to the stakeholders to enable them to make
informed decisions. To achieve uniformity for this purpose, financial accounting
- a language of business - must be within the framework of GAAP (Generally
Accepted Accounting Principles). The term ‘GAAP’ is used to describe general
rules, conventions and practices of Financial Accounting as also preparation of
Financial Statements accepted by the accounting fraternity and users of
financial statements in a particular country.

These rules of financial accounting comprise Accounting Concepts, Principles

and Conventions. Accounting Principles are the basic norms and assumptions on
which the whole system of financial accounting is established. However, the
GAAP of one country may differ from that of another country, although the
main principles remain undistorted. Thus, US GAAP may differ from Indian GAAP
and with the GAAP of any other country.

The proposed IFRS is expected to eliminate these differences to a large extent

among those countries who would adopt it.

a) Discuss the various accounting concepts.

b) Discuss the various accounting principles.
c) State the elements of financial statements.

18
1. Discuss the various accounting concepts.
[Learning Outcome a]

Accounting concepts are the fundamental ideas and assumptions in

accounting.

These are the fundamental rules that must be followed while preparing the
financial statements. A clear disclosure must be made in the financial
statements if these are not followed.

Accounting concept refers to the basic assumptions and rules which work as the
basis of recording business transactions, maintaining accounts and preparation
of financial statements. Accounting concepts are postulates, assumptions or
conditions upon which accounting records and statements are based.

These concepts are assumed and accepted in accounting to provide uniform

structure, rules and logic to the accounting process. The accounting
transactions and financial statements are interpreted in the light of accounting
concepts, which have universal application. Accounting concepts provide the
basic assumptions and postulates that lay the foundation on the basis of which
the accounting principles are formulated. The accounting concepts, with their
universal application, enable maintaining uniformity and consistency in
accounting records as well as in interpreting financial statements in the same
meaning and sense. All the concepts have been developed over the years from
experience before they have been universally accepted as rules.

Important accounting concepts

1. Business Entity Concept

2. Money Measurement Concept
3. Going Concern Concept
4. Accounting Period Concept
5. Accounting Cost Concept
6. Duality Aspect Concept
7. Realisation Concept
8. Accrual Concept
9. Matching Concept

19
These are elaborated in the following paragraphs.

1. Business Entity Concept

This concept states that the business entity and its owner(s) are two separate
independent entities for the purpose of accounting. Thus, business transactions
and personal transactions of the owner of a business are separately entered in
the business’ books of account and in personal books of record respectively.

For example, when an owner invests money in the business, it is recorded as a

liability of the business entity to the owner either as capital or as a loan. It is
shown on the liability side of the Balance Sheet. Similarly, when the owner
draws cash or goods for his personal use from the business, it is treated as
drawings, not as business expense. Let us take an example.

Mr. Arora started his business investing Rs. 10,00,000. He purchased plant &
machinery of Rs. 3,00,000, furniture & fixture for Rs. 1,00,000, and goods for
Rs. 5,00,000, keeping Rs. 1,00,000 in hand.
Plant & machinery, furniture & fixture, stock of goods and cash in hand are
assets of the business, and not of the owner according to the business entity
concept. Rs. 10,00,000 will be treated by the business entity as capital, i.e. as a
liability of the business towards Mr. Arora.

2. Money Measurement Concept

The money measurement concept states that a business should only record an
accounting transaction if it can be expressed in terms of money. This concept
assumes that all business transactions must be measurable in terms of money,
that is, in the currency of a country. Thus, as per the money measurement
concept, only transactions that can be expressed in terms of money are
recorded in the books of account. In our country, such transactions are
measured in terms of Rupee that has gained a new symbol ₹ of its own in July,
2010.

Purchase of goods for Rs.10,00,000, sale of goods worth Rs. 20,00,000, wages
paid Rs.5,00,000, rent paid Rs.1,00,000 and salary paid Rs.1,00,000 in a
business enterprise for the year 2009-10 are all transactions.

These transactions are expressed in terms of money, and hence they can be
recorded in the books of account to determine the profit earned or loss incurred
20
by the entity. It naturally follows that transactions which cannot be expressed
in monetary terms are not transactions and hence, are not recorded in the
books of account. Another aspect of this concept is that records of the
transactions are to be kept not in physical units or in quantitative terms, but in
monetary units. Quantitative particulars may be required for the purpose of
reconciliation.

For example, a general insurance company issued 10-lakh personal accident

(PA) policies covering 1-crore persons. The financial transactions reflect the
premium only and not the number of policies. Thus under this concept, the
insurance transactions which can be expressed in terms of money only are
recorded in the account books.

This concept guides accountants what to record and what not to record. It helps
in recording business transactions uniformly. It also facilitates comparison of
performance of two different periods of the same firm or of two different firms
for the same period.
3. Going Concern Concept

This concept states that an entity will continue to carry on its business activities
for an indefinite period of time. It means that transactions are recorded and
financial statements are prepared on an assumption that the business entity has
continuity of life and will not be dissolved in the near future. This is an
important assumption of accounting, as it provides a basis for showing the value
of assets in the balance sheet.

For example, an insurance company spent Rs.50 crore for installation of new
computers for its 300 operational units in 2020-21. The new computers each
have a life span of 5 years. Applying this concept, certain percentage (say 20%)
of the total cost of computers will be considered business expenses as
‘Depreciation on Computer’ and the balance amount will be shown as an item of
assets i.e. Computers in the Balance Sheet as at 31.03.2021.

Under this concept, if an amount is spent for acquiring an asset which will be
used in business for many years, it will not be proper to charge the entire
amount as expenses of the firm for the year in which the item is acquired.
Therefore, only a part of the value is shown as expense in the year of purchase
and the remaining balance is shown as an asset. On the basis of this concept,
depreciation, being the cost of the annual use of an asset, is charged on the
fixed assets and the balance is carried over for the remaining useful life in the
books of the business concern.

21
4. Accounting Period Concept

An accounting period is the span of time covered by a set of financial

statements. All transactions are recorded in the books of account on the
assumption that financial results of such transactions are to be ascertained for a
specified period known as the accounting period, which is usually one year,
called Financial year. In India, the financial year is calculated from April of a
year to March of next year. This concept requires that the financial statements,
like the balance sheet and profit & loss account, should be prepared
periodically – e.g. annually, half yearly or quarterly as the case may be. This is
necessary for different purposes like calculation of profit, determination of
financial position, tax computation, various performance analysis etc. In general
insurance business, financial statements are prepared on quarterly basis as per
legal and regulatory norms, in addition to half yearly and annual accounts, for
which statutory audit is carried out.

According to the accounting period concept, all the transactions are recorded in
the books of account for an accounting period as stated above.

Goods purchased and sold during a particular period and rent, salaries and other
expenses incurred and paid for that period are accounted for in that period
only.

In general insurance business, premium income is accounted for on “Net

Premium Earned” basis, and not on “Gross Premium Collected” basis. Similarly,
Claims are accounted for as “Incurred Claim”, and not as “Claims Paid”.

This implies that income is to be considered for a particular period only even
when it is received in excess or in advance or may be accrued but not yet
received. Only that portion of the income which pertains to the particular
period under consideration is to be incorporated, whether received fully or not
and whether accrued but not received as also whether received in excess or in
advance. A similar principle applies in the case of expenses also.

The methods of computation of “Net Premium Earned” and “Incurred Claim”

are discussed elaborately in Unit 10.

22
This concept helps not only in determining the correct result of all financial
transactions that occur in the accounting period, but also in predicting the
future prospects of the business from the financial accounting viewpoint. It
helps in calculating the appropriate tax liability on business income calculated
for a particular time period and in determining the correct amount of profits to
be distributed as dividend for the period. It also helps all stakeholders to assess
and analyse the performance of a business for a particular period.

5. Accounting Cost Concept

Accounting cost concept states that all assets are recorded in the books of
accounts on the basis of historical cost or at their purchase price that includes
cost of acquisition, transportation and installation, and not at the market price.
It means that fixed assets like Property, Plant, Equipment, furniture, etc. are
recorded in the books of accounts at the price paid for them.

A building was purchased by XYZ Insurance Co. Ltd for Rs. 50,00,000 in May
2020.
An amount of Rs. 5,00,000 was spent for further development and elevation
coupled with another Rs. 5,00,000 for registration of charges in the same year.
On 31st March 2021, the market value of the said building was found to be Rs.
70,00,000. The total amount at which the building is to be recorded in the
books of accounts would be Rs. 60,00,000 (50 Lakhs +5 Lakhs + 5 lakhs), and not
Rs.70,00,000.

The accounting cost concept is also known as historical cost concept.

The effect of this concept is that if the business entity does not pay anything for
acquiring an asset, that asset would not appear in the books of account. Thus,
goodwill of a company appears in the accounts only if the entity has purchased
this intangible asset for a price.

6. Dual Aspect Concept

Dual aspect concept is the foundation of double entry book-keeping system.

Under this concept, every transaction or event has two aspects.

If we consider this concept in regard to an item of assets having been involved

in a transaction, it may result in any of the under mentioned alternatives.

 It increases one asset and simultaneously decreases another asset.

23
 It increases one liability and decreases another liability.
 It increases an asset and simultaneously increases/creates a liability.
 It decreases one asset and decreases a liability.

Following is an extract of the balance sheet as at 31st March 2021 of X Insurance

Co.

Balance Sheet as at 31-03-2021

Liability Rs in Asset Rs in
crores crores
Capital 200 Investments 11,000
Reserves & Surplus 5,000 Fixed Assets 200
Borrowings NIL Current Assets (including 300
Cash & Bank Balance)
Current Liabilities 6,300
(Including O/S Claims
Rs.4200cr. & Unexpired
Reserve Rs.2100cr.)
11,500 11,500

Prepare the balance sheet of the company as at 1st April 2021, assuming that
there is only one transaction of settlement of one O/S claim for Rs.100 crores.

The balance sheet as at 1.4.2021 will be as follows:

Balance Sheet as at 01-04-2021

Liability Rs in Asset Rs in
crores crores
Capital 200 Investments 11,000
Reserves & Surplus 5,000 Fixed Assets 200
Borrowings NIL Current Assets (including 200
Cash & Bank Balance)
Current Liabilities 6,200
(Including O/S Claims Rs.
4,100cr. & Unexpired
Reserve Rs. 2,100cr.)
11,400 11,400

Thus, a decrease in the Current Liability (O/s Claim) by Rs. 100 crores has
reduced the current asset value by Rs.100 crores.

This concept assumes that every transaction has a dual effect, i.e. it affects
two accounts on opposite sides. Therefore, the transaction should be recorded
24
at two places. It means that both the aspects of the transaction must be
recorded in the books of account. Thus, the duality concept is commonly
expressed in terms of the fundamental accounting equation:

Assets = Liabilities + Capital

Diagrammatically, it can be presented as:

The above accounting equation states that the assets of a business are always
equal to the claims of the owner/owners and the outsiders. This claim of the
owner(s) is termed capital or owners’ equity and that of outsiders as liabilities
or creditors’ equity.

7. Realisation Concept / Revenue Recognition Concept

This concept states that revenue from any business transaction should be
included in the accounting records only when it is realised. The term realisation
means creation of legal right to receive money. While selling goods is realisation
amounting to a transaction, receiving an insurance proposal is not a transaction
to be recorded in the books of account. Here, revenue is said to have been
realised when premium is received or the right to receive cash has been
accrued on the sale of goods or services or both.

X Insurance Co Ltd received a fire insurance proposal for the insurance of a

factory for Rs. 5 crores. The business proposal was accepted for a premium of
Rs. 5 lakh on 30th March 2021, but the premium cheque was received on 6th
April, 2021.

This transaction would be entered in the books of account when the premium
cheque was received on 6th April 2021 and the insurance coverage would be
operative from that date only, i.e. w.e.f. 6th April 2021.

This is in accordance with the provisions of Section 64VB of the Insurance Act,
1938 as amended by The Insurance (Laws) Amendment Act 2015 which is a
special requirement in the matter of receipt of insurance premium.

25
P & Co sold goods on credit for Rs. 50,000 during the year ending 31st March
2021. The goods have been delivered in March 2021 but the payment was
received only in April 2021.

Here, P & Co’s revenue of Rs. 50,000 would be entered in the books in March
2021 because the goods have been delivered to the customer in March 2021 and
revenue became due in March 2021 itself.

In the above example, revenue is realised when the goods were delivered to the
customers. The concept of realisation states that revenue is realised at the time
when goods or services are actually delivered or rendered. In short, realisation
occurs when the goods and services have been sold or rendered either for cash
or on credit. It also refers to inflow of assets in the form of receivables.

An insurance transaction for premium income recognition being at the time of

receipt of premium differs from a transaction of income belonging to a
commercial organisation. This difference can be understood from the examples
stated above.

8. Accrual Concept

Accrual concept requires revenue to be recognised when it is realisable or

realised, and expenses to be recognised when they become due and payable,
without having regard to the time of receipt for goods delivered or services
rendered and the time of payment for goods or services received.

It means that revenues are recognised when they become receivable whether
the amount is immediately received or not and the expenses are recognised
when they become payable whether the amount is immediately paid or not.
Both the transactions are to be recorded in the accounting period to which
they relate.

Therefore, the accrual concept makes a distinction between the actual receipt
and the right to receive as regards revenue and actual payment and obligation
to pay as regards expenses.

The accrual concept assumes that revenue is realised at the time of sale of
goods or services rendered, irrespective of the time when the amount is
actually received.

26
A firm sold goods for Rs. 50,000 on 25th March 2021, but the payment was not
received until 10th April 2021.

The amount of sale proceeds was receivable by the firm on the date of sale, i.e.
25th March 2021. It must be entered in the books of account as revenue for the
year ending on 31st March 2021.

Similarly, expenses are to be recognised at the time when goods are purchased
or services are received, irrespective of the time of actual payment.

Under this concept, all insurance claims are registered and entered in the books
of account by an insurance company on receiving claim intimation from the
policyholders.

However, the accrual concept is not applicable to general insurance companies

in the matter of revenue from premium in view of the mandatory provisions of
Section 64VB of the Insurance Act, 1938 as amended by The Insurance (Laws)
Amendment Act 2015 (as mentioned elsewhere in this unit).

A provision is created for unexpired risk to cover the risks associated with
receipt of premium, insurance coverage of which extends beyond the
accounting period in which the premium was received.

9. Matching Concept
The matching concept is an accounting practice whereby entities recognize
revenues and their related expenses in the same accounting period. The
matching concept states that the revenue and the expenses incurred to earn
such revenue must belong to the same accounting period.

Hence, once the revenue is realized, the next step is to allocate it to the
relevant accounting period and the expenses related to such revenue are also to
be identified in the same accounting period. The purpose of the matching
concept is to avoid misstating earnings for a period.

The Matching concept follows the Accrual concept discussed earlier.

Let us study the following transactions of a business during the year 2020-21.

 Sales are Rs. 10,000 (cash Rs. 6,000 and credit Rs. 4,000). Book Debt is Rs.
3,000 as on 31.3.2021.
27
 Paid for Purchase, Rs. 5,000.
 Wages & Salaries paid, Rs. 2,000. Salary &Wages Outstanding Rs. 1,000 on
31.3.2021.
 Commission paid Rs. 1,000 including the amount paid in excess, Rs. 500.

In the above example, expenses would be matched with revenue when the
accountant calculates “expenses incurred” instead of amount paid for expenses.

Continuing with the previous example

Here, total revenue for the year is Rs. 10,000, while total Incurred Expenses are
Rs. 8,500 though total expenses paid amount to Rs. 8,000.

Under the matching concept, profit for the year will be Rs. 1,500 i.e.
Rs. [10,000 - {(5,000) + (2,000 + 1,000) + (1,000 – 500)}].

Workings

W1 Expenses paid W2 Expenses incurred

Rs. Rs. Rs.

Purchases 5,000 Purchases 5,000

Wages and salary 2,000
Add: Outstanding 1,000 3,000

Commission 1,000
Less: Prepaid 500 500

Wages and salary 2,000

Commission 1,000
8,000 8,500

If the Matching Concept is not followed, Profit will Rs. 2,000 [Revenue Rs.
10,000-(Expenses Rs. 5,000 + Rs. 2,000 + Rs. 1,000), which will not be a true
and fair view of profit for the year.

Therefore, the matching concept implies that all revenues earned during an
accounting year, whether received or not during that year and all cost incurred,
whether paid or not during the year should be taken into account while
ascertaining the profit or loss for that year.

28
This concept shows how the expenses should be matched with revenue for
determining the exact profit or loss for a particular period. It is very helpful for
the management, investors and shareholders to know the exact amount of profit
or loss of the business.

In general insurance business, the Matching Concept is applied in recognition

of income and expenses.

For example:

 Premium income is recognised as income over the contract period or the

period of risk, whichever is appropriate.

 Unearned premium and premium received in advance which do not

represent premium income relating to the current accounting period are
treated and disclosed separately in the financial statements.

 A Reserve for Unearned Premium is created against that part of premium

written which is attributable to the subsequent accounting periods.

Match the following:

(i) Business entity concept (a) Health of director is not recorded in the books
of accounts
(ii) Money measurement (b) Owner’s personal expenses are recorded as
concept drawings in the books of accounts
(iii) Going concern concept (c) Order received for supply of goods is not
recorded
(iv) Accounting period (d) Fixed assets are shown in the books at their
concept cost
(v) Accounting cost (e) Transaction should be recorded at two places
concept
(vi) Dual aspect concept (f) Goodwill appears in the accounts only if the
entity has purchased this intangible asset for a
price
(vii) Realisation concept (g) Goods purchased and sold during the period,
rent, salaries etc. paid for the period are
accounted for and against that period only
(viii) Accrual concept (h) Income is the excess of revenues over expenses
(ix) Matching concept (i) Revenue is recognised when it is realised and
expenses are recognised when they become
due / payable

29
2. Discuss the various accounting principles.
[Learning Outcome b]

2.1 Accounting principles

Accounting principles are a body of doctrines commonly associated with the

theory and procedures of accounting, serving as an explanation of current
practices and as a guide for selection of conventions or procedures, where
alternatives exist.

Financial accounting provides information that is assembled and reported

objectively in accordance with universally accepted principles. Accounting
principles have been developed over the years from experience, research,
usage, conventions and concepts. They are judged on their general
acceptability rather than on universal acceptability to the makers and the
users. Therefore they are called Generally Accepted Accounting Principles or
GAAP. The IRDAI has prescribed Accounting Principles for preparation of
financial statement in Part 1 of Schedule B to IRDAI (Preparation of Financial
Statements and Auditor’s Report of Insurance Companies) Regulations, 2000 and
the Master Circular on General Insurance Business, subsequently issued by IRDAI
(preparation of Financial Statements and Auditor’s report of Insurance
companies) regulations, 2002 vide circular Ref. IRDA/F&A/CIR/231/10/2012
dated 05.10.2012. These principles are separately discussed in Unit 12. All
insurance companies in India are required to follow the said principles.
Accounting Principles are usually developed by professional bodies like the
American Institute of Certified Public Accountants in the US, the Institute of
Chartered Accountants of England and Wales (in the UK), the Institute of
Chartered Accountants of India in India, and the like.

Following are the basic principles.

1. Accrual Principle
2. Matching Principle
3. Realisation Principle
4. Continuity Principle or Going Concern Principle
5. Periodicity principle or Accounting period principle
6. Consistency Principle
7. Prudence Principle
8. Materiality/ Disclosure Principle

The first five principles have already been discussed in the earlier Learning
Outcome on Accounting Concepts and the other three principles are briefly
discussed hereafter.
30
1. Principle of consistency
The principle of consistency requires that the financial statements be prepared
in the same manner, period after period. Same method or principle should
follow for all items. There will not be any change in the accounting policy. In
case of any change, the necessity and impact of such change must be disclosed
in the financial statements for the information of users.

Shivam Co valued its stock under the last in first out method (LIFO) until 2010.
But AS 2 Inventories does not permit the LIFO method of inventory valuation and
is applicable to the accounting periods in 2005. Therefore, the company has to
follow a different method for valuing inventory from 2005.

Until 2009, Raghunath Traders followed the reducing balance method (RBM) for
charging depreciation on assets. However, in 2010, the company calculated
depreciation according to the straight line method (SLM). Here, Raghunath
Traders has not followed the principle of consistency.
If Raghunath Traders wants to change its accounting policy, the necessity and
impact of the change in the depreciation amount must be disclosed in the notes
to the financial statements.

2. Principle of prudence / conservatism

This principle aims at showing the state of affairs on “as is" basis; there should
not be any attempt to make things look better or healthier than they actually
are.

The concept of prudence implies that the profit should not be over-stated but
all anticipated losses should be recognised. The implication of this is that all
anticipated losses should be recognised and recorded immediately. But profits
should be recognised and recorded in the books of account only when realised
(this need not necessarily be in cash).

The following are the examples of the principle of prudence:

 Bad debt expense is recorded in the books of accounts to avoid net income
being overstated.
 Stock is recorded at the lower of cost and net realisable value.
 Contingent liabilities are disclosed, but contingent assets are not disclosed
in the books of accounts.

31
3. Principle of Materiality/ Principle of Disclosure

Materiality means relative importance. Material items are important items that
the users of the financial statements must be aware of. The financial
statements should show all the material items separately. The concept of
materiality relates to the time, efforts and the cost of accounting in relation to
the usefulness of the data generated. Materiality requires that only those items
which have a bearing on the determination of financial position and
computation of profit and loss during the accounting period should be recorded
and disclosed in the financial statements.

Pertinently, the materiality depends not only on the amount of the item, but
also on the value, size and importance of the information. What is material is a
question that depends on the situation and related matters of the issue. The
materiality concept does not apply to cash transactions.

Manoj Group of Industries, a large manufacturing firm, has a total of company’s

debtor accounts for the year 2021 as Rs. 9,50,000.

One of the company’s stationery providers to whom Rs. 100 was given as
advance, closed his business. It was clear that the company would not be able
to recover the advance.

Here, considering the company’s scale of operations, Rs. 100 is not a material
amount. Hence, Manoj Group of Industries need not adjust the total debtors’
amount immediately. The financial statements would still be fair.

Which of the following statements are incorrect?

(i) In accounting, all the business transactions are recorded based on the
concept of dual aspect.
(ii) Accrual concept implies accounting on cash basis.
(iii) Revenues are matched with the expenses in accordance with the matching
principle.
(iv) In accordance with the principle of conservatism, the accountant should
provide for all possible losses, but should not provide for anticipated
income.

A All of the above

B Only (i) and (ii)
C Only (iii) and (iv)
D Only (ii) and (iii)
32
State the elements of financial statements.
[Learning Outcome c]

3.1 Accounting assumptions

Financial accounting is based on the following fundamental accounting

assumptions:
 Economic Entity or Separate Entity
 Going Concern
 Accrual
 Consistency
 Money Measurement or Money Unit

All the above stated fundamental assumptions have been discussed in earlier
Learning Outcomes. If nothing is mentioned about accounting assumptions
adopted in the preparation of financial statements, it is assumed that the
preparation of financial statements is based on the fundamental assumptions as
detailed above.

3.2 Financial Statements

The main objectives of financial accounting are:

i) to keep systematic records for all financial transactions of an entity;

ii) to ascertain financial results and financial position; and
iii) to communicate the relevant financial information to all stakeholders of the
entity.

The financial statements are the basic documents through which financial
information is communicated to the stakeholders.
The financial statements generally include:
i) Balance Sheet;
ii) Profit & Loss Account;
iii) Notes to Accounts including significant accounting policies; and
iv) Receipt and Payment account (Cash Flow Statement)

The Financial Statements of a bank will be prepared as per specific regulations

issued by the RBI; the financial statements of an insurance company are
governed by the specific accounting regulations issued by the IRDAI.

33
As per the IRDAI regulations, the following financial statements of an insurance
company are prepared as per specified formats and in accordance with
Accounting Principles and General Instructions for preparation of financial
statements described in the said regulations over and above the compliance
with the requirements of the Companies Act 2013, and the Insurance Laws
(Amendment) Act 2015 and the applicable Accounting Standards (AS).

 Balance Sheet
 Revenue Accounts
 Profit and Loss Account
 Receipts and Payments Account – Cash Flow Statement

These financial statements primarily show the financial position and financial
performance of an enterprise. The financial position of a business as reflected
in the Balance Sheet covers the following aspects as on a particular date.

a) Assets
Resources controlled by the enterprise as a result of contribution from the
promoters, shareholders and past performances from which future economic
benefits are expected to arise to the enterprise.

Examples include:
 Fixed assets
 Stock in trade
 Cash and Bank (debit) Balance

b) Liabilities
Obligations of the enterprise arising from the borrowings made by the
promoters, shareholders and past performances, the settlement of which is
expected to make use of the enterprises' resources, i.e., assets.

Examples include:
 Creditors
 Bank loan
 Outstanding expenses

34
Equity

It refers to owners’ capital or residual interest in the assets of the enterprise

after deducting all the liabilities. This is also called the Net Worth of the
enterprise.

Examples include:
 Owners’ contribution
 Retained earnings

3.3 The financial performance of an enterprise is primarily provided in Revenue

Accounts prepared for three departments, viz, Fire, Marine and
Miscellaneous, followed by an Income Statement or Profit and Loss Account
covering the following aspects.
a) Revenues
It refers to increases in economic benefits during an accounting period in the
form of inflows or increase of assets and decrease in the liabilities. However, it
does not include the contributions made by the equity participants, i.e.,
proprietor, partners and shareholders.

Examples include:
 Sales revenue
 Income from investments
 Dividends received

b) Expenses
It refers to decreases in economic benefits during an accounting period in the
form of outflows or depletion of assets or appreciation in liabilities that result
in decrease in equity.

Examples include:
 Wages and salaries paid
 Interest on borrowings
 Office maintenance

The financial statements must disclose all reliable and relevant information.
The disclosure should be full, fair and final so that the users can correctly
assess the financial position of the enterprise. The disclosures of all the major

35
accounting policies and other information are to be provided in the form of
‘Notes to the Financial Statements’.

Which of the following items represents income?

A Interest received
B Share capital
C Cash received from sale of machinery
D Salaries and wages paid to employees

Summary

 Generally Accepted Accounting Principles refer to the rules or guidelines

adopted for recording and reporting of business transactions in order to
bring uniformity in the preparation and presentation of financial statements.
These principles are also referred to as concepts and conventions.
 The important accounting concepts are business entity, money
measurement, going concern, accounting period, cost, dual aspect,
realisation, accrual, and matching concepts.
 Business entity concept assumes that for accounting purposes, the business
enterprise and its owner(s) are two separate entities.
 Money measurement concept states that only those transactions and
happenings in an organisation that can be expressed in terms of money are
to be recorded in the books of accounts. Also, records of the transactions
are to be kept not in physical units, but in monetary units.
 Going concern concept states that a business firm will continue to carry on
activities for an indefinite period of time.
 Accounting period concept states that all the business transactions are
recorded in the books of accounts on the assumption that profits of
transactions is to be ascertained for a specified time period.
 Accounting cost concept states that all assets are recorded in the books of
accounts at their cost price (not at the market price).
 Dual aspect concept states that every transaction has a dual effect. It is
commonly expressed in terms of the fundamental accounting equation
Assets = Liabilities + Capital
 Revenue recognition concept requires that the revenue for a business
transaction is considered to be realised when a legal right to receive it
arises.
 Matching concept emphasises that expenses incurred in an accounting
period should be matched with revenues during that period. It follows that
the expenses incurred to earn this revenue must belong to the same
accounting period.

36
 Consistency concept states that accounting policies and practices followed
by an entity should be uniform and consistent so that results are
comparable.
 Conservatism (prudence) concept requires that business transactions
should be recorded in such a manner that profits are not overstated. All
anticipated losses should be accounted for but all unrealised gains should be
ignored.
 Materiality concept states that accounting should focus on material facts. If
the item is likely to influence the decision of a reasonably prudent investor
or creditor, it should be regarded as material, and should be disclosed in the
financial statements.

Answers to Test Yourself

Answer to TY 1
(i) Business entity (b) Owner’s personal expenses are recorded
concept as drawings in the books of accounts
(ii) Money (a) Health of director is not recorded in the
measurement books of accounts
concept
(iii) Going concern (d) Fixed assets are shown in the books at
concept their cost price
(iv) Accounting period (g) Goods purchased and sold during the
concept period, rent, salaries etc. paid for the
period are accounted for and against that
period only
(v) Accounting cost (f) Goodwill appears in the accounts only if
concept the entity has purchased this intangible
asset for a price
(vi) Dual aspect (e) Transaction should be recorded at two
concept places
(vii) Realisation (c) Order received for supply of goods is not
concept recorded
(viii) Accrual concept (i) Revenue is recognised when it is realised
and expenses are recognised when they
become due / payable
(ix) Matching concept (h) Income is the excess of revenue over
expenses

Answer to TY 2
The correct option is D. Statement (ii) is incorrect because the accrual concept
implies accounting on accrual basis. Statement (iii) is incorrect because
expenses are matched with revenue in accordance with the matching principle.
37
Answer to TY 3
The correct option is A. Interest received is income. Share capital will be
included in equity; salaries and wages to employees are expenses of the
business.

While cash has been received in exchange for an asset; the income in this
transaction would be the amount received over the fair value (value) of the
asset. This amount would be known as gain on sale of asset.

Self-Examination Questions
Question 1

According to which of the following accounting concepts / assumptions will

sincerity, loyalty and honesty of employees not be recorded in the books of
accounts?

A Business entity
B Going concern
C Dual aspect
D Money measurement

Question 2

Which of the following concepts states that a business entity will not be closed
down in the near future?

A Money measurement concept

B Going concern concept
C Accounting cost concept
D Realisation concept

Question 3

According to which of the following assumptions / concepts are transactions

between the owner and business recorded separately?

A Business entity
B Historical cost
C Accounting period
D Accrual

38
Question 4

Business concerns must prepare financial statements at least once in a year:

this is based on the ___________ assumption.

A Consistency
B Accounting period
C Dual aspect
D Business entity
Question 5
Stock in trade is to be recorded at cost or market price whichever is lower; this
is based on the _____________ principle.
A Materiality
B Going concern
C Prudence
D Consistency

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is D. In accordance with the money measurement concept,
transactions which can be expressed in terms of money are recorded in the
books of accounts. Hence, the factors which cannot be measured in terms of
money (e.g. sincerity, honesty etc.) are not recorded in the books of accounts.
Answer to SEQ 2
The correct option is B. This concept states that an entity will continue to carry
on its business activities for an indefinite period of time.
Answer to SEQ 3
The correct option is A. According to the business entity assumption, for
accounting purposes, the business enterprise and its owners are two separate,
independent entities.
Answer to SEQ 4
The correct option is B. Business concerns must prepare financial statements at
least once in a year: this is based on the accounting period assumption.
Answer to SEQ 5
The correct option is C. Stock in trade is to be recorded at cost or market price
whichever is lower: this is based on the prudence / conservatism principle.

39
 CHAPTER 1
ACCOUNTING SCOPE, CONCEPTS, PRINCIPLES AND
STANDARDS

UNIT-3
ACCOUNTING STANDARDS – ‘AS’ AND ‘Ind AS’
- OBJECTIVES AND INTERPRETATION
Chapter Introduction

Financial Accounting communicates the financial results of an enterprise to

various stakeholders through financial statements.

Accounting Standards act as accounting principles, rules and laws in order to

ensure transparency, consistency and comparability in preparation and
presentation of financial statements. Accounting standards are common set of
principles, standards and procedures that define the basis of financial
accounting policies and practices. It is very essential to standardise the
accounting principles and policies for adequacy and reliability of financial
reporting. Accounting Standards provide a framework and standard accounting
policies so that the financial statements of different enterprises become
comparable and possibility of financial statements being misleading and
misrepresentative is avoided.

Indian Accounting standards (Ind-AS) have been notified by the Ministry of

Corporate Affairs and are converged with International Financial Reporting
Standard (IFRS).

a) Understand the objectives of Indian Accounting Standards.

b) Learn about Accounting Standards and the Companies Act 2013.
c) Understand the development, applicability and broad classification of Accounting
Standards.
d) Comparison of Accounting Standard AS vs. International Financial Reporting
Standards IRFS
e) Learn about the salient aspects of MCA Notification on Ind AS

40
1. Understand the objectives of Indian Accounting Standards
[Learning Outcome a]

1.1 Objectives of Accounting Standards

The objective of financial statements is to provide information about the

financial position, financial performance and cash flows of an entity that is
useful to a wide range of users in making economic decisions.

To meet this objective, financial statements need to be prepared in accordance

with the provisions of Accounting Standards. Accounting Standards are common
set of principles, standards and procedures that define the basis of financial
accounting policies and practices.

Accounting Standards have become upgraded now from national standards

known as Accounting Standards (ASs) to the international standards known as
International Financial Reporting Standards (IFRS). In India, IFRS will not be
directly applied. IFRS-converged Indian Standards (abbreviated as Ind-AS) which
are named and numbered in the same way as the corresponding International
Financial Reporting Standards (IFRS), will be implemented in India in place of
direct application of IFRS. Indian Accounting Standards (Ind-AS) are based on
and substantially converged with IFRS. At present there are 35 Accounting
Standards issued by The Institute of Chartered Accountants of India (ICAI) and
notified by Ministry of Corporate Affairs.

Presently, India has two sets of accounting standards being followed by

different entities as under:

i. Accounting standards, (known as ASs) under Companies (Accounting

Standards) rules, 2006. The ‘Accounting Standards’ issued by the Accounting
Standards Board establish standards which have to be complied by the business
entities so that the financial statements are prepared in accordance with
generally accepted accounting principles (GAAP) in India.

27 Accounting standards are in force as on 01.04.2021.

ii. IFRS - Converged Indian Standards, (known as Ind-AS). The IFRS -

Converged Indian Standards i.e. Ind-AS are being implemented in phased
manner in India.

1.2 Newly Notified Ind-AS and IFRS of IASB

Indian Accounting Standards (abbreviated as Ind-AS) are a set of accounting

standards notified by the Ministry of Corporate Affairs which are converged
with International Financial Reporting Standard (IFRS). These accounting
41
standards are formulated by Accounting Standards Board (ASB) of The Institute
of Chartered Accountants of India. Companies and their auditors shall comply
with the Indian Accounting Standards (Ind AS) in preparation of their financial
statements and audit as directed by MCA. Ind- AS are thus Indian Accounting
Standards harmonized and converged with IFRS.

39 Ind-AS (Indian Accounting Standards) have been notified by the Ministry of

Corporate Affairs as on 01.04.2020.

Implementation of Ind-AS was voluntary for the financial year 2015-16 but
mandatory from financial year 2016-17 for all Indian companies. Once a
company follows Ind-AS either mandatorily or voluntarily, it cannot revert to old
method of accounting.

For insurance companies, status of implementation of Ind-AS is as under:

It has been decided by the IRDAI in its meeting held on 20th December 2019, to
implement Ind AS 109 and Ind AS equivalent of IFRS 17 simultaneously, along
with all other applicable Ind AS. The effective date of implementation shall be
decided after the finalisation of IFRS 17 by IASB.

Therefore, presently insurance companies prepare the financial statements as

per ASs only.

1.3 Objectives of Accounting Standards

Financial Accounting as a 'language of business' communicates the financial

results of an enterprise to various stakeholders through financial statements. If
the financial accounting process is not properly regulated by proper accounting
rules and laws, there is a possibility of financial statements being misleading,
misrepresentative and providing a distorted picture of the business, rather than
exhibiting the true state of affairs. Accounting Standards act as accounting
principles, rules and laws in order to ensure transparency, consistency and
comparability in preparation and presentation of financial statements.

The primary objectives of Accounting Standards are the following:

i) To harmonize the different accounting policies. The policies are used in

preparation of financial statements. The objective of accounting standards
is to bring a standard to the policies.
ii) To bring uniformity in accounting methods by proposing standard treatments
to the accounting issues.
iii) To provide a suitable starting point for accounting.
iv) To provide a standard for the diverse accounting policies and principles.
v) To increase the reliability of the financial statements.
vi) To define the standards which are comparable over all periods presented.
42
vii) To ensure transparency, consistency, comparability, adequacy and reliability
of financial reporting.
viii) To eliminate huge amount of variation in the treatment of accounting
standards.
ix) To facilitate ease of both inter-firm and intra-firm comparison.
x) To reduce the possibility of difference in methods, procedures, perspectives
and terminology in the preparation of financial statements.
xi) To provide the framework, rules, and regulations, thereby enabling
comparative analysis of financial statements of different enterprises.
xii) To help the auditors. The Accounting standards lay down the terms and
conditions for accounting policies and practices by way of codes, guidelines
and adjustments for making and interpreting the items appearing in the
financial statements. Thus, these terms, policies and guidelines etc. become
the basis for auditing the books of accounts.

2. Understand the development, applicability and broad classification

of Accounting Standards
[Learning Outcome b]
2.1 Development of Accounting Standards (ASs)

The council of the Institute of Chartered Accountants of India has, so far, issued
thirty two Accounting Standards. These standards are developed and designed
by the Accounting Standards Board (ASB) constituted by the Council of ICAI in
April, 1977. The ASB now also has representatives from financial institutions like
banks, insurance companies, SEBI, C&AG, CBDT, Management institutes and
universities, CBDT, CBEC etc.

2.2 Application of Accounting Standard in Insurance industry

The IRDAI (Accounts and Audit) Regulations 2002 provides that the Balance
Sheet, Revenue Account, Receipts and Payments Accounts and Profit & Loss
Account shall be in conformity with all accounting standards issued by the ICAI
except,
1. AS3 – Cash flow statements
2. AS13 – Accounting of Investments
3. AS17 – Segment Reporting

2.4 List of Accounting Standards (ASs) Developed and Issued by ICAI:

The ICAI has issued 32 Accounting Standards (ASs) so far. Presently 27 are in
operation as 5 Ass were withdrawn. Following is the list of 27 ASs. The MCA vide
its notification dated 23rd June, 2021 has brought Companies (Accounting
Standards) Rules, 2021.
43
AS A S Title Mandatory for all companies?
No
1 Disclosure of Accounting Policies Yes
2 Valuation of Inventories Yes
3 Cash Flow Statements Insurance companies use
‘Direct Method’ only
4 Contingencies and Events Occurring Yes
after the Balance Sheet Date
5 Net Profit or Loss for the Period, Prior Yes
Period Items and Changes in
Accounting Policies
7 Construction Contracts Yes

9 Revenue Recognition Yes

10 Property, Plant and Equipment Yes

11 The effects of Changes in Foreign Yes

Exchange Rates
12 Accounting for Government Grants Yes

13 Accounting for Investments Insurers have separate

regulation on Investments
14 Accounting for Amalgamations Yes

15 Employee benefits Yes

16 Borrowing Costs Yes

17 Segment Reporting Shall apply to all insurers

irrespective of the
requirements regarding listing
and turnover

18 Related Party Disclosures For Listed companies

19 Leases Yes
20 Earnings Per Share Yes
21 Consolidated Financial Statements Mandatory for companies
required to submit consolidated
Financial statements
22 Accounting for Taxes on Income For Listed companies
23 Accounting for Investments in Mandatory for companies
Associates in Consolidated Financial required to submit consolidated
Statements Financial statements
44
 24 Discontinuing Operations For Listed companies

25 Interim Financial Reporting For Listed companies

26 Intangible Assets For Listed companies

27 Financial Reporting of Interests in Joint Mandatory for companies

Ventures required to submit consolidated
Financial statements
28 Impairment of Assets For Listed companies

29 Provisions, contingent Liabilities and For Listed companies

Contingent Assets

The students may refer the full text of the accounting standards (ASs) available
on the ICAI website www.icai.org.

Which body is responsible for issuing the Accounting standards in India?

A IRDAI (Insurance Regulatory and Development Authority)

B ICAI (Institute of Chartered Accountants of India)
C Ministry of Corporate Affairs
D Institute of Companies Secretaries of India (ICSI)

3 Comparison of Accounting Standard AS vs. International Financial

Reporting Standards IRFS
[Learning Outcome c]

It needs a detailed discussion on the difference between IFRS and the Indian
Accounting Standards. As such detailed discussion is not possible here; a few
examples are given below to highlight certain conceptual differences between
IFRS and the existing Indian Accounting Standards for general understanding of
the two standards in respect of Scope, use, framework, direction, presentation
etc.

Conceptual Differences between IFRS and ASs

Area / IFRS Indian Accounting

Subject Standard
1 Scope and IFRS provides scope of ASs are generally rule based
Use judgment & requires and are less flexible
45
 information to be presented compared with IFRS
on the basis of substance
rather than rule
2 Basis Usage by investors or other It is accepted in India that
users is prime consideration. Law overrides standards
3 Directions IFRS framework provides No directions and
directions for setting definitions for setting
standards & defines standards on the basis of
components of Asset, needs of the users
Liability, equity, revenue etc.
4 Presentation IAS 1: “Presentation of AS 1: “Disclosure of
Financial” provides guidelines Accounting Policies” does
and overall requirements. It not define any standard
specifies certain information requirement for disclosure.
that are required to be Only Sch. VI of Co’s Act
presented on the face of defines format and other
Balance Sheet requirements
5 Extra Item IAS 1 disallows any extra AS 5 specifically requires
ordinary item to be presented extra-ordinary item to be
separately presented separately
6 Reports IAS 1 specifies 5 statements Sch. VI of the Co’s Act 1956
to be presented and reported; 3 Statements to be
i) Balance Sheet, ii) Income reported i) Balance Sheet,
statement, iii) Cash Flow ii) Profit & Loss A/c iii)
Statement, v) Statement of Notes to Accounts. As per
changes in Equity & vi) Notes Reg. Ins. Co is to present
to Accounts Cash Flow Statement,
7 Revenue IAS 18 provides for recognition AS 9 provides option for
Recognition of revenue on transfer of recognition of revenue on
risks, reward and control proportionate method or
completed method.
8 Depreciation IAS 16 provides for charging Sch. XIV of the Co’s Act
depreciation on Property, 1956 provides minimum
plant & Equipment on the rates of depreciation
basis of useful life of the asset

India has now entered into a new era of accounting reforms with the adoption
of the new Indian Accounting Standards (Ind-AS) converged with IFRS from 2015-
16 on voluntary basis and from 2016-17 mandatorily phase-wise as per MCA
notification dt.16-2-2015 which has been discussed briefly hereinafter.

Financial Accounting and preparation of financial statements in India are now

required to follow the IFRS-converged Indian Accounting Standards (Ind As) to
ensure transparency, consistency, comparability, adequacy and reliability of

46
financial reporting. India has chosen the path of IFRS convergence instead of
adoption of IFRS to the letter.

4 Learn about the salient Aspects of MCA Notification on Ind AS

[Learning Outcome d]

a) Entities not covered by the roadmap given by MCA notification can adopt the
Ind-AS voluntarily. Once having adopted Ind-AS, they cannot go back to AS
for preparation and presentation of financial statements.

b) Insurance, banking and non-banking financial companies are not required to

apply Ind-AS either voluntarily or mandatorily. However, experts opine that
if these entities are subsidiaries, joint venture or associates of a parent
company which is covered by the MCA roadmap, they will have to report
Ind-AS adjusted accounting figures for their parent company‘s consolidated
financial statements to be prepared on the basis of Ind-AS.

The rules specify that in case of any conflict between Ind-AS and any statute,
the provisions of the relevant law or regulation shall prevail and the financial
statements shall be prepared accordingly.

List of Ind-AS as per MCA - Applicable for accounting period on or after

01.04.2021.
S.No. Ind AS No Subjects
1 Ind AS 101 First-time Adoption of Indian Accounting Standards
2 Ind AS 102 Share-based Payment
3 Ind AS 103 Business Combinations
4 Ind AS 104 Insurance Contracts
5 Ind AS 105 Non-current Assets Held for Sale & Discontinued
Operations
6 Ind AS 106 Exploration for and Evaluation of Mineral Resources
7 Ind AS 107 Financial Instruments: Disclosures
8 Ind AS 108 Operating Segments
9 Ind AS 109 Financial Instruments
10 Ind AS 110 Consolidated Financial Statements
11 Ind AS 111 Joint Arrangements
12 Ind AS 112 Disclosure of Interests in Other Entities
13 Ind AS 113 Fair Value Measurement
14 Ind AS 114 Regulatory Deferral Accounts
15 Ind AS 115 Revenue from Contracts with Customers
16 Ind AS 116 Leases
17 Ind AS 1 Presentation of Financial Statements
18 Ind AS 2 Inventories

47
 19 Ind AS 7 Statement of Cash Flows
20 Ind AS 8 Accounting Policies, Changes in Accounting
Estimates & Errors
21 Ind AS 10 Events after the Reporting Period
22 Ind AS 12 Income Taxes
23 Ind AS 16 Property, Plant and Equipment
24 Ind AS 19 Employee Benefits
25 Ind AS 20 Accounting for Government Grants & Disclosure of
Govt. Assistance
26 Ind AS 21 The Effects of Changes in Foreign Exchange Rates
27 Ind AS 23 Borrowing Costs
28 Ind AS 24 Related Party Disclosures
29 Ind AS 27 Separate Financial Statements
30 Ind AS 28 Investments in Associates and Joint Ventures
31 Ind AS 29 Financial Reporting in Hyperinflationary Economies
32 Ind AS 32 Financial Instruments Presentation
33 Ind AS 33 Earnings per Share
34 Ind AS 34 Interim Financial Reporting
35 Ind AS 36 Impairment of Assets
36 Ind AS 37 Provisions, Contingent Liabilities and Contingent
Assets
37 Ind AS 38 Intangible Assets
38 Ind AS 40 Investment Property
39 Ind AS 41 Agriculture

Ind AS 19 notified by MCA deals with:

A Employee benefits
B Earnings per share
C The Effects of Changes in Foreign Exchange Rates
D Accounting for Government Grants & Disclosure of Govt. Assistance

Summary

 Financial statements are a structured representation of the financial

position and financial performance of an entity.

 The objective of financial statements is to provide information about the

financial position, financial performance and cash flows of an entity that is
useful to a wide range of users in making economic decisions. To meet this
objective, financial statements need to be prepared in accordance with the
provisions of Accounting Standards now which have become upgraded from

48
 national standards known as Accounting Standards (ASs) to the international
standards known as International Financial Reporting Standards (IFRS).

 The Accounting Standards reduce the possibility of difference in methods,

procedures, perspectives and terminology in the preparation of financial
statements and provide the framework, rules, and regulations in this regard
thereby enabling comparative analysis of financial statements of different
enterprises.

 Indian Accounting Standards (abbreviated as Ind-AS) are a set of accounting

standards notified by the Ministry of Corporate Affairs which are converged
with International Financial Reporting Standard (IFRS).

 Accounting Standards whether AS, Ind- AS or IFRS deal with the issues of

i. recognition of events and transactions in the financial statements,

ii. measurement of these transactions and events,
iii. Presentation of these financial transactions in the financial statements
in a meaningful and understandable manner to the users of the financial
statements with compliance of disclosure requirements for various
stakeholders.

 The Institute of Chartered Accountants of India has, so far, issued 32

Accounting Standards out of which 27 are vogue. These standards are
developed and designed by the Accounting Standards Board (ASB)
constituted by the Council of ICAI.

 At present India is now having two sets of accounting standards

o viz. existing accounting standards (ASs) under Companies (Accounting
Standard) Rules, 2021 dated 23rd June, 2021 and
o IFRS converged Indian Accounting Standards (Ind AS) as per the MCA
notification dated 16 February 2015. The new set of Ind-ASs are
named and numbered in the same way as the corresponding IFRS.

 Financial Accounting and preparation of financial statements in India are

now required to follow the IFRS-converged Indian Accounting Standards (Ind
As) to ensure transparency, consistency, comparability, adequacy and
reliability of financial reporting.
 India has chosen the path of IFRS convergence instead of adoption of IFRS.
 The applicability of IFRS to Indian Insurance companies are currently
deferred by IRDA.

49
Answers to Test Yourself

Answer to TY 1
The correct option is B. ICAI is responsible for issuing the Accounting standards
in India

Answer to TY 2

The correct option is A. Ind AS 19 notified by MCA deals with Employee benefits.

Self-Examination Questions

Question 1

IFRS refers to ….
A International Fund Reporting Standards
B Indian Finance Reporting Standards
C Indian Financial Reporting Standards
D International Financial Reporting Standards

Question 2
________ is used for preparing cash flow statements of an insurance company.

A Percentage of completion method.

B Historical cost method
C Direct method
D Indirect method

Question 3

The converged form of IFRS in India is …

A India AS
B Ind AS
C Indian AS
D International AS

50
Question 4
Which of the following is true for accounting for investments as per AS – 13?

A It is not applicable to investments of General Insurance companies

B It is not applicable to investment in immovable property
C It is applicable to operating lease but not to financial lease
D It is applicable only to short term investments.

Answers to Self Examination Questions

Answer to SEQ 1

IFRS refers to International Financial Reporting Standards. So, the correct

answer is D.

Answer to SEQ 2

The correct answer is C. There are basically two methods of preparing cash flow
statements, (a) Direct, and (b) Indirect. Out of these, the direct method is
specifically used in the case of accounting for insurance companies.

Answer to SEQ 3

The correct answer is B.

The IFRS is converged into ‘Ind AS’ in India.

Answer to SEQ 4

The correct answer is A.AS – 13, as amended, is no longer applicable to

Insurance companies.

51
 CHAPTER 1
ACCOUNTING SCOPE, CONCEPTS, PRINCIPLES AND
STANDARDS

UNIT-4
ACCOUNTING POLICIES
Chapter Introduction

In this chapter, we discuss the fundamental accounting policies and concepts

which should be followed while preparing financial statements.

a) Accounting policies and their objectives.

b) Changes to Accounting Policies.
c) Accounting policies generally applicable to non-life insurance business.

52
1. Accounting policies and their objectives.
[Learning Outcome a]

1.1 Accounting policies

The accounting policies are the specific policies and procedures that are used
by a company to prepare its financial statements. The accounting policies
include methods, measurement system and procedure for presenting
information in financial statements.

Accounting policies are based on various accounting concepts, conventions,

assumptions and principles, which have been discussed in Unit 2.

Accounting policies of one enterprise may differ from those of another,

depending on the nature, type and structure of the enterprises.

Accounting policies followed by insurance companies are different from those

followed by banking companies.

Also, accounting policies followed by life insurance companies are different

from those followed by non-life insurance companies.

Again, accounting policies followed by a domestic general insurance company

may differ to some extent from the accounting policies followed by a
multinational general insurance company.

There is no single set of accounting policies, which are strictly followed by all
enterprises in all circumstances, although all accounting policies are governed
by the fundamental accounting principles, concepts, assumptions and
conventions.

Enterprises operate in diverse environmental situations with different products

having different structure and legal status. Hence, accounting policies tend to
vary in different types of enterprises. Besides, interpretation of financial
statements largely depends on the selection of accounting policies adopted by
the enterprise.

1.2 Objectives of Accounting Policies

The main objectives of accounting policies are:

53
1. To maintain quality of financial statements: As the accounting policies are
judiciously decided by the management in consideration of the fundamental
accounting principles, accounting norms and regulations, these policies help
in maintaining the quality of information that is provided in the financial
statements for the users.

2. To ensure reliability: In the absence of appropriate accounting policies, the

financial accounting, statements and information provided therein might
pose a risk of material misstatement or erroneous statement leading to
wrong decisions being made by the users and investors of the organisation.

3. To maintain consistency: Accounting policies are followed consistently from

one period to another and a change in accounting policies is made only in
exceptional circumstances. This facilitates comparison and maintenance of
uniformity of useful information.

4. To bring about comparability of financial statements: For comparability of

the financial statements of one enterprise with those of other enterprises or
compare financial statements of the same enterprise of one period with
another period (in other words inter comparison and intra comparison) to
make a comparative analysis of performance is possible only when the same
set of accounting policies are consistently followed by the enterprise(s) over
the period.

5. To ensure full, fair and adequate disclosure: A change in accounting

policies brings about a material effect on the financial results and
performance reflected in the financial statements. So, a change in the
accounting policies is permitted only in exceptional circumstances with full,
fair and adequate disclosure of such change and the impact thereof by way
of inclusion in ‘Notes to accounts’.

The term "accounting policies" refers to:

A The measurement bases used by an entity

B The accounting concepts and conventions adopted by an entity
C The accounting principles applied by an entity
D All of the above

54
2. Changes to Accounting Policies.
[Learning Outcome b]

2.1 Change in accounting policies

As mentioned earlier, accounting policies are followed consistently from one

period to another and a change in the accounting policies is made only in
exceptional circumstances.

An enterprise generally makes changes in accounting policies in the following

circumstances:
 To bring the books of accounts in accordance with the Accounting Standards
 To comply with the provisions of law
 To ensure that the changed circumstances or methods will reflect a truer
and fairer view of the financial statements

For any change in the accounting policy, there must be a full, fair and
adequate disclosure of such change and the impact thereof in the ‘Notes on
accounts’ as per AS 1, more particularly material impact on financial
statements including the amount of impact.

2.2 Disclosure of Accounting Policies

The requirement for disclosure of significant accounting policies followed by

a company in preparing and presenting financial statements to ensure that
the true and fair view of the state of affairs and of the profit and loss are
reflected by the financial statements is contained in Accounting Standard 1.

As per the Accounting Standards 1(AS1), all significant accounting policies

adopted by the organisation for preparation of financial statement should be
disclosed in the financial statements and form integral part of the financial
statements.

When can an entity change one of its accounting policies?

A Whenever it wishes to do so
B If this would result in the provision of reliable and more relevant
information
C If this would reduce the cost of preparing the financial statements
D Never

55
3. Accounting Policies applicable to Non-Life Insurance Business
[Learning Outcome c]

Financial statements of insurance companies consist of the significant

accounting policies and notes forming integral part of financial
statements. Given below are the major items heads on which disclosure
is made in financial statements about significant policies.

1. Accounting Convention
2. Premium and Commission Recognition
3. Use of Estimates and basis of estimation
4. Reinsurance Accepted & Reinsurance Ceded
5. Premium received in advance
6. Reserves for Un-expired Risk/s
7. Premium Deficiency Reserve
8. Acquisition Costs.
9. Incurred Claims
10. Incurred but not reported claims
11. Salvage and Claim Recoveries
12. Provisions, Contingent Liabilities & Contingent Assets
13. Loans and Investments
14. Foreign Currency Transactions
15. Fixed Assets
16. Depreciation
17. Intangible Assets
18. Employee Benefits
19. Expenses of Management-Basis of Apportionment to revenue accounts
20. Segregation of Policy Holders and Share Holders funds:
21. Income from Investments -Basis of Apportionment
22. Apportionment of Interest, Dividend and Rent
23. Impairment of Assets, Amortisation of Premium and Unrealised gains
24. Taxation.

Reserve for unexpired risk is made at ____________ for marine hull business and
________ for other classes of domestic business.

A 50% of the net premium, 100% of the net premium

B 100% of Net Written premium, 1/365 of the net premium
C 100% of the claims accepted, 50% of the claims accepted
D 50% of the claims accepted, 100% of the claims accepted

56
Summary

 Accounting policies are based on various accounting concepts, conventions,

assumptions and principles.
 Accounting policies of various organisations depend on the nature, type and
structure of the enterprises and hence policies of one organisation may
differ from those of another organisation.
 The main objectives of the accounting policies are to maintain the quality
and consistency ensure reliability and bring about comparability of the
financial statements, and to ensure full, fair and adequate disclosure.
 Appropriate selection of accounting policies is very important as wrong
selection may lead to overstatement or understatement of the financial
position and performance of the enterprise.
 Any changes to the accounting policies should be made only in exceptional
circumstances. For any change in an accounting policy, there must be full,
fair and adequate disclosure of such change and the impact thereof in the
‘Notes on accounts’, as per AS 1.
 The financial statements of non-life insurance companies are drawn up in
accordance with the provisions of section 11 (1) of as amended by the
Insurance Laws (Amendment) Act 2015 and the Regulations framed under
the Insurance Regulatory Development Act, 1999.
 These financial statements are prepared on the historical cost convention
and accrual basis.

Answers to Test Yourself

Answer to TY 1

The correct option is D. All of the above

Answer to TY 2

The correct option is B. An entity may change its accounting policy if this would
result in the provision of reliable and more relevant information.

Answer to TY 3

The correct option is B. Reserve for unexpired risk is made at 100% of the net
written premium for marine hull business and 1/365 of the net premium for
other classes of domestic business.

57
Self Examination Questions

Question 1

For all changes in accounting policy, the entity concerned must disclose:

A The title of the international standard that has caused the change to occur
B The reasons which suggest that the change will provide reliable and more
relevant information
C The nature of the change
D The fact that the change has been accounted for in accordance with
transitional provisions specified in the applicable standard

Question 2

A change in an accounting policy which does not result from the initial
application of an international standard must normally be accounted for:

A Retrospectively
B Prospectively
C Either retrospectively or prospectively
D Prospectively, unless it is impracticable to account for impact of change

Question 3

In which of the following areas can accounting policies of one enterprise differ
from other enterprises?

A Valuation of current assets

B Valuation of inventories
C Valuation of shares
D Valuation of debentures

Question 4

In foreign currency transactions, the assets and liabilities (including contingent

liabilities) of the non-integral foreign operations, both monetary and non-
monetary, are translated at ______________.

A The opening rate

B The closing rate
C The average rate
D The economy rate
58
Question 5

A provision is made for _________for all timing differences arising between

taxable incomes and accounting income at currently enacted tax rates.

A Deferred tax
B Current tax
C Total tax
D 50% tax of the net profit

Answers to Self Examination Questions

Answer to SEQ 1

The correct option is C. For all changes in accounting policy, the entity
concerned must disclose the nature of the change.

Answer to SEQ 2

The correct option is A. A change in an accounting policy which does not result
from the initial application of an international standard must normally be
accounted for retrospectively.

Answer to SEQ 3

The correct option is B. Accounting policies of one enterprise may differ from
other enterprises in: Methods of Depreciation, Valuation of Inventories,
Valuation of Investments, Valuation of Fixed Assets, Treatment of Goodwill,
Recognition of Income, and Recognition of Expenditure.

Answer to SEQ 4

The correct option is B. The assets and liabilities (including contingent

liabilities) of the non-integral foreign operations, both monetary and non-
monetary, are translated at the closing rate.

Answer to SEQ 5

The correct option is A. A provision is made for deferred tax for all timing
differences arising between taxable incomes and accounting income at
currently enacted tax rates.

59
 CHAPTER 2

ACCOUNTING PROCESS, METHODS & CONTROL

AND FINALISATION OF ACCOUNTS

UNIT-5

ACCOUNTING PROCESS
Chapter Introduction

This chapter aims to provide you with an understanding of the accounting

process. You will also learn about the different types of accounts, the golden
rules of accounting and how transactions are classified on the basis of these
rules.

a) Understand the accounting process.

b) Get introduced to double entry system of bookkeeping.
c) Learn about classification of accounts.
d) Understand the golden rules of accounting.
e) Get introduced to principal books and subsidiary books.

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1. Understand the accounting process.
[Learning Outcome a]
1.1 Accounting Process
Financial accounting is the process of identifying, measuring, classifying,
recording, summarising, analysing, interpreting and reporting the financial
performance and the financial position of the enterprise through financial
statements. The process stated above is called Accounting Process.

Accounting process is based on certain Accounting Concepts, Accounting

Principles and Accounting Standards comprising accounting policies for
preparation and presentation of financial statements. To be precise, accounting
process refers to the process of book keeping as well as process of preparation
of final accounts, that is, preparation of financial statements.

Steps or stages of accounting process

1. Recording financial transactions in journal under proper account

2. Posting journal entries to respective ledger accounts.
3. Balancing of ledger accounts
4. Preparation of Trial Balance
5. Preparation of Profit and Loss accounts
6. Preparation of Balance Sheet

The stages of accounting process involve preparation of trial balance, profit &
loss account and _______

A Spread sheet
B Balance sheet
C Income sheet
D Profitability sheet

2. Get introduced to double entry system of book-keeping.

[Learning Outcome b]

2.1 Book-keeping

Book-keeping is the foundation of financial accounting. Book-keeping is an

activity that involves recording of financial data from financial transactions
relating to business operations in a systematic and chronological order.
61
It covers procedural aspects of financial accounting and record keeping
function. Some people are mistaken in referring to ‘book-keeping’ and
‘accounting’ as synonymous terms. Accounting is a broad subject of which book-
keeping is the small part but groundwork on which huge spectrum or edifice of
financial accounting rests.

2.2 Accounting systems

Single entry system: Single entry system is an accounting system for recording
financial information in which only one aspect of the transaction is recorded.

Double entry system: Double entry system of book-keeping is used in almost all
financial accounting software for corporate houses including all insurance
businesses. The basic principle of double entry book-keeping is that there are
always two entries for every transaction. One entry is known as Debit entry and
the other a Credit entry. The double entry book-keeping system, which has
emerged in the process of evaluation of various accounting techniques, was
codified in the 15th century by an Italian named Lucas Pacioli.

Every financial transaction has two aspects – a debit leg and a credit leg. It is a
process by which the dual aspects of business transactions are recorded. It
records both the two aspects, debit and credit in each business transaction, in
equal values.

Double entry system is an accounting system of book keeping based on a set of

rules (golden rules of accounting) for recording financial information related to
both (debit and credit) aspects of the transaction in such a way that both sides
are equally balanced.

A financial transaction may have

 one debit and one credit (one-to-one) or
 one debit and multiple credits (one-to-many) or
 multiple debits and one credit (many-to-one) or
 multiple debits and multiple credits (many-to-many)

62
In double entry system when a financial transaction is recorded, irrespective of
the number of debits or credits it may have, the total of both the sides is always
balanced.

In double entry system, two aspects are recorded for every transaction and
hence the name ‘double entry’ for this system of book keeping. The set of rules
which form the basis for classifying the aspects of a transaction are known as
golden rules of accounting.

The two aspects of every transaction are DEBIT and CREDIT

The double entry accounting system records financial transactions in relation to

asset, liability, income or expense through accounting entries.

1. Asset: It is something that a company owns and adds value to the company.
Assets can generate revenue for the company or can be used for utility
purpose.
Examples: cash, land, machinery, goods, investments, debtors, vehicle etc.

2. Liability: It is something that a company owes to others. It can be

obligations or payments due to others.
Examples: bank loans, bills payable, creditors etc.

3. Income: It is the revenue earned by the business from its core activity of
selling products or offering services or from other sources.
Examples: profit earned selling products or offering services, income from
sale of assets, income from investments like bank interest, dividend from
shares etc. In Insurance, premium is an income.

4. Expense: It is the amount spent by the business for running the day-to-day
operations of the business, marketing expenses for selling of goods and
services.
Examples: salaries paid to employees, rent paid for premises; interest paid
on loan, office expenses like printing, postage, travelling, electricity, IT,
repair and maintenance, telephone, stationery etc. In Insurance, the
examples are Commission, Brokerage etc.

An accounting entry in double entry bookkeeping system has two

effects:
 one of increasing account and the other of decreasing another
account by an equal amount or
 increasing of both accounts or
 decreasing of both accounts

63
i) A business purchases machinery worth Rs 2,50,000 in cash.
ii) In this case, machinery (asset) increases by Rs 2,50,000;
Cash or bank balance (asset) decreases by the same amount of Rs 2,50,000.
 The transaction has two effects. These two effects on purchase of an
asset in cash will be recorded as
‘Asset account – Dr. ; Cash account – Cr.’
iii) The transaction will be recorded in asset register / ledger and in cash book.
iv) In both the accounts i.e. asset account and cash account, the balances will
be modified by an equal amount after recording the single transaction i.e.
purchase of asset by cash.

Now let us assume the same machinery (as mentioned in the above case) is
purchased on credit.
v) In this case, machinery (asset) increases by Rs 2,50,000; Seller’s (Liability)
increases by the same amount of Rs 2,50,000.
vi) When the creditor is paid off, there will be decrease in both;
Seller’s account and Cash/bank account by Rs 2,50,000.

Advantages of double entry system

Double entry system of accounting has some distinct advantages over the single
entry system. The advantages are as under:

1. The arithmetical accuracy of financial accounting is established through trial

balance, a summary of balances of all the ledger accounts including that of
cash and bank on a particular date. The financial results including
performance of transactions recorded and the consequent changes in the
financial positions of the enterprise can be measured and assessed
systematically and logically through preparation of financial statements
including Trading A/c, Profit & loss A/c, Balance sheet, Income statement.

2. Double entry system is based on a set of rules and principles and hence the
results and positions shown by financial systems are considered more
authentic and reliable. It exhibits a higher degree of true and fair view of
the financial position of the entity through financial statements.

3. Double entry system is globally and extensively used in business firms and is
based upon laid down principles and standards and hence the financial
statements of various firms in an industry are comparable both nationally
and internationally, hence useful for analysis and decision making.

4. It is possible to compare financial activity in a meaningful way between

periods such as month-to-month, quarter-to-quarter or year-to-year.

64
In which type of accounting system some transactions are recorded on both
sides, some on one side and some transactions are not recorded at all?

A Unique entry system

B Single entry system
C Double entry system
D Dual entry system

3. Learn about classification of accounts

[Learning Outcome c]

3.1 Classification of accounts and accounting transactions

An accounting system records, retains and reproduces financial information

relating to financial transaction flows and financial position. Financial
transaction flows encompass primarily inflows on account of incomes and
outflows on account of expenses.

Accounts are classified as:

 Personal accounts
 Real accounts
 Nominal accounts

1. Personal Accounts:
Personal accounts relate to individuals, partnership firms, corporate entities
and local or statutory bodies including governments or other legal entities.

Personal accounts are of three types

i) Natural personal accounts: it relates to transactions of human beings such
as Ram A/c, X A/c, John A/c etc.
ii) Artificial personal accounts: For business and financial accounting, business
entities are treated as separate legal entities. Examples: ABC Insurance Co.
Ltd., XYZ Cop. Society. etc.
iii) Representative personal accounts: These are not in the name of any
persons or organisation but represented as persons. Examples: Capital a/c or
Drawings A/c is a representative personal A/c.

2. Real accounts:
These relate to assets of the firm.
Tangible assets – (physical form) – eg. Land, building, investment, furniture.
Intangible assets – (No physical form) – eg. Goodwill, patents, copyrights

65
3. Nominal accounts:
These accounts relate to expenses, losses, gains, revenue etc. like salary,
wages, printing & stationery, interest paid, interest received, commission,
premium received, claims paid A/c etc. Classification of Accounts

Account Nature Examples

Personal Business Natural: Artificial: Representative:
entities and Individuals Firms, Capital,
individual Corporate Drawings
entities, Banks,
Insurance cos.,
Statutory
bodies etc.

Real Tangible Tangible: Intangible:

assets and Cash, Bank, Plant Patents,
intangible & machinery, Goodwill,
assets Furniture & Copyrights
fixtures, Stock

Nominal Elements of Income: Expenditure:

income, gains, Investment Rent, Wages &
revenue, income, Salary,
profits, Dividend, Commission,
expenditure, Interests Stationery etc
losses etc.

Goodwill will be classified under which type of account?

A Personal Account
B Unreal Account
C Real Account
D Nominal Account

4. Understand the golden rules of accounting

[Learning Outcome d]

4.1 Golden rules of accounting

A transaction is recorded as a ‘Debit entry’ (Dr.) in one account and a ‘Credit
entry (Cr)’ in the other account. The process of debiting and crediting accounts
is governed by golden rules of accounting. These golden rules imply the rules of
66
debit and credit for recording transactions in the books of accounts under
double entry system.

4.2 Application of rules of accounting

Type of a/c Debit rule Credit rule
1. Personal Debit the receiver Credit the giver
2. Real Debit what comes in Credit what goes out
3. Nominal Debit all expenses and losses Credit all incomes and gains

Personal Account: Accounting Rule:

Debit the receiver; Credit the giver

Real Account: Accounting Rule:

Debit what comes in; Credit what goes out

Nominal Account: Accounting Rule:

Debit all expenses and losses; Credit all incomes, revenue and gains

Let us see an example with the combination of these rules.

Company ABC Ltd. sold goods worth Rs. 2,000 to Company XYZ Ltd. on credit.

Entry in the books of ABC Ltd.

Debit the receiver Credit what goes out

XYZ Ltd. is the receiver of goods and The second aspect is that goods are
hence as per the accounting rule for going out of the company. Hence as
personal account, XYZ Ltd. will be per the accounting rule for real
debited for Rs. 2,000. accounts, Goods account will be
credited for Rs. 2,000.

After 1 month, XYZ Ltd. makes a cash payment of Rs. 2,000 to Company ABC.

Entry in the books of ABC Ltd.

Debit what comes in Credit the giver

Cash of Rs. 2,000 is coming into ABC XYZ Ltd. is the giver of Rs. 2,000 and
Ltd. Hence as per the accounting rule hence as per the accounting rule for
for real accounts, Cash account will be personal account, XYZ Ltd. will be
debited for Rs. 2,000. credited for Rs. 2,000.

67
Let us see another example of combination of these rules.

ABC Ltd. paid Rs.5,000 as telephone bill.

Entry in the books of ABC Ltd.

Debit all expenses Credit what goes out

As per the accounting rule for nominal The second aspect is that Cash is going
account, Telephone expenses a/c will out of the company. Hence as per the
be debited for Rs.5,000. accounting rule for real accounts, Cash
a/c will be credited for Rs. 5,000.

Example: Company ABC received Rs.1000 as interest on bank deposit.

Entry in the books of ABC Ltd.

Debit what comes in Credit all Incomes

As Cash comes in, as per the Interest is an income. Hence as per
accounting rule for real accounts, Cash the accounting rule for nominal
a/c will be debited for Rs. 1,000. account, interest a/c will be credited
for Rs.1,000.

Students should also note following fundamental aspects for better

understanding of golden rules of accounting.

1. In real account, when there is an increase in the amount of an asset, such

asset A/c is to be debited and the related account which gets reduced in
amount for the transaction is to be credited.
Example: a firm purchases a computer and pays by cheque for Rs. 40,000,
the entry is the books of the firm would be,

Computer A/c Dr. Rs. 40,000

Bank A/c Cr. Rs. 40,000

2. If the firm purchases the computer on credit from a firm called M/s
Electronic Systems, then,

Computer A/c Dr. Rs. 40,000

Electronic Systems A/c Cr. Rs. 40,000

68
3. When M/s Electronic Systems A/c will be paid off for the price of the
computer purchased, the entry will be,

Electronic Systems A/c Dr. Rs. 40,000

Bank A/c Cr. Rs. 40,000

According to the said rule, all expenses or losses are debited while incomes
and gains are credited. If there is reduction of expenses, expense A/c will
be credited. Similarly, if there is reduction of gains or incomes, income A/c
will be debited.

1. Rules for ascertaining debit and credit may be elaborated for comprehensive
understanding which are stated below:

Rules for ascertaining debit and credit

Personal Accounts
Dr. Cr.
Debtor or receivable Increases Decreases
Creditor or payable Decreases Increases
Real Accounts
Asset Increases Decreases
Liability Decreases Increases
Nominal Accounts
Expense or loss Increases Decreases
Income or gain Decreases Increases

Company ABC paid Rs.1,000 as telephone bill. What will be the accounting entry
in this case?

A Telephone exp. a/c credited by Rs.1,000, company a/c debited by Rs.1,000

B Telephone exp. a/c debited by Rs.1,000, cash a/c credited by Rs.1,000
C Cash a/c debited by Rs.1,000, telephone exp. a/c credited by Rs.1,000
D Cash a/c credited by Rs.1000, company a/c debited by Rs.1000

5. Get introduced to principal books and subsidiary books.

[Learning Outcome e]

5.1 Principal books and subsidiary books

In business, separate registers are maintained for each and every class of
transactions for purchase, sales, receipts and payments of cash.
69
Such registers or books are called ‘books of prime entry‘ or ‘books of original
entry’ or ‘subsidiary books’ as the transactions are recorded there initially.
They are nothing but journals. Ledgers where individual accounts are
maintained are called ‘principal books’ or ‘final books of account’.

Following subsidiary books are commonly maintained in business firms.

Sales day book records credits sales on a daily basis

Purchase day records credit purchases on daily basis
book
Cash book records receipts and disbursements of cash or bank
account transactions on daily basis
Bank receipts day records all receipts of cheques and deposits into banks
book where banking transactions are not recorded in cash
book
Sales return book records return of goods sold. This book is also referred
to as return inward book.
Purchases return records return of goods purchased. This book is also
book referred to as returns outward book

Bills receivable records all receipts of bills, promissory notes

book
Bills payable book records commitments for bills accepted

In insurance business,

Primary books Subsidiary books

o General ledger for o Premium register
premium o Claim payment register
o Claims paid account o Commission register
o Commission account o Cheque dishonor register
o Bank account Etc.
Etc.

5.2 Concepts of capital & revenue expenditure and receipts –

treatment

1. Capital and revenue

Business results can be properly ascertained if proper distinction is made
between capital and revenue transactions.

70
Capital transaction
A capital transaction is one, benefit of which is extended beyond one
accounting period.

Revenue transaction
A revenue transaction is one, benefit of which is exhausted within one
accounting period.

2. Receipt and expenditure

A capital transaction may either be capital receipt or capital expenditure.

Capital receipt
A capital receipt is converted into liability or capital contribution or which
results from disposal of an asset.

Capital expenditure
A capital expenditure gives rise to an item of asset usually enhancing earning
capacity.

Revenue receipt
A revenue receipt can be an income or gain

Revenue expenditure
A revenue expenditure gives rise to an expense

Both capital receipts and capital expenditure appear in the balance sheet while
both revenue receipts and revenue expenditure appear in the profit & loss A/c.

The distinction between capital vs. revenue expenditure and capital vs. revenue
receipts is required for placing the items in the appropriate financial
statements i.e. profit & loss account or Balance sheet. Importantly, capital
expenditure is also ultimately taken into profit & loss account over a period of
its usage life in the form of depreciation.

Sales return book is also known as _______.

A Returns inward book

B Returns indoor book
C Returns outward book
D Returns outdoor book

71
Summary

 Accounting process refers to the process of identifying, measuring,

classifying, recording, summarising, analysing, interpreting and reporting
the financial performance and the financial position of the enterprise
through financial statements.
 Stages of accounting process include journalising transactions, ledger
posting, balancing ledger; preparing trial balance, profit & loss account and
balance sheet.
 Accounting systems are of two types: single entry system and double entry
system.
 Accounts are classified into two main types: personal and impersonal
 Personal accounts can be natural, artificial and representative
 Real accounts can be tangible and intangible
 Nominal accounts include all expenses and losses, incomes and gains
 Golden rules of accounting:
 Personal: debit the receiver and credit the giver
 Real: debit what comes in and credit what goes out
 Nominal: debit all expenses and losses and credit all incomes and gains
 Subsidiary books maintained in business include: sales book, purchase book,
cash book, bank receipts book, sales return book, purchase return book,
bills receivable, bills payable

Answers to Test Yourself

Answer to TY 1

The correct answer is B. The stages of accounting process involve preparation of

trial balance, profit & loss account and balance sheet.

Answer to TY 2

The correct answer is B. In single entry system of accounting, some transactions

are recorded on both sides; some on one side and some transactions are not
recorded at all.

Answer to TY 3

The correct answer is C. Goodwill will be classified under real account.

Answer to TY 4

The correct answer is B. Telephone expenses account will be debited by Rs.

1,000 and cash account will be credited by Rs. 1,000.

72
Answer to TY 5

The correct answer is A. Sales return book is also known as returns inward book.

Self-Examination Questions

Question 1

In bookkeeping, in systematic recording of financial transactions, which is the

first step?

A Journalising transactions with debit and credit

B Balancing of ledger accounts
C Preparation of profit & loss account
D Preparation of balance sheet

Question 2

Company ABC bought goods worth Rs 1000 from Company XYZ on cash. In this
transaction cash will be classified as which type of account?

A Personal account
B Real account
C Nominal account
D Normal account

Question 3

As per the golden rules of accounting, from the below, which one is applicable
to personal accounts?

A Debit all expenses and losses and credit all incomes and gains
B Debit what comes in and credit what goes out
C Debit the receiver and credit the giver
D Debit what goes out and credit what comes in

Question 4

Returns of purchased goods are recorded in which book?

A Returns inward book

B Returns indoor book
C Returns outdoor book
D Returns outward book

73
Question 5
Bank paid interest Rs 1000 to Company XYZ, as interest on bank deposit. In this
case Bank account will be _____ and interest account will be ______ in the
books of Company XYZ
A Debited, credited
B Credited, debited
C Debited, no effect
D Credited, no effect

Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is A. In bookkeeping, in systematic recording of financial
transactions, the first step is journalising transactions with debit and credit.
Answer to SEQ 2
The correct answer is B. Company ABC bought goods worth Rs 1000 from
Company XYZ on cash. In this transaction cash will be classified as real account.
Answer to SEQ 3
The correct answer is C. As per the golden rules of accounting, for personal
accounts – Debit the receiver and credit the giver.
Answer to SEQ 4
The correct answer is D. Returns of purchased goods are recorded in returns
outward book.
Answer to SEQ 5
The correct answer is A. Bank paid interest Rs 1000 to Company XYZ, as interest
on bank deposit. In this case Bank account will be debited and interest account
will be credited in the books of Company XYZ.

74
 CHAPTER 2
ACCOUNTING PROCESS, METHODS, CONTROL AND
FINALISATION OF ACCOUNTS

UNIT-6
ACCOUNTING METHODS, PROCEDURES AND CONTROL
Chapter Introduction

In this unit we will study the methods and procedures through which financial
data and information flow from the source documents to the stage where final
accounts are prepared.

The accounting methods and procedures include:

1. Methods of Journalising
2. Methods of Ledger Posting
3. Methods of Trial Balance Preparation and
4. Methods of Preparation of Final Accounts and Financial Statements.

Thus, to arrive at the final stage of financial accounting, an accountant has to

complete the various stages as mentioned above.

a) Accounting methods.
b) Explain Journals.
c) Explain how Cash Book is prepared.
d) Learn the objectives, rules and process of preparation of the trial balance.
e) Demonstrate the preparation of Final Accounts.

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1. Accounting Methods.
[Learning Outcome a]

Accounting method refers to the rules a company follows in reporting revenues

and expenses. An accounting method is a set of rules used to determine how
and when income and expenses are reported. The entity must consistently use
an accounting method that clearly shows income and expenses for the
accounting period. The entity must use the same accounting method to prepare
the books of accounts.

There are two accounting methods:

1. Cash basis method
2. Accrual basis method

1. Cash basis method

Accounting records prepared using the cash basis recognise income and
expenses according to real time cash flow. Income is recorded upon receipt of
funds rather than based upon when it is actually earned. Expenses are recorded
as they are paid, rather than as they are actually incurred. The actual receipt
and payment of funds is the basis of accounting for income and expenses
respectively. When the income will accrue or expenses will be due for payment
is immaterial in cash basis accounting method. ‘Cash basis’ is generally
practised by small companies and users because it is comparatively easier.

2. Accrual basis method

An entity using ‘accrual basis’ method for accounting recognises both income
and expenses at the time they are earned or incurred, regardless of, when
cash associated with those transactions is received or paid. Under this system,
revenue is recorded when it is earned rather than when payment is received;
expenses are recorded when they are incurred rather than when payment is
made.

The accounting on ‘accrual basis’ is perceived as more precise measure of a

company’s profit and productivity. The accrual method of accounting is
supported under both generally accepted accounting principles (known as GAAP)
as well as international financial reporting standards (known as IFRS).

The accrual method of accounting is more preferred when a more

comprehensive reporting of company’s properties, liabilities and stakeholders’
equity at the termination of an accounting period is required. A more accurate
reporting of a company’s income, expenditure and net income for a precise
time interval, based on monthly, quarterly or yearly basis is required.

76
2. Explain Journals.
[Learning Outcome b]

For recording and analysing business transactions of a financial nature, they are
classified into various types of accounts such as assets, liabilities, capital,
revenue and expenses. These are either debited or credited in accordance with
the ‘golden rules of accounting’ applicable to the specific accounts. Applying
dual aspect, one account is debited and the other account is credited. Every
transaction can be recorded in the journal. This process of recording
transactions in the journal is known as ‘Journalising’.

The journal is the book in which transactions are recorded for the first time. It
is also known as the ‘Book of Original Record’ or ‘Book of Primary Entry’.

The following flow chart shows how journal plays an important role in the
preparation of financial statements.

Journals are prepared in a particular form, as shown below:

JOURNAL
Date Particulars Ledger Folio Debit Credit
Amount Amount

At the end of the journal entry, a narration or an explanation of the entry is

given. Journal entries can be a combination of Debit(s) and Credit(s). But in
both the cases, the total of debits must equal the total of credits.

Example: A firm purchased goods for Rs. 40,000 and made the payment partly in
cash, Rs. 10,000, and the balance by cheque.

The journal entries for this transaction will be as follows:

Date Particulars Ledger Debit Credit

Folio Amount Amount
1.1.2021 Purchase A/c Rs. 40,000
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1.1.2021 To Cash A/c Rs. 10,000
1.1.2021 To Bank A/c Rs. 30,000

(Being goods purchased)

We will discuss the journalising process through more examples for better
understanding.

Example:
Journalise the following transactions in the books of the business started by Mr.
Rajesh in April 2021.
1st April: Mr.Rajesh commenced a stationery business with Cash Rs.1,00,000.
1. 2nd April: he opened a bank account and deposited Rs.80,000.
2. 4th April: he purchased furniture in cash Rs.10,000.
3. 5th April: he purchased a computer for Rs.30,000 and paid by cheque.
4. 7th April: he purchased goods for Rs. 40,000 and paid by cheque.
5. 8th April: he sold goods for cash Rs.5000.
6. 9th April: he deposited Rs 5000 into the bank.
7. 10th April: he sold goods for Rs.10000 to M/s Unique Stationers who made
the payment by cheque which was deposited into the bank immediately.
8. 15th April: he purchased goods worth Rs.50000 on credit from M/S XYZ Ltd.
9. 20th April: he sold goods worth Rs.40000 to M/S P B Stores on credit.
10. 25th April: M/S P B Stores paid Rs 25000 through cheque, which was
deposited into the bank.
11. 26th April: M/S XYZ Ltd was issued a cheque for Rs.30,000 as payment dues.
12. 28th April; he withdrew Rs 15,000 from bank, paid rent Rs 5000 by cheque.
13. 29th April: he paid salary Rs 5000 to his staff by cheque.
14. 30th April: he drew Rs 5000 for personal use.
Pass the necessary journal entries in the books of the business.

Solution:
Journal
In the books of the business of Rajesh (Amount in Rs.)
Date Particulars L Dr Cr
F
01.04.2021 Cash A/c Dr 1,00,000
To Capital A/c 1,00,000
(Being business commenced with cash)
02.04.2021 Bank A/c Dr 80,000
To Cash A/c 80,000
(Being cash deposited into bank)
04.04.2021 Furniture A/c Dr 10,000
To Cash A/c 10,000

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 Date Particulars L Dr Cr
F
(Being furniture purchased)
05.04.2021 Computer A/c Dr 30,000
To Bank A/c 30,000
(Being cheque issued for computer)
07.04.2021 Purchase A/c Dr 40,000
To Bank A/c 40,000
(Being cheque issued for goods)
08.04.2021 Cash A/c Dr 5,000
To Sales A/c 5,000
(Being goods sold on cash)
09.04.2021 Bank A/c Dr 5,000
To Cash A/c 5,000
(Being cash deposited into bank)
10.04.2021 Bank A/c Dr 10,000
To Sales A/c 10,000
(Being cheque for sales deposited)
15.04.2021 Purchase A/c Dr 50,000
To M/S XYZ Ltd A/c 50,000
(Being goods purchased on credit)
20.10.2021 M/S P.B. Stores A/c Dr 40,000
To Sales A/c 40,000
(Being goods sold on credit)
25.10.2021 Bank A/c Dr 25,000
To M/s P. B. Stores 25,000
(Being cheque from debtor deposited)
26.10.2021 XYZ Ltd A/c Dr 30,000
To Bank A/c 30,000
(Being cheque issued to creditor)
28.10.2021 Cash A/c Dr 15,000
To Bank A/c 15,000
(Being cash withdrawn from bank)
28.10.2021 Rent A/c Dr 5,000
To Bank A/c 5,000
(Being rent paid by cheque)
29.10.2021 Salary A/c Dr 5,000
To Bank A/c 5,000
(Being salary paid to staff for Apr 2021)
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 Date Particulars L Dr Cr
F
30.10.2021 Drawings A/c Dr 5,000
To Cash A/c 5,000
(Being cash drawn by proprietor)

In another example, we shall discuss how transactions in a general insurance

business are recorded in journals.

The following transactions took place in May 2021 in the business of Y General
Insurance Co. Ltd.:

1. Premium collected Rs. 10,000 in Fire Dept, Rs. 30,000 in Motor Dept, Rs.
10,000 in Marine Dept
2. Commission accrues on all types of business @ 10%.
3. Commission Rs. 6,000 accrued in April was paid in May, 2021 which includes
Rs. 1,000 for Fire Dept, Rs. 2,000 for Motor Dept, Rs. 1,000 for Marine Dept
and Rs. 2,000 for Misc. dept. 10%TDS on commission was deposited.
4. Fire Claims paid for Rs. 10,000.
5. Marine Claims reported for Rs. 2,00,000.

Solution

In the books of Y General Insurance Co Ltd: Journal

(Amount in Rs.)
Date Particulars LF Dr Cr
May 2021 Bank A/c Dr 50,000
To premium Control A/c 50,000
(Being premium collected in May 2021)

May 2021 Premium Control A/c Dr 50,000

To Fire Premium A/c 10,000
To Motor Premium A/c 30,000
To Marine Premium A/c 10,000
(Being premium collected in May
booked in respective Dept.)
In the books of Y General Insurance Co Ltd: Journal
(Amount in Rs.)
Date Particulars LF Dr Cr
May 2021 Commission on Fire Dr 1,000
Commission on Motor Dr 3,000
Commission on Marine Dr 1,000
To Commn. Control 5,000
(Being commission for May21 booked)
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 May 2021 Commission Control Dr 6,000
To Bank A/c 5,400
To TDS on commn. 600
(Being commission for April’21 paid)

May 2021 TDS on Commission A/c Dr 600

To Bank A/c 600
(Being TDS on Commission deposited)

May 2021 Fire Claims Paid A/c Dr 10,000

To Bank A/c 10,000
(Being fire claims paid)

May 2021 Marine Claims Dr 2,00,000

Outstanding at the End
To Outstanding 2,00,000
Liability for Claims
(Being marine claims reported in May)

Journalising transactions is advantageous to the accountant in the following

ways:

 Transactions are recorded in a chronological order; one can get complete

information about the nature and process and period of transactions
occurred as the entries in the journals are supported by proper narrations.

 Journals facilitate proper posting of entries easily and systematically in

ledger accounts as they provide a basis for posting.

Which of the following statements related to the recording of journal entries is

correct?

A For any given journal entry, credits must exceed debits.

B Usually, credits are recorded on the left side and debits on the right side.
C The chart of accounts discloses the amount taken to the debit and credit of
the affected accounts.
D Journalisation is the process of converting transactions and events into a
debit-credit format.

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3. Explain how Cash book is prepared.
[Learning Outcome c]

Cash transactions are straightway recorded chronologically in the Cash Book. On

the basis of records or entries in the cash book – on Debit and Credit sides for
receipts and payments of cash respectively - the cash book is prepared as a
Ledger Account.

The Cash Book is balanced like other accounts and the net balance is calculated
and placed in the trial balance and final statement of accounts. Though cash
book is a subsidiary book, it serves as Cash Account and Bank Account. Thus,
the Cash Book is both a subsidiary book and a principal book serving the
purpose of both types of books.

A cash book may be either the Main Cash Book or Petty Cash Book.
Diagram 1: Types of Main Cash Book
3.1 Simple Cash Book
It is a single column cash book providing only one amount column on each side.
The left-hand side keeps the records of cash receipts while the right-hand side
amount column records the cash payments. Both the columns are totalled and
the balance is determined. The receipts column (debit side) is always higher
than the payments column (credit side). The excess balance on the debit side is
written on the credit side as ‘By balance c/d’, which is then taken to the Debit
Side as ‘’To Balance b/d” after the total to show the cash balance in hand at
the beginning of the next period. The following illustration will explain the
concept better.

Enter the following transactions that occurred in July 2021 in a simple cash book
maintained by Mr. X for his sole proprietor business:
2021 Rs.
1 Jul Cash in hand 12,000
5 Jul Received from Rahim, a debtor 3,000
8 Jul Sold goods for Cash 3,000
10 Jul Purchased goods for cash from Prakash 2,000
15 Jul Sold goods to Mr. Z on credit 5,000
20 Jul Purchased furniture for cash 10,000
25 Jul Sold goods for cash 12,000
28 Jul Paid rent in cash 1,000
30 Jul Paid salary in cash 1,000
31 Jul Cash withdrawn for personal use 2,000

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Solution

Dr Cash book Cr
Date Particulars LF Amount Date Particulars LF Amount
2021
Jul
1 To Balance 12,000 10 By Purchase 2,000
b/d
5 To Rahim 3,000 20 By Furniture 10,000
8 To Sales 3,000 28 By Rent 1,000
20 To Sales 12,000 30 By Salary 1,000
31 By Drawings 2,000
31 By Balance c/d 14,000
30,000 30,000
2021
Aug
1 To Balance 14,000
b/d

Note: The transaction for 15 July, for sold goods to Mr. Z on credit, Rs. 5000
will not be recorded in the cash book, as no cash transaction has happened.

3.2 Double Column Cash Book

In a double column cash book, both Cash account and Bank account are
prepared simultaneously and the double entry related to cash and bank
transactions is made in the book with a facility for cross verification at any
time, especially for reconciliation of cash and bank transactions.

Following is the format of Double Column Cash Book:

Dr Cash Book Cr
Dt Particulars LF Cash Bank Dt Particulars LF Cash Bank

In this book, chances of errors in respect of banking transactions are reduced to

the minimum. The information regarding Cash in hand and Balance at Bank can
be obtained easily without any separate ledger of a particular bank account. In
double-column Cash Book, the following points must be kept in mind:
1. All receipts are written on the receipts side—Cash in the Cash Column and
Cheques in Bank column. In the particulars column, the name of the account
in respect of which payment has been received is to be entered.

2. All payments are entered on the payment side, cash payment in the cash
column and payment by cheques in the bank column.
83
3. Contra Entries are made for transactions relating to cash withdrawn from
bank for office use and on cash deposited into bank. For cash withdrawn
from bank, the amount is entered in the bank column on the payment side
and in the cash column on the receipt side. Conversely, for cash deposited
into bank, the amount is entered in the bank column on the receipt side and
in the cash column on the payment side. For such contra entries, the letter
“C” should be entered in the L.F column to indicate that these are ‘contra
entries’.

4. Entries for cheques dishonoured are made on the payment side of the bank
column with the name of the related party in the particulars column.

5. Closing Balance of Cash in hand and the Balance at Bank is obtained through
balancing of the Cash Account and Bank Account – which involves
determining the excess of the receipt side over the payment side for both
cash column and bank column.

The following example explains the method of preparation of the double-

column cash book.

In the books of the sole proprietor, Mr. Ramesh, prepare a double column cash
book.

2021 Rs.
1 Aug Cash in hand 22,000
Balance at Bank 25,000
5 Aug Received a cheque from Rahim, a debtor 30,000
6 Aug Cheque deposited into bank
8 Aug Sold goods for Cash 30,000
9 Aug Deposited cash into bank
20,000
10 Aug Purchased goods for cash from Prakash 20,000
15 Aug Sold goods to Mr. Z on credit * 50,000
20 Aug Purchased furniture; paid in cash 10,000
and balance by cheque 20,000
25 Aug Sold goods for cash 12,000
28 Aug Paid rent by cheque 10,000
29 Aug Cash withdrawn from bank
20,000
30 Aug Paid salary in cash 10,000
31 Aug Cash withdrawn for personal use 2,000

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Dr Cash Book Cr
Dt Particulars LF Cash Bank Dt Particulars LF Cash Bank
1 To Balance b/d 22,000 25,000
5 To Rahim A/c 30,000
6 To Cash A/c C 30,000 6 By Cash A/c C 30,000
8 To Sales A/c 30,000
9 To Cash A/c C 20,000 9 By Cash A/c C 20,000
10 By Purchase A/c 20,000
20 By FurnitureA/C 10,000 20,000
25 To Sales A/c 12,000
28 By Rent A/c 10,000
29 To Bank A/c C 20,000 29 By Cash A/c C 20,000
30 By Salary A/c 10,000
31 By Drawings A/c 2,000
31 By Balance c/d 22,000 25,000
1,14,000 75,000 1,14,000 75,000

* 15 Aug: sold goods to Mr. Z on credit – this transaction will not be recorded in
the Cash Book as it is a credit transaction.

Note: in a Cash book, Cash A/c will always have a debit balance but Bank A/c
may have either a debit or a credit balance. Credit balance in a Bank A/c
represents Bank Overdraft.

The following transactions occurred in July 2021 (up to 10th July) in Lucknow
Branch I of Good Luck General Insurance Company. The premium collected for a
day is deposited into the bank the very next day.

Rs.
1 July Cash in hand 22,000
Balance at Bank 4,50,000
2 July Premium Collection (Cash Rs. 20,000 & Cheques Rs. 2,20,000
200,000)
5 July Premium Collection (Cash Rs. 30,000 & Cheques Rs. 4,30,000
400,000)
6 July Premium Collection (Cash Rs. 50,000 & Cheque Rs. 400,000) 4,50,000
7 July Premium Collection (Cash Rs. 40,000 & Cheques Rs. 5,40,000
500,000)
7 July Remittance sent to Head Office 10,00,000
8 July Commission for June disbursed by cheque after deducting 1,44,000
TDS Rs. 16,000
8 July Premium Collection (Cash Rs. 20,000 & Cheques Rs.
500,000) 5,20,000
9 July TDS on Commission deposited 16,000
85
9 July Premium Collection (Cash Rs. 60,000 & Cheques Rs. 5,60,000
500,000)
10 July Remittance sent to Head Office 14,40,000
Premium Collection (Cash Rs 40000 & Cheques Rs 300,000)
3,40,000
Festival Advance paid to staff 15,000
Cash withdrawn from bank 10,000

Prepare the Cash Book and show the closing balance as on 10-07-2021. Verify the
closing balance of the Cash A/c and Bank A/c as on 10-7-2021.

Solution:

Dr Cash Book Cr
Dt Particulars LF Cash Bank Dt Particulars LF Cash Bank
1 To Balance b/d 22,000 4,50,000
2 To Premium 2,20,000
control A/c
5 To Cash A/c C 2,20,000 5 By Bank A/c C 2,20,000
6 To Premium 4,30,000
control A/c
6 To Cash A/c C 4,30,000 6 By Bank A/c C 4,30,000
6 To Premium 4,50,000
control A/c
7 To Cash A/c C 4,50,000 7 By Bank A/c C 4,50,000
7 To Premium 5,40,000 7 By Head Office 10,00,000
control A/c A/c
8 To Cash A/c C 5,40,000 8 By Bank A/c C 5,40,000
8 To Premium 5,20,000 8 By Agency 1,44,000
control A/c Commission A/c
9 To Cash A/c C 5,20,000 9 By Bank A/c C 5,20,000
9 To Premium 5,60,000 9 By TDS on 16,000
control A/c commission A/c
10 To Cash A/c C 5,60,000 10 By Bank A/c C 5,60,000
10 To Premium 3,40,000 10 By Head Office 14,40,000
control A/c A/c
10 To Bank A/c C 10,000 10 By Cash A/c C 10,000
10 By Festival 15,000
Advance A/c
10 By Balance c/d 3,57,000 5,60,000
30,92,000 31,70,000 30,92,000 31,70,000

Note: sometimes in the cash book a short narration is given for every transaction.

3.3 Petty cash book

There could be certain transactions such as payment for postage, local transport
or food and refreshments that may not be paid for by cheque. These payments
have to be made in cash as these are of small amounts. As indicated by the

86
literal meaning of the word ‘petty’ i.e. insignificant or small, petty cash
transactions mean small cash transactions. Petty cash refers to the cash that is
held by the entity for small expenses. The petty cash book has a number of
columns for amount on the payment side. Each of the amount columns is
allotted to specific, common expenses. The last column is allotted for
miscellaneous expenses. At the end of the period, all amount columns are
totalled. The total of the amount paid is deducted from column 1 to calculate
the petty cash balance.

In a double column cash book, contra entries are shown in -

A Cash column
B Bank column
C Both in Cash and Bank column
D Neither Cash nor cheque column

4. Learn the objectives, rules and process of preparation of the trial

balance.
[Learning Outcome d]

Under the double entry system, for every debit entry, there is a corresponding
credit entry of the same amount when we record a transaction for financial
accounting. Consequently, the total amount of all the debit entries should be
equal to the total of all credit entries for any particular period of accounting.

A Trial balance is a book-keeping or accounting report that list the balance in

each of organisation’s journal ledger accounts as on a particular date. The debit
balance amounts are listed in a column with the heading “Debit Balances” and
the credit balance amounts are listed in another column with the heading
“Credit Balances”.

Trial balance is a list of closing balances of ledger accounts on a certain date

and is the first step towards the preparation of financial statements. It is
usually prepared at the end of an accounting period (Monthly/ Quarterly/
Annually) to assist in drafting of financial statements.

Trial balance is prepared with net balances in ledger accounts (i.e. net of Debit
and Credit amounts). Financial statements are prepared on the basis of the trial
balance. Nominal Accounts are taken into Trading and Profit &Loss Account,
while the balances of Personal Accounts and Real Accounts are shown in the
Balance Sheet. Debit Balances of Personal Accounts and Real Accounts are
shown on the Asset Side and Credit Balances of these accounts are shown on the

87
Liability Side of the Balance Sheet. Thus, Trial Balance is the foundation for
financial statements.

The following example will help you to understand the method of preparation of
Trial Balance.

From the following balances of accounts of a sole proprietor business, prepare a

Trial Balance as on 31.3.2021

Rs. Rs.
Purchase of goods 3,10,000 Furniture and fittings 22,000
Sales of goods 4,20,000 Advertising & 10,000
publicity
Discount on sales 20,000 Printing & stationery 10,000
Opening stock 50,000 Motor car 48,000
Cash in hand 2,100 Bad debts 2,000
Cash at bank 12,000 Cash discounts 4,000
Proprietor’s capital 2,88,600 General expenses 14,000
Drawings 4,000 Carriage inwards 22,000
Rent, rates and taxes 5,000 Carriage outwards 10,000
Salaries 32,000 Wages 20,000
Postage and 11,500 Sundry creditors 40,000
telephones
Commission paid to 35,000 Sundry debtors 96,000
salesmen
Insurance premium 9,000

Solution: (Tip – Identify the side (Debit or Credit side) where the particular Account head will appear)
Trial Balance as on 31.03.2021
(Amount in Rs.)
Account head Dr Cr
Purchase of goods 3,10,000
Sales of goods 4,20,000
Discount on sales 20,000
Opening stock 50,000
Cash in hand 2,100
Cash at bank 12,000
Proprietor’s capital 2,88,600
Drawings 4,000
Rent, rates and taxes 5,000
Salaries 32,000
Postage and telephones 11,500
Commission paid to salesmen 35,000
Insurance premium 9,000
Furniture and fittings 22,000
88
 Advertising & publicity 10,000
Printing & stationery 10,000
Motor car 48,000
Bad debts 2,000
Cash discounts 4,000
General expenses 14,000
Carriage inwards 22,000
Carriage outwards 10,000
Wages 20,000
Sundry creditors 40,000
Sundry debtors 96,000
7,48,600 7,48,600

Note: If the totals of the two amount columns of the trial balance do not agree,
it means there may be some mistake in the ledger posting.

A credit balance in which of the following accounts would indicate a likely

error?

A Premium received
B Share capital
C Claims incurred
D Accumulated depreciation

5. Demonstrate the preparation of Final Accounts.

[Learning Outcome e]

Preparation of Final Accounts or Financial Statements is the concluding stage of

financial accounting. Final Accounts include Trading and Profit & Loss Account
and Balance Sheet, which are drawn at the end of the accounting or trading
period to ascertain the trading or operating results and to present the state of
affairs of the business at the end of a year, after adjustment of operating
results including profit or loss during the period.

5.1 The Trading Account

Trading account is a statement showing the calculation of gross profit of

business activities during a specific period. It is a part of the final accounts.
Trading account shows the details of total sales, total purchases and direct
expenses relating to these sales and purchases, opening stock and closing stock.
Only, trading and manufacturing firms prepare this account. It is not prepared
by business people who provide services like insurance.
89
 Trading account
Opening stock 10,000 Sales 1,80,000
Purchases 2,00,000 Closing stock 1,20,000
Factory expenses 40,000
Wages 20,000
Gross profit 30,000
transferred to P/L
Account
Total 3,00,000 3,00,000

5.2 The Profit and Loss Account

The account that shows net profit or net loss of business is called Profit and
Loss account. It is prepared to determine the net profit or net loss of a trader.
Profit and loss account is a component of a final accounts. Example:

Profit & Loss account

Administrative expenses 25,000 Gross Profit transferred 30,000
from Trading account
Other expenses 10,000 Other income 50,000
Net Profit 45,000
Total 80,000 80,000

Net Profit/Net Loss is the difference between the total revenue for a certain
period.

5.3 Profit and Loss appropriation account

It is an extension of P/L account that a firm prepares to show the

distribution/utilisation of profit/loss of the organisation. The amount should not
be confused with the typical profit and loss account but rather seen as an
extension of it as it is made after making Profit and Loss account.

The trading account, profit and loss account and profit and loss appropriation
account are usually prepared together, that is, they are drawn as one account
with three distinct parts – the first part showing the gross profit, the second
part, the net profit and the third part the distribution of profit.

90
Which of the following is NOT debited to the profit and loss account?
A Gross loss
B Net loss
C Salary paid
D Interest on loan

5.4 Balance Sheet

A Balance Sheet is a financial statement that reports summary of company’s

Asset, Liabilities and shareholders’ equity on a particular date and provides a
basis for computing the rate of return and evaluating it’s capital structure (i.e.
debt and equity). It is a financial statement that provides a snapshot of what a
company owns and owes, as well as the amount invested by the shareholders.

The balance sheet adheres to the following accounting equation where assets
are one side and ‘liabilities plus shareholders’ equity’ on the other side.

Assets = Liabilities + Shareholders’ equity

A Balance sheet is also called “Statement of Financial Position”. The balance

sheet in a vertical form shows the sources and application of funds during the
accounting period.

The last stage of final accounts is the balance sheet.

The balance sheet has acquired the status of a highly important accounting
report, because it serves as a valuable source of information to owners and
other stakeholders. It sets out in summary a picture of the financial position of
the business. It provides a reasonable basis for an analytical study for necessary
interpretation and critical examination of the assets and liabilities of the entity
on a particular date.

If balance sheets of two different periods of the same entity is compared, then
the net changes can be easily seen and the use of the statement as a mirror of
results and as a determinant of trading policy is enhanced. From the following
illustrations, you will see how balance sheet is prepared from the trial balance
after preparation of the Trading and Profit& Loss account.

The following examples will help you understand the method of preparation of
Final Accounts.

91
Final accounts can be prepared from the Trial Balance illustrated in the
example given in Learning Outcome 3 along with the following information:

The following adjustments are to be made:

1. Stock on 31st March, 2021 was valued at Rs.1,45,000.

2. The owner has taken out for personal use goods costing Rs. 5,000 out of
purchases during the year.
3. Furniture purchased for Rs. 10,000 was wrongly included in purchases.
4. Rs. 5,000 due from a debtor included in sundry debtors has become bad.
5. Creditors include a balance of Rs. 4,000 to the credit of Mr. Ram in respect
of which it has been settled that only Rs.1,000 is to be paid to him.
6. Provision for bad debts to be created at 5% on sundry debtors.
7. Depreciate furniture and fittings by 10% and motor car by 25%.
8. The salesmen are entitled to a commission of 10% on sales.

Solution: (Tip – As the above adjustments are not appearing in the given Trial Balance,
applying the double entry book keeping principle, they should be reflected in 2 places either in
Trading P/L or Balance sheet)
Trading and Profit & Loss Account For the year
Dr ended 31st March 2021 Cr
Rs. Rs.
To Opening stock 50,000 By Sales 4,20,000
To Purchases 3,10,000 Less: Discount 20,000 4,00,000
Less: Personal use 5,000 By Closing stock1 1,45,000
Less: Furniture 10,000 2,95,000
To Wages 20,000
To Carriage inwards 22,000
To Gross Profit c/d 1,58,000
5,45,000 5,45,000
To Rent, rates and 5,000 By Gross Profit b/d 1,58,000
taxes
To Salaries 32,000 By Discount from 3,000
Creditors
To Postage & 11,500
telephones
To Commission 35,000
Add: Outstanding 5,000 40,000
(10% on Sales 4,00,000)
To Insurance premium 9,000
To Advertising and 10,000
publicity expenses
To Printing and 10,000
stationery
To Bad debts (2,000 + 7,000
5,000)
To cash discounts 4,000
To General expenses 14,000
To Carriage outwards 10,000
To Provision for bad 4,550
debt
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 To Depreciation
Motor car 12,000
Furniture and fittings 3,200 15,200 By Net Loss 11,250
transferred to
Capital A/c
1,72,250 1,72,250

Balance Sheet as at 31st March 2021

Capital and Liabilities Rs. Assets Rs.
Capital Account Fixed Assets
Opening balance 2,88,60 Motor Car 48,000
0
Less: Net loss 11,250 Less: Depreciation 12,000 36,000
25%
277,350 Furniture & fittings 22,000
Less: Drawings (5,000 + 9,000 2,68,350 Add: Addition during 10,000
4,000) year
32,000
Less: Depreciation 3,200 28,800
10%
Current liabilities Current Assets
Sundry Creditors 37,000 Stock in trade 1,45,000
(40,000 – 3,000*)
(4,000-1,000)*
O/s Salesman 5,000 Sundry Debtors 91,000
Commission (96,000 – 5,000)
Less: 5% Provision 4,550 86,450
for bad debts
Cash at Bank 12,000
Cash in hand 2,100
3,10,350 3,10,350

Prepare Trading and Profit & Loss Account and Balance Sheet as at 31st March
2021 from the following trial balance as on 31.3.2021 in the books of Mr X
Agarwal
Trial Balance as on 31.3.2021
(Amount in Rs.)
Particulars Dr Cr
Opening stock 50,000
Purchases 1,25,000
Bills receivable 13,200
Sales 2,60,000
Sales return 2,000
Purchase return 1,200
Discounts 300 250
Carriage outwards 500
Salaries 10,000

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 Insurance 1,200
Rent 3,000
Sundry debtors 45,000
Sundry creditors 20,000
Income-tax 900
Cash and bank 5,000
Furniture and fittings 5,000
Bad debts 2,000
Plant and machinery 80,000
Freight and duty 1,500
Wages 15,000
Provision for bad debts 1,750
Capital 81,400
Drawings 5,000
TOTAL 3,64,600 3,64,600
Additional information
a) Stock on 31st March, 2021 was valued at Rs. 60,000.
b) The provision for bad debts is to be maintained at 5% on sundry debtors.
c) Total bad debts to be written off during the year Rs. 3,200.
d) Outstanding liabilities for Salaries Rs. 2,000 and Wages Rs. 3,000.
e) Rent and insurance paid during the year were for 15 and 18 months
respectively.
 Depreciate Furniture and fittings by 5%, Plant and machinery by 10%.
Solution:
X Agarwal
Trading and Profit & Loss Account for the year ended 31st March 2021

Dr Cr
Rs. Rs.
To Opening stock 50,000 By Sales 2,60,000
To Purchases 1,25,000 Less: Returns 2,000 2,58,000
Less: Returns 1,200 1,23,800 By Closing stock 60,000
To Freight and 1,500
duty
To Wages 15,000
Add: Outstanding 3,000 18,000
To Gross Profit 1,24,700
c/d
3,18,000 3,18,000
To Discount 300 By Gross Profit 1,24,700
Allowed b/d
To Carriage 500 By Discount 250
Outwards Received

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To Salaries 10,000
Add: Outstanding 2,000 12,000
To Insurance 1,200
Less: Prepaid 400 800
(6/18 months)
To Rent 3,000
Less: Prepaid 600 2,400
(3/15 months)
To Provision for 2,190
Bad Debts
(5% on Rs.43,800)
Add: Bad debts 3,200
written off
5,390
Less: Existing 1,750 3,640
Provision
To Depreciation:
Plant & 8,000
Machinery
Furniture & 250 8,250
Fittings
To Net Profit 97,060
transferred to
Capital
1,24,950 1,24,950
X Agarwal
Balance Sheet As At 31st March 2021

Capital and Liabilities Rs. Assets Rs.

Capital Account Fixed Assets
Capital A/c Op 81,400 Plant & 80,000
Balance Machinery
Add: Net Profit 97,060 Less: 8,000 72,000
depreciation 10%
1,78,460 Furniture& 5,000
Fittings
Less: Drawings 5,000 Less: 250 4,750
depreciation 5%
Less: Income tax 900 1,72,560 Current Assets
Current liabilities Stock in trade 60,000
Sundry creditors 20,000 Sundry debtors 45,000
Outstanding Less: Bad debt 1,200
expenses written off Rs.
(3,200 – 2,000)
Wages payable 3,000 43,800
Salaries payable 2,000 5,000 Less: Provision 2,190 41,610
95
 for bad debts
(5% on 43,800)
Bills Receivable 13,200
Cash and Bank 5,000
Prepaid Expenses
Insurance 400
Rent 600 1,000
1,97,560 1,97,560

Which of the following is not an element of the balance sheet?

A Income
B Assets
C Liabilities
D Equity

Summary

 A journal is a book of accounts in which all day-to-day transactions are

recorded in the order of their occurrence.
 Do not confuse a journal entry and a journal (i.e. journal proper). A journal
entry is a way of recording a transaction in a debit / credit form. A journal
proper is a book of special transactions, which are not otherwise recorded in
the books of prime entry. These are generally the adjustment entries such
as provisions for doubtful debts, income receivable, expense payable etc.
 The Cash Book records all transactions related to receipts and payments
made in cash only.
 The Cash Book itself is a Cash Account, and hence, no separate cash account
will be maintained in the ledger.
 When there is a transaction that relates to both cash and bank, this will be
written on one side of the Bank Column and on other side of the Cash
Column. Such transactions are known as ‘Contra entries’.
 A separate cash book to record small transactions is called a petty cash
book.
 The Trial Balance may be defined as a statement containing balances of all
ledger accounts on a particular date.
 The Trial Balance helps to determine the arithmetical accuracy of posting in
the ledger.
 Final Accounts (Financial statements) are the statements that are prepared
at the end of the accounting period, which is generally one year. These
include the income statement i.e. Trading and Profit & Loss Account, Profit
and Loss appropriation account and Balance Sheet.

96
  Trading Account is prepared to ascertain the results, gross profit or gross
loss, of the trading activities of the business.
 Profit and Loss Account is prepared to find out the Net Profit/Net Loss.
 Profit and loss appropriation account is prepared to show the
distribution/utilisation of the profit.
 Balance Sheet is prepared to ascertain the financial position of a firm on
a particular date.

Answers to Test Yourself

Answer to TY 1
The correct option is D. Journalisation is the process of converting transactions
to their debit / credit form and recording them in the general journal. Option A
is incorrect because for any given journal entry, whether single or compound,
debits must equal credits. Option B is incorrect because traditionally, debits are
recorded on the left side and credits on the right side. Option C is incorrect
because the chart of accounts is a listing of accounts in use (and their
corresponding reference number).

Answer to TY 2
The correct option is C. Contra entries are shown in both ‘Cash’ and ‘Bank’
columns.

Answer to TY 3
The correct option is C. Claims incurred are expenses and should have debit
balance.

Answer to TY 4
The correct option is B. Net loss will be recorded on the credit side of the P&L
A/c as it indicates excess of expenses over income.

Answer to TY 5
The correct option is A. Income is an element of profit and loss account. All
other items are elements of the balance sheet.

Self Examination Questions

Question 1
A contra entry in the cashbook would include:
A Totalling up the bank and cash columns at the end of each month
B Transferring the discounts to the accounts in the general ledger
C Transferring cash into the petty cash box
D Withdrawing cash from the bank account

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Question 2
The amount of cash discount allowed on a transaction will initially be recorded
in the:
A Sales day book
B Sales invoice only
C Cash book (receipts side)
D Cash book (payment side)

Question 3
A transaction which does not involve payroll, cash or credit is likely to be
recorded in:
A The journal
B The purchase day book
C The cash book
D The petty cash book

Question 4
Which of the following items would appear in the trial balance as a credit
balance?
A Carriage inwards
B Carriage outwards
C Returns inwards
D Returns outwards

Question 5
Which of the following errors will not affect the arithmetical accuracy of the
Trial Balance?
A Wrong balancing of an account
B Writing an amount in the wrong account but on the correct side
C Wrong totalling of an account
D None of the above

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is D. Contra entries are:
1. Cash deposited into the bank account
2. Cash withdrawn from the bank account
Answer to SEQ 2
The correct option is C. The amount of cash discount allowed on a transaction
will initially be recorded in the discount column on the receipts side of the cash
book.
Answer to SEQ 3
The correct option is A. A transaction which does not involve payroll, cash or
credit is likely to be recorded in the journal.
98
Answer to SEQ 4
The correct option is D. Return outwards i.e. purchase returns (reduction in
purchases) would appear in the trial balance as a credit balance. All other items
are expenses and hence will have a debit balance.
Answer to SEQ 5
The correct option is B. Writing an amount in the wrong account but on the
correct side will not affect the arithmetical accuracy of the Trial Balance.

99
 CHAPTER 2
ACCOUNTING PROCESS, METHODS, CONTROL AND
FINALISATION OF ACCOUNTS

UNIT-7
DEPRECIATION ACCOUNTING
Chapter Introduction
Value of a fixed asset decreases over a period with its use. The portion of fixed
asset utilised for generating revenue during the accounting year should be
considered as an element of cost of production and charged as an expenses of
the same period.

This allocation of portion of fixed assets is the concept of depreciation, which

will be discussed in detail with in this unit. We will also study in detail about
the concept of depreciation, causes and nature of depreciation, methods of
depreciations and accounting treatment of depreciation, provisions for
depreciations under the Companies Act 2013.

a) Define depreciation and understand its objectives

b) Learn about the methods of providing for depreciation
c) Understand the impact of change in the method of depreciation
d) Know about disposal of depreciable assets and its accounting treatment
e) Understand the methods of revaluation of depreciable assets
f) Learn about depreciation accounting under the Companies Act 2013
g) Understand the changes between the Companies Act 1956 and the Act 2013 in
respect of Depreciation
h) Learn about depreciation accounting under AS 6 and under the Companies Act
2013

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1. Define depreciation and understand its objectives
[Learning Outcome a]

1.1 Introduction

Capital expenditures in the form and nature of fixed assets give benefits for
many years in the process of production, trade and commerce. Fixed assets are
utilized over a number of accounting periods. Value of fixed asset decreases
with the its use and with passage of time. So the portion of fixed asset/ capital
expenditure utilized for generating revenue during the accounting year should
be recovered and considered as element of cost of production and accounted as
an expense of the same period.

Depreciation is also an expense like repair and maintenance and must be

debited to profit and loss account to ascertain the correct profit or loss of the
business for the period.

This allocation of portion of fixed assets is the concept of depreciation, which

will be discussed in detail with in this unit. The objective of this lesson is to
make students understand the meaning, causes and nature of depreciation,
methods of depreciations and accounting treatment of depreciation, provisions
for depreciations under the Companies Act, 2013.

1.2 Definition of Depreciation

The Institute of Charted Accountants of India has defined depreciation as “a

measure of the wearing out, consumption or other loss of value of a depreciable
asset arising from use, effluxion of time or obsolescence through technology and
market changes. Depreciation is allocated so as to charge a fair proportion of
depreciable amount in each accounting period during the expected useful life of
the asset. Depreciation includes amortisation of assets whose useful life is
predetermined.”

The Companies Act 2013 in the Schedule II has defined depreciation as “the
systematic allocation of the depreciable amount of an asset over its useful life.
The depreciable amount of an asset is the cost of an asset or other amount
substituted for cost, less its residual value. The useful life of an asset is the
period over which an asset is expected to be available for use by an entity, or
the number of production or similar units expected to be obtained from the
asset by the entity. For the purpose of this Schedule, the term depreciation
includes amortisation.

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Thus, depreciation is a process of allocating the cost of a fixed asset over its
estimated useful life in a rational and systematic manner.

1.3 Causes of Depreciation

a) Physical wear and tear caused due to constant use, strain, weathering,
intensity of use, chemical reaction, handling etc.
b) Physical deterioration resulting from atmospheric exposure
c) Passage of time and aging of asset even without use thereof
d) Depletion of assets (such as mines) due to continuous extraction
e) Obsolescence due to technical changes and technical progress in industries
f) Changes in tastes and habits of consumers

1.4 Objectives of providing for depreciation

The main objective is to allocate the used up cost of an asset in the

accounting periods in which the services of the said asset are utilized. This will
ensure recovery of the cost of the asset over its useful life from the profit
earned treating it as a part of cost of business operation.

To sum up, we enumerate the objects of providing for depreciation in the

following points.

a) To ascertain the correct cost of production of goods and services

b) To ascertain the correct profit by way of deducting cost of use of asset
c) To show assets at their proper values. If depreciation is not provided, the
assets will be overstated.
d) To make provision for replacement of assets: Depreciation is a non-cash
expense, the amount charged is kept separately as fund basis and invested
and the particular fund with return of investment is utilized for the
replacement of the fixed asset after the expiry of the useful life of the
asset.
e) To maintain the capital invested in fixed assets intact in the business so that
it can be reinvested in profit earning process.
f) To derive maximum tax benefit
g) To meet the legal requirements as specified by the Companies Act 2013,
Accounting Standards AS 6 or Ind AS 16.
h) To ensure payment of dividends only out of profits, but not out of capital.

1.5 Nature of Depreciable Assets and Depreciation Accounting

Definitions provided in AS 6 are given here to know the views of ICAI which is
the regulatory body in our country for regulation of the profession of
accountancy.

102
a) “Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, effluxion of time or
obsolescence through technology and market changes. Depreciation is
allocated so as to charge a fair portion of the depreciable amount in each
accounting period during the expected useful life of the asset. Depreciation
includes amortisation of assets whose useful life is predetermined.”

b) “Depreciable assets are assets which are expected to be used during more
than one accounting period; and have a limited useful life; and are held by
an enterprise for use in the production or supply of goods and services, for
rental to others, or for administrative purposes and not for the purpose of
sale in the ordinary course of business.”

c) “Useful life is either (i) the period over which a depreciable asset is
expected to be used by the enterprise; or (ii) the number of production or
similar units expected to be obtained from the use of the asset by the
enterprise.”

d) “Depreciable amount of a depreciable asset is its historical cost, or other

amount substituted for historical cost in the financial statement, less the
estimated residual value.”

To conclude this lesson, let us reiterate that depreciation is an inevitable

constituent of revenue expenditure forming cost of operation of any business
where Fixed Assets are utilized for running such business organization.
Depreciation accounting thus deals with different aspects of providing for
depreciation including policy, methods, rates and of course, the ultimate action
for bringing it into accounts of any business organisation.

In accordance with AS 6, which of the following assets does not fit into the
definition of a depreciable asset?
A Land
B Machinery
C Building
D Coal mine

2. Learn about the methods of providing for depreciation

[Learning Outcome b]

Methods of providing for depreciation

As per the ‘Explanation’ to AS 6, ‘Assessment of depreciation and the amount

to be charged in respect thereof in an accounting period are usually based on
the following three factors:
103
a) Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued;
b) Expected useful life of the depreciable asset; and
c) Estimated residual value of the depreciable asset’

At least 4 steps emanate from the explanation as quoted above to determine

the amount of depreciation in respect of a particular asset for a particular
accounting period. These are:

i) Determination of the historical cost of the asset that will include

o cost of acquisition,
o cost of installation,
o cost of commissioning till the asset is put to use and
o other costs related to additions or improvement of the asset.

ii) Making an estimate of the salvage or scrap or resale value of the asset at the
end of the useful life that depends on a number of factors. Experience plays a
vital role in this matter as the nature of the asset, its use and market situation
of scrap are to be considered too.

iii) The next step is the determination of the difference between historical cost
as clarified earlier and the estimated salvage value.

iv) The last step is the distribution of this difference over the period of its
useful life by a method that will suit the requirement of the business as per the
decision of the Management. However, statutory requirements are to be kept in
mind also such as the provisions of Companies Act, 2013 and The Income Tax
Act, 1961 as amended and others, if any.

There are several methods of providing for depreciation. We mention the

methods below:

1. Straight Line / Fixed Instalment Method,

2. Diminishing Balance / Reducing Balance method,
3. Depletion Method,
4. Annuity Method,
5. Depreciation Fund / Sinking Fund Method,
6. Revaluation Method,
7. Insurance Policy Method and
8. Machine Hour Rate Method.

First two methods are very common in practice and are used by majority of the
entities, while others are employed in special circumstances.

104
Depreciation is expressed as a rate percent per annum. Depreciation is provided
as per the depreciation policy framed by the entity.

There are 2 methods by which assets are shown in the books.

1. The assets is shown at its historical cost in the Asset side of Balance
sheet; and the depreciation charged every year is accumulated and
shown as a Liability as ‘Provision for depreciation / Depreciation
fund’ account.

2. The historical cost of asset is reduced every year by the amount

charged as depreciation and the net value called ‘Written Down
Value (WDV) is shown as an asset in the Balance sheet.

Journal Entries for Depreciation Accounting:

Purchase of asset:
Asset Dr. 10,000
Bank Cr. 10,000

Method 1: Depreciation entry

Depreciation Dr. 500
Provision for depreciation Cr. 500

Balance Sheet
LIABILITY SIDE ASSET SIDE
Accumulated depreciation 500 Asset 10,000

Method 2: Depreciation entry

Depreciation Dr. 500
Asset Cr. 500

Balance Sheet
LIABILITY SIDE ASSET SIDE
Asset (WDV) 9,500

a) Entry for sale/disposal of asset:

Working: Profit/Loss on Sale of Asset

Particulars Amount Rs.

Cost Price of the Asset 10,000
Less: Accumulated Depreciation on the date of disposal 8,000
105
A: Value of the Asset  WDV on the date of sale 2,000
B: Sale Price 3,000
C: Profit on Sale of Asset 1,000

If sale price is less the WDV, then there will be a loss. In case, the asset was
sold for 1,500, then the loss would be 2,000 – 1,500 = 500.

2.1 Straight Line Method

Depreciation is arrived at by deducting salvage value from the historical cost

and then dividing the difference thus determined by the number of years of
useful life.

Historical cost – Scrap value

Depreciation = ------------------------------------
No. of years of useful life

It can also be expressed as a percentage per annum of the historical cost.

Depreciation
Rate of depreciation = ------------------------- x 100
Historical cost

One major shortcoming in this method is depreciation is uniform amount

throughout the life of the asset, as an asset will be depreciated more as the
year passes. Hence, this method is not suitable for exhausting assets like Plant
& Machinery, Vehicles etc. It is suitable for assets like Furniture & Fixture etc.

A machine purchased for Rs.60,000 on 01.04.2015 is expected to have a life of 5

years. Estimated salvage/scrap value after the expiry of 5 years is Rs. 10,000.
Depreciation is considered under Straight Line Method.

Show necessary accounts.

a) If the Asset account is maintained at written down value

Machine Account
Dr. Cr.
Date Particulars RS. Date Particulars RS.
01.04.2015 To Bank A/c 60,000 31.03.2016 By Depreciation A/c 10,000
31.03.2016 By Balance b/d 50,000
Total 60,000 Total 60,000
01.04.2016 To Balance b/d 50,000 31.03.2017 By Depreciation A/c 10,000
31.03.2017 By Balance c/d 40,000
Total 50,000 Total 50,000

106
 01.04.2017 To Balance b/d 40,000 31.03.2018 By Depreciation A/c 10,000
31.03.2018 By Balance c/d 30,000
Total 40,000 Total 40,000
01.04.2018 To Balance b/d 30,000 31.03.2019 By Depreciation A/c 10,000
31.03.2019 By Balance c/d 20,000
Total 30,000 Total 30,000
01.04.2019 To Balance b/d 20,000 31.03.2020 By Depreciation A/c 10,000
By Bank A/c – Sale
proceeds of Salvage
31.03.2020 10,000
Total 20,000 Total 20,000

Depreciation Account
Dr. Cr.
Date Particulars RS. Date Particulars RS.

31.03.2016 To Machine A/c 10,000 31.03.2016 By Profit & Loss A/c 10,000
31.03.2017 To Machine A/c 10,000 31.03.2017 By Profit and Loss A/c 10,000
31.03.2018 To Machine A/c 10,000 31.03.2018 By Profit and Loss A/c 10,000
31.03.2019 To Machine A/c 10,000 31.03.2019 By Profit and Loss A/c 10,000
31.03.2020 To Machine A/c 10,000 31.03.2020 By Profit and Loss A/c 10,000

b) If the Asset account is maintained at historical cost

Machine Account
Dr. Cr.
Date Particulars RS. Date Particulars RS.
01.04.2015 To Bank A/c 60,000 31.03.2016 By Balance c/d 60,000
01.04.2016 To Balance b/d 60,000 31.03.2017 By Balance c/d 60,000
01.04.2017 To Balance b/d 60,000 31.03.2018 By Balance c/d 60,000
01.04.2018 To Balance b/d 60,000 31.03.2019 By Balance c/d 60,000
31.03.2020 By Provision for 50,000
Depreciation
01.04.2019 To Balance b/d 60,000 By Bank Account 10,000
60,000 31.03.2020 60,000

Provision for Depreciation Account

Dr. Cr.
Date Particulars RS. Date Particulars RS.

31.03.2016 To Balance c/d 10,000 31.03.2016 By Depreciation 10,000

01.04.2016 By Balance b/d 10,000
31.03.2017 To Balance c/d 20,000 31.03.2017 By Depreciation 10,000
20,000 20,000
01.04.2017 By Balance b/d 20,000
31.03.2018 To Balance c/d 30,000 31.03.2018 By Depreciation 10,000
30,000 30,000

107
 01.04.2018 By Balance b/d 30,000
31.03.2019 To Balance c/d 40,000 31.03.2019 By Depreciation 10,000
40,000 40,000
01.04.2019 By Balance b/d 40,000
31.03.2020 ToMachine A/c 50,000 31.03.2020 By Depreciation 10,000
50,000 50,000

Workings:

60,000 – 10,000
i) Depreciation = ------------------------ = Rs.10,000
5
10,000
ii) Rate of Depreciation = ------------- x 100 = 16.66% p.a.
60,000

2.2 Diminishing Balance Method

This method is widely used in commercial organizations. Like any other method,
it has its merits and limitations also. However this system is more equitable
than Straight Line Method. Since the amount of depreciation goes on decreasing
with the amount of repairs increasing, the as expenses turns to be a balanced
every year. It is calculated on the cost of the assets as reduced by the amount
of annual depreciation or in other words, on written down value (WDV) and not
on the historical original cost as in the case of Straight Line Method.
Depreciation under this method is expressed as a rate percent per annum on the
WDV of the asset.

This method is useful in the cases of exhausting and costly assets like Plant and
Machinery, Electronic Equipments etc.

Example: A machine purchased for Rs.30,000 on 01.04.2017 depreciates at 10%

p.a. under Diminishing Balance method. Write up the necessary accounts for 3
years.
Machine Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
Rs. Rs.
01.04.2017 To Bank A/c 30,000 31.03.2018 By Depreciation A/c 3,000
31.03.2018 By Balance c/d 27,000
Total 30,000 Total 30,000
01.04.2018 To Balance b/d 27,000 31.03.2019 By Depreciation A/c 2,700
31.03.2019 By Balance c/d 24,300
Total 27,000 Total 27,000
01.04.2019 To Balance b/d 24,300 31.03.2020 By Depreciation A/c 2,430
31.03.2020 By Balance c/d 21,870
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 Total 24,300 Total 24,300

As done in Straight Line Method, ‘Provision for Depreciation Account’ can be

maintained alternatively which is not repeated for the sake of brevity.

2.3 Depletion Method

This method is also known as ‘Unit Charging Method’ or ‘Output Method’.
Usually this method is applied in the case of assets of wasting nature as well as
to intangible assets like patents, copyrights and leaseholds etc. Rate of
depreciation per unit is determined by dividing ‘total cost’ by ‘expected
number of output’. Annual depreciation is obtained by multiplying the ‘output
in number of units’ by ‘rate per unit’.

2.4 Annuity Method

This method takes into account the opportunity cost of interest, had the
monetary outlay in the asset been invested elsewhere. This is, to some extent,
a variation of Straight Line Method with consideration for interest that could be
earned on the investment made in the asset. The asset is debited with the
amount of interest on the diminishing value of the asset and amount of
depreciation is ascertained with reference to present value of the capital
investment or the original cost of the asset usually with the help of Logarithmic
Table. A formula also is there for such ascertainment. This method is useful for
long-term leases.

2.5 Depreciation Fund / Sinking Fund Method

This is a very important method specifically in respect of Plant & Machinery of
very high value where replacement of is desired at the end of its effective life
in order to keep liquidity position of fund in good position. An equal amount of
depreciation that is computed either with the help of Annuity Table or
Logarithm Table is credited to Depreciation Fund/Sinking Fund instead of Asset
Account by debiting Depreciation Account or Profit & Loss Account direct.

Equal amount is invested in interest earning securities in such a manner that the
annual investment together with compound interest becomes equal to the
original cost of the asset. At the end of the useful life of the asset, this
earmarked investment is sold for replacing the asset.

2.6 Revaluation Method

This method is selected in the case of assets in respect of which usual
depreciation is not applied such as Loose Tools, Livestock etc. It is resorted to
by Printing Press and similar business concerns. Revaluation is done both at the
beginning and at the close of the accounting period. Difference thus arrived is
written off as depreciation through Profit & Loss Account.

109
2.7 Insurance Policy Method
It resembles Depreciation Fund Method with the major difference that annual
investment is made by contribution to an Insurance Policy as premium instead
of investment in securities. The policy is made usually for a period equal to the
useful life of the asset and for a sum assured that is expected to provide fund
for replacement of the asset. If annual interest is desired to be accounted for,
surrender value of the policy at the particular year-end is referred to. This is
adopted in the cases of vehicles for the uncertainty of their useful lives.

2.8 Machine Hour Rate Method

This method is chosen for machines where productivity is relevant in their
performance and in the case of machines with high cost. Depreciation is
charged on the basis of number of hours for which any particular machine is
utilized in the production process. It has got a similarity with the ‘Depletion
Method’ as depreciation is charged based not on time but on utilization; that is
volume of production. Rate per hour is calculated by dividing the historical
original cost after deducting salvage value by the expected total number of
hours of the effective/useful life of the asset.

If the equipment account has a balance of Rs. 45,000 and its accumulated
depreciation account has a balance of Rs. 28,000, the book value of the
equipment will be:
A Rs. 45,000
B Rs. 28,000
C Rs. 17,000
D Rs. 73,000

3. Understand the impact of change in the method of depreciation

[Learning Outcome c]

Impact of change in the method of depreciation

This is a very important aspect of depreciation accounting. The moot point is

whether any business organization is at liberty to switch over from one method
of depreciation to another method at its own discretion and whenever it likes.
Answer to this point and other incidental matters connected with change in the
method of depreciation have been dealt with by Accounting Standard 6 (AS 6)
issued by The Institute of Chartered Accountants of India. The relevant
guidelines are quoted herein.

110
‘The method of depreciation is applied consistently to provide comparability of
the results of the operations of the enterprise from period to period. A change
from one method of providing depreciation to another is made only if the
adoption of the new method is required by statute or for compliance with an
accounting standard or if it is considered that the change would result in a more
appropriate preparation or presentation of the financial statements of the
enterprise.

When such a change in the method of depreciation is made,

1. Depreciation is recalculated in accordance with the new method from the
date of the asset coming into use.
2. The deficiency or surplus arising from retrospective recomputation of
depreciation according with the new method is adjusted in the accounts in
the year in which the method of depreciation is changed.
3. In case the change in the method results in deficiency in depreciation in
respect of past years, the deficiency is charged in the statement of profit
and loss.
4. In case the change in the results in surplus, the surplus is credited to the
statement of profit and loss. Such a change is treated as a change in
accounting policy and its effect is quantified and disclosed.’

The above stated guidelines leave no ambiguity as to when and how to effect
any change in the method of depreciation. It is, hence, necessary to implement
any change in the method of depreciation with retrospective effect. Evidently,
the difference between depreciation under existing method and the changed
method will have to be ascertained and necessary entries have to be
incorporated also. The example given below will make the position clear.

A firm purchased on 01.04.2014 certain machinery for Rs.1,16,400 and spent

Rs.3,600 on its erection. On 01.10.2014, additional machinery costing Rs.40,000
was purchased. On 1st October 2016, the machinery purchased on 01.04.2014
having become obsolete was auctioned for Rs.57,200 and on the same date,
fresh machinery was purchased at a cost of Rs.80,000.

Depreciation was provided annually on 31st March every year @ 10% p.a. on
WDV. In 2017-18, however, the firm changed this method of providing
depreciation and adopted the method of providing 5% depreciation p.a. on the
original cost of the machinery. Prepare the Machinery Account as it would stand
at the end of each year from 2014-15 to 2017-18.

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 Machine Account
Dr. Cr.
Date Particulars RS. Date Particulars RS.

01.04.2014 To Bank A/c 1,16,400 31.03.2015 By Depreciation 14,000

01.04.2014 To Bank A/c 3,600
01.10.2014 To Bank A/C 40,000 31.03.2015 By balance c/d 1,46,000
1,60,000 1,60,000
01.04.2015 To Balanceb/d 1,46,000 31.03.2016 By Depreciation 14,600
31.03.2016 By Balance c/d 1,31,400
1,46,000 1,46,000
01.04.2016 To Balanceb/d 1,31,400 01.10.2016 By Depr. On 1st 4,860
01.10.2016 To Bank A/c 80,000 Machine
By Bank A/c 57,200
01.10.2016 By Loss on Sale 35,140
31.03.2017 By Depreciation 7,420
31.03.2017 By Balance c/d 1,06,780
2,11,400 31.03.2017 2,11,400
01.04.2017 ToBalance b/d 106780 31.03.2018 By Depreciation 6,000
To Excess 5% of (40000 +
depreciation 80000)
written Back 6,220 31.03.2018 By Balance c/d 1,07,000
1,13,000 1,13,000

Workings
a) Calculation of Depreciation @ 10% p.a. on Diminishing Balance method and
Loss on sale of Machinery

Particulars Machine I Machine II Machine III

Rs. Rs. Rs.
Cost 01.04.2014 1,20,000
Cost 01.10.2014 40,000
Depreciation for 2014-15 12,000 2,000
WDV as on 31.03.2015 1,08,000 38,000
Depreciation for 2015-16 10,800 3,800
WDV as on 31.03.2016 97,200 34,200
Cost 01.10.2016 80,000
Depreciation for 2016-17 4,860 3,420 4,000
WDV as on 1.10.16 92,340
Sale Proceeds 57,200 - -
Loss on sale of Machine I 35,140
WDV as on 31.03.2017 30,780 76,000

b) Calculation of Depreciation @ 5% p.a. on Straight Line Method and WDV

thereof

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Particulars Machine II Machine III
Rs. Rs.
Cost 40,000 80,000
Depreciation – Machine II for 2 ½ years 5,000 ---
Depreciation – Machine III for ½ year --- 2,000
WDV as on 31.03.2017 35,000 78,000

c) Amount to be written back to Profit & Loss Account to restore the WDV of
two machines as on 31.03.2017 based on Depreciation @ 5% p.a. on Straight Line
method.

WDV as on 31.03.2017 as per S L method (35,000+78,000) Rs.1,13,000

Less: WDV on 31.03.2017 as per WDV method (30,780+76,000) Rs.1,06,780
Rs. 6,220

The deficiency / surplus arising from retrospective recomputation of

depreciation according with the new method is adjusted in the accounts
__________.

A. In the year of change of depreciation method

B. Retrospectively from the date of change relates to
C. Deferred prospectively over a period of 5 years
D. None of the above

4. Know about disposal of depreciable assets and accounting

treatment [Learning Outcome d]

4.1 Disposal of depreciable assets and accounting treatment

Disposal of depreciable assets means sale, removal, destruction or exchange of

any particular asset usually when the usefulness of the said asset ceases. It is
sold as an item of salvage or scrap. Sometimes, it may be exchanged for a part
of the cost with payment for remaining cost.

AS 6 issued by ICAI provides for requirement of disclosure of certain information

in the financial statement. Relevant paragraph is quoted herein.

‘Where depreciable assets are disposed of, discarded, demolished or

destructed, the net surplus or deficiency, if material, is disclosed separately.’

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Let us assume the book value of an asset as Rs. 10,000 and its accumulated
depreciation as Rs. 8,000. Let’s analyse the scenarios if the asset is sold for i)
Rs. 4,000 ii) Rs. 1,000 or iii) Rs. 2,000. The journal entries would be:

Case 1 – Rs. 4,000:

Asset a/c Cr. 10,000
Depreciation fund a/c Dr. 8,000
Bank a/c Dr. 4,000
Profit on sale of asset Cr. 2,000

Case 2 – Rs. 1,000:

Asset a/c Cr. 10,000
Depreciation fund a/c Dr. 8,000
Bank a/c Dr. 1,000
Loss on sale of asset Cr. 1,000

Case 3 – Rs. 2,000:

Asset a/c Cr. 10,000
Depreciation fund a/c Dr. 8,000
Bank a/c Dr. 2,000

Sanjay bought a machine for Rs. 12,750. He paid for the new machine by taking
out a loan of Rs. 8,000 and trading in his old machine. The old car originally
cost Rs. 8,500 and had been depreciated by Rs. 4,148 at the time of the trade
in. What is the gain on disposal of the old machine?
A Rs.398
B Rs.102
C Rs. 648
D Rs.500

5. Learn depreciation accounting under the Companies Act 2013

[Learning Outcome e]

5.1 Depreciation Accounting under the Companies Act 2013

Sec. 123 of the Companies Act 2013 provides that “no dividend shall be declared
or paid by a company for any financial year except (a) out of the profits of the
company for that year arrived at after providing for depreciation in accordance
with the provisions of sub-section (2), or out of the profits of the company for
any previous financial year or years arrived at after providing for depreciation in

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accordance with the provisions of that sub-section and remaining undistributed,
or out of both..”

Again Sub-sec 2 Section 123 of the Companies Act 2013 further provides that
depreciation shall be provided in accordance with the provisions of Schedule II
of the Companies Act 2013. The extract of Schedule II which provides the basis
of depreciation accounting has been furnished hereinafter for dealing with the
accounting treatment of depreciation for companies.

Method of providing depreciation and accounting treatment has been changed

by the Companies Act, 2013. Now depreciation is required to be provided on the
basis of useful life of asset as per provisions of the Schedule-II of the Companies
Act, 2013. Schedule-II of the Companies Act, 2013 has prescribed the useful life
of individual assets for the purpose of depreciation on fixed asset. The
Companies Act, 2013 has introduced a Component approach for accounting of
depreciation as envisaged in Ind-AS 16 “Property, Plant and Equipment” which
was required by the Companies Act, 1956. All aspects of the new method of
depreciation and accounting treatment as required by the Companies Act 2013
and its Schedule-II cannot be discussed here.

Only few legal requirements are being discussed. The interested students and
readers may go through the provisions of Schedule II of the Companies Act 2013
and Ind-AS 16 for better understanding of Legal Aspects of new method of
Depreciation Accounting.

Extract of Schedule II of the Companies Act 2013

PART “A”

1. Depreciation is the systematic allocation of the depreciable amount of an

asset over its useful life. The depreciable amount of an asset is the cost of
an asset or other amount substituted for cost, less its residual value. The
useful life of an asset is the period over which an asset is expected to be
available for use by an entity, or the number of production or similar units
expected to be obtained from the asset by the entity.

2. For the purpose of this Schedule, the term depreciation includes

amortisation.

3. Without prejudice to the foregoing provisions of paragraph 1,—

(i) In case of such class of companies, as may be prescribed and whose

financial statements comply with the accounting standards prescribed
for such class of companies under section 133 the useful life of an asset
shall not normally be different from the useful life and the residual
value shall not be different from that as indicated in Part C, provided
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 that if such a company uses a useful life or residual value which is
different from the useful life or residual value indicated therein, it shall
disclose the justification for the same.

(ii) In respect of other companies the useful life of an asset shall not be
longer than the useful life and the residual value shall not be higher than
that prescribed in Part C.

(iii) For intangible assets, the provisions of the Accounting Standards

mentioned under sub-para (i) or (ii), as applicable, shall apply.

PART ‘B’

4. The useful life or residual value of any specific asset, as notified for
accounting purposes by a Regulatory Authority constituted under an Act of
Parliament or by the Central Government shall be applied in calculating the
depreciation to be provided for such asset irrespective of the requirements
of this Schedule.

6. Computation of Depreciation under the provisions of the Companies Act

2013

For the purpose of computation of depreciation under the provisions of the

Companies Act 2013 the following terminologies used in the Schedule II to the
Act 2013 must be properly understood

i. Asset Cost: the original value of your asset or the depreciable cost; the
necessary amount expended to get an asset ready for its intended use
ii. Salvage Value: The value of the asset at the end of its useful life; also
known as residual value or scrap value
iii. Useful Life: The expected time that the asset will be productive for its
expected purpose
iv. Placed in Service: Select the month and enter the year the asset started
being used for its intended purpose

A Ltd purchased a machinery for Rs. 11,00,000 on 1st August 2013. The useful
life of the machinery is 5 years and the salvage value of the same is Rs 100000.
Calculate Depreciation to be charged to the statement of Profit & Loss of the
company for the financial years 2013-14, 2014-15 and 2015-16 and show the
Depreciation Schedule for the entire period of useful life of the machine
keeping in view the provisions of the Companies Act 2013 and the schedule II to
the Companies Act.

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Solution

Depreciation Calculation Process:

The depreciation of an asset is spread evenly across the life, which will be
calculated as follows;

Asset value – Salvage value 11,00,000 – 1,00,000

Depreciation per year = ---------------------------------- = ------------------------- = Rs.2,00,000
Useful life 5

Depreciation per year 2,00,000

Rate of depreciation = -------------------------------- x 100 = -------------- = 20%
Asset value – Salvage value 10,00,000

Depreciation Schedule for the entire useful life of the Machine

Year Book Value Depreciation Accumulated Book Value
Year Start Expense (20%) Depreciation Year End

2013-14 - 8 months 11,00,000 1,33,333 1,33,333 9,66,667

2014-15 9,66,667 2,00,000 3,33,333 7,66,667

2015-16 7,66,667 2,00,000 5,33,333 5,66,667

2016-17 5,66,667 2,00,000 7,33,333 3,66,667

2017-18 3,66,667 2,00,000 9,33,333 1,66,667

2018-19 - 4 months 1,66,667 66,667 10,00,000 1,00,000

Under the revised Companies Act 2013, what is the basis of charging
depreciation:

A Rate of depreciation prescribed by Companies Act

B Useful life of asset
C 10 years presumed for furniture and fixture and 20 years for building
D None of the above

Summary

 Depreciation is a process of allocating the cost of a fixed asset over its

estimated useful life in a rational and systematic manner.
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 As per ‘Explanation’ to AS 6: ‘Assessment of depreciation and the amount to
be charged in respect thereof in an accounting period are usually based on
the following three factors:

i. Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued;
ii. Expected useful life of the depreciable asset; and
iii. Estimated residual value of the depreciable asset’

 There are several methods of providing for depreciation out of which two
methods are very common which are Straight Line Method and Diminishing
Balance Method.

 In selecting a method, the principle of equitable distribution of the cost of

the asset should be given an essential consideration though a secondary
thought of replacement of the asset should also be kept in mind in a given
situation. The implications of profit, tax, dividend and cash flow are the
important considerations while choosing a method of depreciation.

 Straight line method is considered as the simplest of all the methods of

providing for depreciation. Depreciation is arrived at by deducting salvage
value from the historical cost and then dividing the difference thus
determined by the number of years of useful life.

 Diminishing Balance Method is widely used in commercial organizations.

Depreciation under this method is expressed as a rate percent per annum on
the Written Down Value of the asset. This method is useful in the cases of
exhausting and costly assets like Plant and Machinery, Electronic Equipment
etc.

 Depreciation Fund is a very important method specifically in respect of Plant

& Machinery of very high value where replacement of is desired at the end
of its effective life in order to keep liquidity position of fund in good
position.

 Disposal of depreciable assets means sale, removal, destruction or exchange

of any particular asset usually when the usefulness of the said asset ceases.
It is sold as an item of salvage or scrap.

Answers to Test Yourself

Answer to TY 1
The correct option is A. Land is not a depreciable asset as it has unlimited
useful life for the enterprise.
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Answer to TY 2
The correct option is C.
Book value of equipment = Opening balance – Accumulated depreciation
= Rs. 45,000 – Rs. 28,000 = Rs. 17,000

Answer to TY 3
The correct option is A. The deficiency or surplus arising from retrospective
recomputation of depreciation according with the new method is adjusted in
the accounts in the year in which the method of depreciation is changed

Answer to TY 4
The correct option is A.

Asset a/c Cr. 8,500

Depreciation fund a/c Dr. 4,148
New asset a/c Dr. 12,750
Loan a/c Cr. 8,000
Profit on sale of asset Cr. 398
16,898 16,898
Answer to TY 5
The correct option is B. Depreciation is required to be provided on the basis of
useful life of asset as per provisions of the Schedule-II of the Companies Act,
2013

Self-Examination Question
Question 1
A mine was purchased at Rs. 3,00,000 and estimated quantity of mineral in the
mine is 10,000 tonnes. In the year 2020-21, a total of 1,700 tonnes of ore was
mined. Depreciation for 2020-21 will be:

A Rs. 3,00,000
B Rs. 51,000
C Rs. 10,000
D None of the above

Question 2
Sukh-Sagar Ltd owns some land and buildings for which the following details are
available:

Cost of land Rs. 50,000

Cost of buildings Rs. 1,00,000
Estimated life of buildings 20 years
Estimated residual value of buildings Rs. 2,000
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Estimated residual value of land Rs. 50,000
The company uses the straight line depreciation method. Which is the correct
annual depreciation charge for this asset?
A Rs. 4,000
B Rs. 4,900
C Rs. 7,400
D Rs. 7,500

Question 3
Shivam Corporation purchased a machinery of Rs. 50,000 on 1 January 2019 and
incurred an installation charges of Rs. 10,000. The depreciation is calculated at
10% on a straight line basis. On 30 June 2021, the machinery was sold for Rs.
42,500.
If the depreciation is calculated by written down value method, the book value
of the machinery on 30 June 2021 will be more by:
A Rs. 1,170
B Rs. 3,000
C Rs. 2,500
D Rs. 2,430

Question 4
Parmar Group of Industries, which has a calendar year accounting period,
purchased a new machine for Rs. 1,20,000 on April 1, 2066. At that time Parmar
Group of Industries expected to use the machine for 9 years and then sell it for
Rs. 12,000. The machine was sold for Rs. 66,000 on 30 September 2021.
Assuming straight-line depreciation, no depreciation in the year of acquisition,
and a full year of depreciation in the year of withdrawal, the gain to be
recognised at the time of sale would be:
A Rs. 12,000
B Rs. 9,000
C Rs. 6,000
D NIL

Question 5
Identify the method of charging depreciation, under which the amount of
depreciation charged every year remains constant.

(i) Reducing Balance Method

(ii) Revaluation Method
(iii) Straight Line Method

A (i) and (ii)

B (ii) and (iii)
C (i) and (iii)
D Only (iii)

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Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is B. Rate of depreciation = Rs. 3,00,000/10,000 tonnes = Rs.
30 per tonne. Annual depreciation = 1,700 tonnes x Rs. 30 = Rs. 51,000

Answer to SEQ 2
The correct option is B. Land is not depreciated, so the depreciation charge for
the building will be: (1,00,000 – 2,000)/20 = Rs. 4,900 p.a.

Answer to SEQ 3
The correct option is A.

SLM WDV
Method Method
Purchase price on 01 January 2019 50,000 50,000
Add: Installation cost 10,000 10,000
Cost of the machinery on 01 January 2019 60,000 60,000
Less: Depreciation on 31 December 2019 6,000 6,000
Book value of machinery on 01 January 2020 54,000 54,000
Less: Depreciation on 31 December 2020 6,000 5,400
Book value of machinery on 01 January 2021 48,000 48,600
Less: Depreciation on 30 June 2021 (6 months) 3,000 2,430
45,000 46,170

Difference = Rs. 46,170 – Rs. 45,000 = Rs. 1,170

Answer to SEQ 4
The correct option is C.
SL Method
Purchase price on 01 Apr 2006 1,20,000
Less: Depreciation on 31 Dec 2006 NIL
Book value of the machinery on 01 Jan 2007 1,20,000
Less: Depreciation on 31 Dec 2007 12,000
Book value of the machinery on 01 Jan 2008 1,08,000
Less: Depreciation on 31 Dec 2007 12,000
Book value of the machinery on 01 Jan 2009 96,000
Less: Depreciation on 31 Dec 2009 12,000
Book value of the machinery on 01 Jan 2010 84,000
Less: Depreciation on 31 Dec 2010 12,000
Book value of the machinery on 01 Jan 2011 72,000
Less: Depreciation on 30 Sep 2011 12,000
Book value of the machinery on 30 Sep 2011 60,000
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 Selling price of machinery 66,000
Profit on sale of machinery 6,000

W1 Annual Depreciation = (Rs. 1,20,000 – Rs. 12,000)/9 years = Rs.12,000

Answer to SEQ 5
The correct option is D. In the straight line method of charging depreciation,
the amount of depreciation charged every year remains constant.

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 CHAPTER 2
ACCOUNTING PROCESS, METHODS AND CONTROL,
AND FINALISATION OF ACCOUNTS

UNIT-8
BANK RECONCILIATION STATEMENT
Chapter Introduction
Every person has a bank account. The entries of deposits and withdrawals are
the key components of bank transactions. All the transactions relating to the
bank have to be monitored properly because this helps in identifying any
differences between the cash book and bank statement.
Generally, there should be no difference between the balances shown on the
bank statement and in the Bank book, because all the entries should appear in
both. It may happen that on a particular date some entries are recorded in the
cash book but are not shown on the bank statement.

While cheques issued are entered in the cash book immediately, it usually takes
1-2 days by the customer to deposit in his bank account. Similarly cheques
collected by Entities are immediately entered in the Bank Book but are
presented to bank after a day or two.

So, these are the most common reasons why there are differences between the
cash book and the bank statement.
It is therefore necessary to prepare a bank reconciliation statement to identify
the differences between the bank statement and the cashbook. This will help to
keep a check on the accounts maintained by the entities and the transactions
recorded by the bank. Most organisations prepare monthly bank reconciliations
to maintain proper records.

Error!
a) Define Bank Reconciliation Statement and highlight its importance.
b) Mention the possible reasons for a difference in the cash book balance and pass
book balance.
c) Explain how Bank Reconciliation Statement is prepared.

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Look at the scenario

Sunil’s cash book showed a balance of Rs. 20,000, whereas the balance per the
bank statement (i.e. pass book) was Rs. 15,000.

When he prepared the bank reconciliation statement, he found that he had

recorded a receipt of cheque of Rs. 5,000 from one of his customers but this
transaction was not reflected in the bank account.

So, by preparing the reconciliation statement, he located the missing amount

and was reassured about the accuracy of accounts.

1. Define Bank Reconciliation Statement and highlight its importance.

[Learning Outcome a]

1.1 Bank reconciliation statement (BRS)

Bank Reconciliation Statement is the statement prepared by an entity that

reconciles the difference between the bank balance shown by the pass book,
herein after called as ‘Bank statement’ and the cash book balance, called as
‘Bank account’.

Thus difference between the two books may These differences are
be classified into two groups: briefly covered in the next
1. Timing Difference and Learning Outcome.
2. Difference due to errors in
recording.
It is the bank reconciliation statement that provides a systematic process of
identifying the reasons for the difference between the balances of two books
and reconciling the difference giving reasons for necessary accounting and
administrative action.

1.2 Importance of BRS

1. Bank reconciliation statement is an important tool for internal control over
both administration and accounting.
2. It provides a check on the accuracy of entries made in both the books.
3. It helps to detect and rectify any error committed in both the books.
4. It indicates any undue delay in the collection and clearance of some
cheques.
5. A regular reconciliation discourages the staff of the customer or of the bank
from embezzlement (fraudulent appropriation of funds).
6. It helps to detect many discrepancies and irregularities in financial
transactions apart from reconciliation of the two balances due to mere time
124
 difference or errors of omission or commission.
7. Proper bank reconciliation is the first and foremost tool to detect and
control fraud.

A bank reconciliation statement is:

(i) prepared by the bank and sent to its account holders
(ii) a statement sent by a bank to those customers who do not maintain a
minimum balance
(iii) not a part of the double entry system
(iv) prepared by the entity to find discrepancies
A (i)
B (ii) and (iii)
C (iii) and (iv)
D (ii) and (iv)

2. Reasons for a difference between Bank account and Bank

statement.
[Learning Outcome b]

Difference in balances between the two books, Bank account and Bank
statement, may arise due to many reasons, which may be broadly classified into
two groups:
1. Timing Difference
2. Difference due to errors in recording

2.1 Timing Difference – Major reasons for differences are following:

1. Cheques deposited by us in bank but not credited in the ‘Bank account’ -

Bank generally gives credit to the customer's account for the said deposits
only after the bank receives clearance advice by the drawee bank.
2. Cheques issued by us but not presented for payment – This is due to delay
by customer in presenting our cheque in his bank.
3. Direct remittances by the customer in our bank - as per his instructions
but not accounted us in our ‘Bank account’.
4. Dishonour of customer’s cheques – Cheques collected and deposited into
our bank but dishonoured due to various reasons. It is not accounted in our
records as the advice of dishonour is not received by us from our bank.
5. Interest income credited by the bank – Interest income earned by us
credited by the bank but not accounted in our books.
6. Expenses debited by the bank – Bank charges / folio charges debited by the
bank but not accounted in our books.
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Difference due to errors in recording – Errors may occur both in Cash book and
Pass book and corrections not made in cash book/Bank account. Errors are
found to occur mostly in recording of entries in the cash book. This may be
incorrect figures entered in our ‘Bank account’ or in ‘Bank statement’. There
may be interchange of sides, like debits entered as credits or vice-versa.

Which of the following does not cause a difference between the cash book and
the bank statement?

A Interest on bank overdraft debited by the bank

B Cheques received and entered in our books, but not yet deposited in to the
bank for collection
C Cheques collected but neither receipted not deposited in the bank.
D customer directly deposited a certain amount in to the bank

A cheque was issued by Matrix Ltd to Jack (supplier), it has not yet appeared on
the bank statement. This cheque is known as ________

A A dishonoured cheque
B A standing order
C An outstanding cheque
D A credit transfer

3. Explain how Bank Reconciliation Statement is prepared.

[Learning Outcome c]

A statement is prepared to show the reason-wise differences between our ‘Bank

account’ and the ‘Bank statement’. This statement is known as the Bank
Reconciliation Statement.

Procedure for preparation of a bank reconciliation statement

Step 1 The ‘Bank account’ for a particular period and the ‘Bank statement’
for the same period are kept ready for comparison.
Step 2 The debit side of ‘Bank account’ and the ‘deposits’ column of the
‘Bank statement is compared item by item. Such items would be,
 Customers’ cheques deposited into the bank but not credited by
the bank
126
  interest credited by the bank not accounted by us
 Customers’ Cheques dishonoured by bank not accounted by us
 Direct credits by customers not accounted by us

Step 3 Items which are matching are marked as ‘contra’, ie, matched items.
Step 4 Items which are not matching are kept separately for identifying the
reason for difference.
Step 5 In the same way, The credit side of ‘Bank account’ and the
‘Withdrawals’ column of the ‘Bank statement is compared item by
item. Such items would be,
 cheques issued by us but presented by customer in their bank
 bank charges debited by the bank not accounted by us
 Direct credits appearing in ‘Bank statement’ but not accounted by
us
 Bank charges debited by the bank but not accounted by us

Step 6 Items which are matching are marked as ‘contra’, ie, matched items.
Step 7 Items which are not matching are kept separately for identifying the
reasons for difference.
Step 8 It is to be remembered that there could have been unmatched entries
of earlier period which would have been cleared in this current
period. Hence, those pending entries should first be taken for
matching.

Normally, bank reconciliation is prepared from our book balance, showing the
reasons for differences, thereby reaching the Bank balance as per Bank
statement. A sample format is as below.

Bank Reconciliation Statement for the month of January, 2021

Particulars Rs. Rs.

Balance as per our books (Dr. bal on left side; Cr. on right side) …
Add: Cheque issued but not presented …
Add: Bank interest …
Add: Direct credit by customers …
…
Less: Standing order …
Less: Cheques deposited in bank but not credited …
Less: Cheques dishonoured (not recorded in cash …
book)
Less: Bank charges …
Balance as per bank statement …

The method of comparison of entries in the Cash Book with those found in the
Pass Book will be clear from the following:

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Following is an extract from the Bank statement and the book balance of M/S
Young & Old for the month of September 2021.
Cash Book (Bank Column only)
Dr Cr
Date Particulars Amount Date Particulars Amount
1 To Balance b/d 40,000
2 To M/S P & Co. 3,500
3 By M/s D Electronics 6,000
6 To M/S B& Co. 7,600
7 By M/s Arora & Co. 10,000
8 To Cash 3,000
16 To M/s Raj & Co. 4,300
17 By M/s Tonk & Sons 12,500
23 To M/S T & Co. 10,500
24 By M/s Dilip & Sons 7,300
25 By Cash 5,000
28 By M/S B& Co. 7,800
29 To M/S D & Sons 3,400
30 By Balance c/d 23,700
72,300 72,300

Bank statement

Date Withdrawal Deposit Balance

(Rs.) (Rs.) (Rs.)
1 Balance 40,000
5 To M/s D Electronics 6,000 34,000
8 By Cash 3,000 37,000
9 To M/s Arora & Co. 10,000 27,000
10 By M/S P & Co. 3,500 30,500
18 To M/s Tonk & Sons 12,500 18,000
18 By M/S B & Co. 7,600 25,600
20 By M/s Raj & Co. 4,300 29,900
25 To Cash 5,000 24,900
29 By Interest from Govt. Securities 2,000 26,900
30 Insurance Premium 2,600 24,300

On examination of the Cash Book and Pass Book entries for the month of
September 2021, we find that although both books have started with the same
balance of Rs 40,000, the closing balances of both the books differ as 23,700
and 24,300.

The entries which are highlighted as bold are not matching due to the following
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timing differences and differences arising from errors in recording certain
transactions:
1. Two deposits on 23rd and 29th Sept for Rs 10,500 and Rs. 3,400 respectively
are not reflected in the bank statement. This may be due to banks still
processing these cheques for clearing.
2. Two cheques issued for Rs. 7,300 and Rs. 7,800 on 24th and 28th Sept
respectively have not been presented till 30th Sept. or presented but still
under processing in the clearing house.
3. Bank’s direct collection - Interest from Govt. Securities - and one direct
payment - Insurance Premium as per Standing Order on 29th and 30th Sept for
Rs. 2,000 and Rs. 2,600 respectively have not been accounted by the firm
till the end of the month.

Let us prepare the Bank Reconciliation Statement with the above-mentioned

extracts.
M/S Young & Old
Bank Reconciliation Statement for the month of September 2021
Particulars Amt. (Rs.)
Balance as per Cash Book (Bank account) 23,700
(Dr. bal on left side; Cr. on right side)
Add:
Interest Collected by bank not entered in Cash Book 2,000
Cheque issued to Dilip & Sons, not yet presented 7,300
Cheque issued to M/S B& Co, not yet presented 7,800
Less:
Insurance Premium paid by bank, but not entered 2,600
Cheque deposited into bank not encashed (T & Co) 10,500
Cheque deposited into bank not encashed ( D &Sons) 3,400
Balance as per Bank statement 24,300
TOTAL 40,800 40,800

ABC & Co’s Cash Book shows an overdraft balance of Rs. 6,34,000 on 30th June
2021 while the Pass Book balance on that date is (-) Rs. 6,33,200.

On examination of the Cash Book and Bank statement (Pass Book), the following
differences are noticed:
1. Rs. 16,000 Interest on Overdraft for the last 6 months appearing in the Bank
Statement is not entered in the company’s Book
2. Rs. 3,000 Bank Charges are not accounted in Cash Book
3. Two cheques for Rs. 1,00,000 and Rs. 16,800 issued by the firm have not
been presented to the bank.
4. Two cheques for Rs. 2,00,000 and Rs. 17,000 deposited on 29.6.2021 have
not been credited by the bank.
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5. Rs. 1,20,000 interest on investments has been credited by the bank on
30.6.2021, but is not accounted by the company.
Prepare Bank Reconciliation Statement on the basis of the above particulars.

Solution:
Bank Reconciliation Statement as on 30th June 2021

Particulars Amount
Overdraft balance as per our books (Bank account) 6,34,000
(Dr. bal on left side; Cr. on right side)
Add:
i) Cheques issued, but not yet presented 1,16,800
ii) Investment interest credited in pass book, not 1,20,000
entered in Cash book
Less:
i) Overdraft Interest debited by bank 16,000
ii) Bank Charges not accounted 3,000
iii) Cheques issued, but not yet presented 2,17,000
Balance as per Bank statement (Overdraft) 6,33,200
TOTAL 8,70,000 8,70,000

XYZ & Co.’s Book shows a bank balance of Rs. 46,100 on 30th June 2021, which
does not agree with the Bank Statement Balance.

On examination, the following differences are observed.

1. 3 cheques for Rs. 40,000, Rs. 20,000 and Rs. 3,000 are credited in
company’s Book, but are not presented before the bank by the payees.
2. 2 cheques totalling Rs. 25,000 are deposited on 29.6.2021, but are credited
in the Pass Book on 2.7.2021.
3. Dividend Rs. 3,800 directly credited in the pass book on 28.6.2021 is
intimated on 2.7.2021.
4. Two cheques totalling Rs. 7,300, dishonoured by the bank are duly debited
in the Pass Book; dishonour intimation received by the firm on 3.7.2021.
5. Bank Charges of Rs. 4,200 and one direct payment of Rs. 1,000 to Trade
Association is debited in the Pass Book, but not yet entered in the Cash
Book.
6. Bank wrongly debited a cheque of Rs. 2,700, which was not issued by XYZ &
Co.

You are required to Prepare Bank Reconciliation Statement as on 30.06.2021

with given bank account balance as per Cash Book.

Solution:
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XYZ & Co.’s Bank Reconciliation Statement as on 30th June 2021
Particulars Amount Amount
Rs Rs
Balance as per Cash Book (Bank account) 46,100
Add:
3 Cheques collected but not presented 63,000
Dividend directly collected by bank 3,800
Less:
2 cheques deposited into bank but not credited 25,000
cheques deposited into bank but dishonoured 7,300
Bank charge debited by bank 4,200
Paid by bank to Trade Associated but not recorded 1,000
Cheque was not issued but wrongly debited by bank 2,700
Bank Balance as per Bank statement 72,700
Total 1,12,900 1,12,900

The cash balance of Krupa Traders was Rs. 700 (debit). The bank statement
showed a credit balance of Rs. 1,600 on 31 March 2021. The difference was
caused due to the following transactions
(i) Cheques of Rs. 500 issued, but not presented in the bank for payment
(ii) A cheque received amounted to Rs. 200, but was entered as Rs. 20
(iii) Payment of Rs. 250 from a customer was directly received by the bank
(iv) The cash book was overstated by Rs. 30

What will be the revised balance in the cash book after revising the above
transactions?
A Rs. 750
B Rs. 850
C Rs. 550
D Rs. 690

Which of the following is a timing difference that reduces the balance according
to the cash book in bank reconciliation?
A Cheques deposited but not cleared
B Cheques issued but not presented
C Bank charges
D Bank interest

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Summary

 Cash book – bank account is the record of cash and bank transactions, which
is prepared by the entity, and the bank statement is the statement of
accounts prepared by the bank.
 Bank statement is a book issued by the Bank to an account holder. It is
almost a copy of the account of the customer / entity in the books of the
bank.
 There can be various reasons due to which the balances of these books do
not match.
 These reasons can be either timing differences or errors in recording.
 Hence, bank reconciliation statement is prepared to reconcile both the
balances.
 Bank reconciliation statement is a statement, not an account.
 Bank reconciliation statement eases checking of errors and detection of
frauds in the cash books and pass books.

Answers to Test Yourself

Answer to TY 1
The correct option is C. The bank reconciliation statement is prepared by an
entity to find the differences, with reasons, between the cash book – Bank
account and the bank statement. It is a statement and not an account and
hence is not a part of the double entry system.
Answer to TY 2
The correct option is C. Since the cheque received is not accounted in our
books, there is no entry in the Bank account. Since it is not deposited in the
bank, there cannot be a credit entry. So, there is no difference, as it is not
accounted in both books.
Answer to TY 3
The correct option is C. It is a cheque issued to Jack for payment but not yet
cashed by him.
Answer to TY 4
The correct option is B. (ii) and (iv) are the errors in the cash book.
The correction in the cash book is made as follows:
Cash Book
Dr Cr
Date Receipts Rs. Date Payments Rs.
To Balance b/d 700 Overstated 30
Wrong cheque amount
(Rs. 200 - Rs. 20) 180 By Balance c/d 850

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 880 880
Answer to TY 5
The correct option is A. Cheques deposited but not cleared.

Self Examination Questions

Question 1

The following information of Suraj Traders is available for July 2021:

1 July Balance as per Cash Book 1,50,000
2 July Cheques deposited in July, credited by bank in August 8,000
3 July Cheques issued in July 2021 but cashed in August 2021 12,000
4 July Cheques entered in the Cash Book in July 2021 but paid 5,000
into bank in August 2021
5 July Interest given by the bank 3,000
6 July Interest charged by the bank 900

From the above details, prepare a bank reconciliation statement as on 31st July
2021, and find out the Balance as per pass book.
A Rs. 1,50,000 balance
B Rs. 1,51,100 overdraft
C Rs. 1,51,100 balance
D Rs. 1,50,000 overdraft

Question 2
The cash book of a trader showed a balance of Rs. 3,000, but it was not
matching with the balance as per Bank statement on the same date. The
following reasons were revealed on the comparison.
(i) Cheques of Rs. 200, Rs. 100 and Rs. 250 respectively had not been presented
for payments
(ii) Cheque of Rs. 800 paid into account had not been cleared.
The balance as per the pass book will be:
A Rs. 2,200
B Rs. 4,350
C Rs. 3,250
D Rs. 2,750

Question 3
Rishita’s cash book shows a credit balance of Rs. 8,700 for January. The balance
of the bank statement does not match with that of the cash book, due to the
following reasons.

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(i) Interest on an overdraft of Rs. 500 had been debited by the bank but not
recorded in the cash book.
(ii) Cheques of Rs. 5,000 issued during the month, but were not presented in the
bank until 31 January. Cheques of Rs. 3,500 were deposited but not cleared.
(iii) Interest on investments of Rs. 1,000 was directly collected by the bank.
(iv) The bank had wrongly debited Rs. 800.

The balance per the bank statement is:

A Rs. 7,500 (debit)
B Rs. 9,500 (debit)
C Rs. 5,900 (credit)
D Rs. 7,500 (credit)

Question 4
The following is a bank reconciliation statement prepared by a trainee
accountant of Surya Ltd:
Rs.
Overdraft per bank statement 40,000
Add: Deposits not credited 45,000
85,000
Less: Outstanding cheques Overdraft per cash
book 6,000
79,000

Assuming the bank statement balance of Rs. 40,000 to be correct, check the
correct Cash book balance.
A Rs. 79,000 overdrawn
B Rs. 6,000 overdrawn
C Rs. 1,000 overdrawn
D Rs. 6,000 cash at bank

Question 5
Debit balance as per Cash Book of Shrinath Enterprises as on 31.3.2021 is Rs.
1,500.

(i) Cheques deposited but not cleared amount to Rs. 100 and cheques issued
but not presented amount to Rs. 150.
(ii) The bank allowed interest amounting Rs. 50 and collected dividend of Rs. 50
on behalf of Shrinath Enterprises.

Balance as per Bank statement should be:

A Rs. 1,600
B Rs. 1,450
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C Rs. 1,850
D Rs. 1,650

Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is C. Bank statement will show Rs. 1,51,100.
Bank Reconciliation Statement as on July 31, 2021
Particulars Amount Amount
Balance as per Book account 1,50,000
Add:
Cheques issued but not cashed 12,000
Interest allowed by bank 3,000
Less:
Cheques deposited into bank but not yet credited 8,000
Cheques entered into Cash Book but not paid by Bank 5,000
Interest charged by Bank 900
Balance as per Pass Book 1,51,100
TOTAL 1,65,000 1,65,000

Answer to SEQ 2
The correct option is C.
Rs. Rs.
Credit balance as per cash book 3,000
Add: Cheque deposited but not cleared 800
Less: Cheques issued but not presented for payment 550
Balance as per Bank statement 3,250
Total 3,800 3,800

Answer to SEQ 3
The correct option is A.
Rs. Rs.
Overdraft balance per Bank account 8,700
Add:
Cheque issued but not presented 5,000
Interest on investment directly collected by bank 1,000
Less:
Interest on overdraft not entered in cash book 500
Cheques deposited but not cleared 3,500

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 Wrong debit by bank 800
Balance per Bank Statement (Overdraft) 7,500
TOTAL 13,500 13,500

Answer to SEQ 4
The correct option is C.
Here, balance according to bank statement is overdraft balance. So, Rs. 40,000
is to be taken as (Rs. 40,000) and then we have to proceed to find the cash book
balance.
A bank reconciliation statement is prepared as follows:
Rs.
Overdraft per Bank Statement 40,000
Add: Outstanding cheques Overdraft per cash book 6,000
Less: Deposits not credited 45,000
Overdraft as per Cash Book 1,000

Answer to SEQ 5
The correct option is D.
Rs. Rs.
Debit balance as per cash book 1,500
Add:
Cheques issued but not presented 150
Bank interest 50
Dividend collected 50
Less:
Cheque deposited but not cleared 100
Balance as per Bank statement 1,650
TOTAL 1,750 1,750

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 CHAPTER 2
ACCOUNTING PROCESS, METHODS AND CONTROL,
AND FINALISATION OF ACCOUNTS

UNIT-9
INTRODUCTION TO COMPANY ACCOUNTS
(BASED ON THE COMPANIES ACT 2013)
Chapter Introduction
In India, the financial statements of a company are prepared in accordance with
the Indian GAAP. The Indian GAAP comprises the provisions of the Companies
Act 2013 the mandatory Accounting Standards issued by the ICAI, and the
specific guidelines or regulations issued by any other regulatory authority like
SEBI, RBI or IRDAI. As per the Indian GAAP, a complete set of financial
statements of a company include the following:

a) Balance Sheet as at the end of financial year;

b) Profit & loss Account (Income & Expenditure Account in the case of company
carrying on activity not for profit)
c) Cash Flow Statement for the financial year;
d) A statement of changes in equity, if applicable; and
e) Explanatory note annexed to or forming part of, any document referred
above
f) Consolidated Financial Statements (listed companies) in accordance with
provisions of Sec.129 of the Companies Act 2013.

The Schedule III to the Companies Act, 2013, lays down principles for
preparation and presentation of balance sheet as well as statement of profit
and loss for Indian enterprises for the financial years commencing on or after
April 1, 2014. The Schedule III has also prescribed formats of balance sheet and
statement of profit and loss for Indian enterprises.

Some amendments were made in the Act in the year 2020 which was issued
under The Companies (Amendment) Act, 2020 and effected from 28.09.2020.

The readers are advised to study the directions and instructions given by the
Schedule III to the Companies Act, 2013for preparation and presentation of
financial statements of companies for their better understanding on company
accounts.

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 a) State the legal requirements relating to preparation and presentation of
financial statements as per the provisions of the Companies Act 2013.
b) Learn about a company, along with various types of companies including
the salient features.
c) Understand the provisions of the Companies Act relating to maintenance
of proper books of accounts
d) Learn about Forms, Contents and Legal Requirements for preparation &
presentation of Financial Statements.
e) Understand taxation and its accounting treatment in Final Accounts

1. State the legal requirements relating to preparation and

presentation of financial statements as per the provisions of the
Companies Act 2013
[Learning Outcome a]

1.1 Introduction

Under Sec. 129 (1) the financial statements shall give a true and fair view of the
state of affairs of the company or companies, comply with the accounting
standards notified under section 133 and shall be in the form or forms as may be
provided for different class or classes of companies in Schedule III:
Provided that the items contained in such financial statements shall be in
accordance with the accounting standards:
Provided further that nothing contained in this sub-section shall apply to any
insurance or banking company or any company engaged in the generation or
supply of electricity, or to any other class of company for which a form of
financial statement has been specified in or under the Act governing such class
of company:
Provided also that the financial statements shall not be treated as not disclosing
a true and fair view of the state of affairs of the company, merely by reason of
the fact that they do not disclose—-
a) in the case of an insurance company, any matters which are not required to
be disclosed by the Insurance Act, 1938, or the Insurance Regulatory and
Development Authority Act, 1999;

The said financial statements also known as general purpose financial

statements are furnished along with the auditors’ report and the Board’s report
in the Annual Report published by the company for public communication and
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especially for various stakeholders including shareholders, the regulator,
customers, financiers and the Government.
Under Sec. 129 (2) of the Companies Act 2013, at every annual general meeting
of a company held under Sec.96 of the Act, the Board of Directors of the
company shall lay before such meeting financial statements for the financial
year.
Under Sec 129(3) where a company has one or more subsidiaries, or associate
companies it shall, in addition to financial statements provided under sub-
section (2), prepare a consolidated financial statement of the company and of
all the subsidiaries and associate companies in the same form and manner as
that of its own which shall also be laid before the annual general meeting of the
company along with the laying of its financial statement under sub-sec (2) ;

Provided that the company shall also attach along with its financial statement,
a separate statement containing the salient features of the financial statement
of its subsidiary or subsidiaries and associate or associates companies in such
form as may be prescribed by the Central Govt.

As required by the Companies Act 2013 (Schedule III to the Act) each item on
the face of the Balance Sheet and Statement of Profit and Loss shall be cross-
referenced to any related information in the notes to accounts. In preparing the
Financial Statements including the notes to accounts, a balance shall be
maintained between providing excessive detail that may not assist users of
financial statements and not providing important information as a result of too
much aggregation. It is also provided in the said schedule, the corresponding
amounts (comparatives) for the immediately preceding reporting period for all
items shown in the Financial Statements including notes shall be also given.

At every annual general meeting the financial statements are presented to the
shareholders by the:

A Statutory Auditors
B Internal Auditors
C Company Secretary
D Board of Directors

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2. Learn about a company, along with various types of companies
including the salient features
[Learning Outcome b]

2.1 Meaning of Company

Under Sec 2(20) of the Companies Act 2013 “company” means a company
incorporated under this Act or under any previous company law. A company
defined in this sec. may mean either private company or public company.

Previous company law means any of the laws specified by the Act 2013- such as:

a) Acts relating to companies in force before

b) The Indian Companies Act, 1866,
c) The Indian Companies Act, 1882,
d) The Indian Companies Act, 1913
e) The Registration of Transferred Companies Ordinance, 1942
f) The Companies Act, 1956; and
g) Any law corresponding to any of the aforesaid Acts or the Ordinances and in
force in the merged territories or in a Part B State (other than the State of
Jammu and Kashmir), or any part thereof, before the extension thereto of
the Indian Companies Act, 1913

2.2 Types of companies

There are different types of companies such as Private Company, Public

Company, Government company, Foreign Company, Holding company and
Subsidiary company.

a) Private company

As per Sec. 2(68) “private company” means a company having a minimum paid-
up share capital as may be prescribed, and which by its articles,—
(i) restricts the right to transfer its shares;
(ii) limits the number of its members to 200
(iii) prohibits any invitation to the public to subscribe for any securities of the
company;

b) Public company

Under Sec,2(71) of the Act “public company” means a company which is not a
private company; provided that a company which is a subsidiary of a company,
not being a private company, shall be deemed to be public company for the
purposes of this Act even where such subsidiary company continues to be a
private company in its articles.
140
A public company may be a listed company or an unlisted company. Listed
companies are those which get their securities listed in any recognized Stock
Exchange in India. An unlisted company is one whose securities are not listed on
any recognized stock exchange. Private companies don’t involve participation
of public in general for funding capital. So the shares of private companies are
not listed in any stock exchange.
The term ‘listed company’ is defined in Sec. 2(52) as a company which has any
of its securities listed in any recognised stock exchange. This proviso is amended
with a new insertion that such class of companies, which have listed or intended
to list such class of securities as may be prescribed, in consultation with the
Securities and Exchanges Board shall not be considered as listed companies.

c) Government company

As per sec 2(45) of the Companies Act 2013 a Government company is a

company in which not less than 51% of the paid capital is held by the central
Government or state Governments or by both of them jointly. The New India
Assurance Company Limited, National Insurance Company Limited, United India
Insurance Company Limited and the Oriental Insurance Company Limited are all
government companies as they are fully owned by Government of India.

d) Foreign company

Under Sec. 2(42) of the Act “foreign company” means any company or body
corporate incorporated outside India which—

(i) has a place of business in India whether by itself or through an agent,

physically or through electronic mode; and
(ii) conducts any business activity in India in any other manner

LG, Samsung, Dell, Goldman Sachs, Google are all foreign companies having
their place of operations in India.

e) Holding Company

As per Sec.2 (46) of the Companies Act 2013 “holding company”, in relation to
one or more other companies, means a company of which such companies are
subsidiary companies. Sec 2(87) further provides that “subsidiary company” or
“subsidiary”, in relation to any other company (that is to say the holding
company), means a company in which the holding company—

i. controls the composition of the Board of Directors; or

ii. exercises or controls more than one-half of the total share capital either at
its own or together with one or more of its subsidiary companies:

141
Provided that such class or classes of holding companies as may be prescribed
shall not have layers of subsidiaries beyond such numbers as may be prescribed.

2.3 Salient Features of a company

Before we proceed to discuss company accounts, it is advisable that the

students must know the following salient features of a company;

a) Incorporation: A company, which is regarded as an artificial legal person

comes into existence only through the operation of law. It must be
incorporated and registered under the Companies Act to obtain its legal
personality.

b) Separate Entity: A company possesses a legal entity separate from its

shareholders, members and management and not affected by any change in
shareholding, membership and management. Having a separate and distinct
entity or legal personality, it can contract, sue or be sued in its own
incorporated name and capacity.
c) Perpetual Succession: Because of its own independent and legal status,
separate from its members, it continues to be in existence irrespective of
death, insolvency or change of members unless and until it is wound up as
per company laws.
d) Common Seal: As the company is an artificial person, it cannot sign
documents or contracts as a natural person. It uses a legal tool called
“Common Seal” to authenticate and affirm the documents with legal
acceptance. The common seal is affixed on all documents by the person
authorized to do so with is signature for and on behalf of the company.
e) Distinction between ownership and management: Shareholders or
members who are very large in number and scattered all over the country or
even over the world cannot participate in the day-to day management of the
company. So the members elect a board of directors and managers for the
management of the company.

f) Limited Liability: The significance of the word “limited” or “Ltd” signifies

that the liability of every shareholder is limited to the amount of shares he
agreed to pay for or purchase. If such shares are fully paid, he will not be
under any obligation to pay for any liability of the company in case of
liquidation or winding-up.

g) Transferability of Shares: Company’s Capital is raised from the

shareholders through their subscription in shares issued by company. Such
shares are transferable by its members except in case of private company
where there are certain restrictions for such transfer.

142
h) Maintenance of Books of Accounts: A company registered under the Act is
required by law to maintain a prescribed set of books of accounts as
discussed hereinafter and any failure in this regard attracts statutory
penalties.

i) Annual Audit: A limited company is required by the Act to gets its annual
accounts audited by the Chartered Accountants appointed by the
shareholders in the annual general meeting on the recommendation of the
board of directors.

j) Access to information and books: The Articles of Association govern the

shareholders’ right to inspect the company’s books of accounts with the
exception of books open for inspection under statute. Shareholders have the
right to seek information from the directors through participation in the
meeting and through the periodic reports as stipulated by the statute.

2.4 Share Capital :

Share capital refers to the funds that a company raises in exchange for
issuing an ownership interest in the company in the form of shares.

The share capital of a company limited by shares shall be of two kinds,

(a) equity share capital
(b) preference share capital

Equity share capital, with reference to any company limited by shares, means
all share capital which is not preference share capital.

Preference share capital, with reference to any company limited by shares,

means that part of the issued share capital of the company which carries or
would carry a preferential right with respect to—
(a) payment of dividend, either as a fixed amount or an amount calculated at a
fixed rate, which may either be free of or subject to income-tax; and
(b) repayment, in the case of a winding up or repayment of capital, of the
amount of the share capital paid-up or deemed to have been paid-up, whether
or not, there is a preferential right to the payment of any fixed premium or
premium on any fixed scale, specified in the memorandum or articles of the
company;

Following are the various stages of equity share capital:

a) Authorised share capital: Authorised share capital of a company is the

maximum amount of share capital that the company is authorised by its
constitutional documents i.e. Memorandum of Association and Articles of
Association, to issue (allocate) to the shareholders.

143
 b) Called up capital: That part of capital which has been called for
payment is termed as Called up capital.

c) Issued Share Capital: Issued Share Capital is that part of capital that
have been issued to the shareholders. Issued capital shall less than the
Authorised share capital as a company cannot issue capital beyond its
authorised capital.

d) Subscribed Share Capital: Subscribed share capital is the value of

shares, for which investors have promised to buy when they are
released. Subscribed share capital is usually part of an IPO.

e) Unsubscribed Share Capital: The un-allotted capital out of the

subscribed share capital is called Unsubscribed Share Capital.

f) Paid-up Share Capital: Paid up share capital is the aggregate amount

of money received from the shareholders for shares issued.

A foreign company is one that is:

A Incorporated or registered in India but has a place of business or operations

outside India
B Incorporated or registered outside India and has a place of business or
operations outside India
C Incorporated outside India and has a place of business in India and conducts
any business activity in India in India
D None of the above

3. Understand the provisions of the Companies Act relating to

maintenance of proper books of accounts
[Learning Outcome c]
3.1 Legal Requirements of Company Accounts

For better understanding of the company accounts and preparation of financial

statements in compliance of the statutory requirements the readers and
students are required to devote special attention to the provisions of the
following Sections of the Companies Act 2013.

144
Sec. of Co’s Act 2013 Reference
2(13) Books of Accounts and records to be maintained
128 Books of Accounts to be kept by company
129 Financial Statement
133 Central Govt. to prescribe Accounting Standards
134 Financial Statement, Board’s Report etc.
143 Powers and duties of auditors and auditing standards

3.2 Books of Accounts to be maintained by company - S.2(13)

As per Sec. 2(13) books of account of a company includes records maintained in
respect of
a) all sums of money received and expended by a company and matters in
relation to which the receipts and expenditure take place;
b) all sales andurchases of goods and services by the company;
c) the assets and liabilities of the company; and
d) the items of cost as may be prescribed under section 148 in the case of a
company which belongs to any class of companies specified under that sec

3.3 Books of account, financial statement to be prepared by company

Under sec.128 (1) of the Act every company shall prepare and keep at its
registered office books of account and other relevant books and papers and
financial statement for every financial year which give a true and fair view of
the state of the affairs of the company, including that of its branch office or
offices, if any, and explain the transactions effected both at the registered
office and its branches and such books shall be kept on accrual basis and
according to the double entry system of accounting:

Provided that all or any of the books of account aforesaid and other relevant
papers may be kept at such other place in India as the Board of Directors may
decide and where such a decision is taken, the company shall, within seven days
thereof, file with the Registrar a notice in writing giving the full address of that
other place:

Provided further that the company may keep such books of account or other
relevant papers in electronic mode in such manner as may be prescribed.

Sec.128(2) refers where a company has a branch office in India or outside India,
it shall be deemed to have complied with the provisions of sub-section (1), if
proper books of account relating to the transactions effected at the branch
office are kept at that office and proper summarized return periodically are
sent by the branch office to the company at its registered office or the other
place referred to in sub-section (1).

145
Sec.128(3) tells that the books of account and other books and papers
maintained by the company within India shall be open for inspection at the
registered office of the company or at such other place in India by any director
during business hours, and in the case of financial information, if any,
maintained outside the country, copies of such financial information shall be
maintained and produced for inspection by any director subject to such
conditions as may be prescribed:

Sec.128(5) mentions the books of account of every company relating to a period

of not less than eight financial years immediately preceding a financial year, or
where the company had been in existence for a period less than eight years, in
respect of all the preceding years together with the vouchers relevant to any
entry in such books of account shall be kept in good order:

As per Companies Act 2013, for existing companies, books of account along with
relevant vouchers must be preserved in good order for a minimum period of:

A 5 years
B 7 years
C 8 years
D 10 years

4. Learn about Forms, Contents and Legal Requirements for

preparation & presentation of Financial Statements
[Learning Outcome d]
4.1 Provisions of Section 129
As required by Sec.129 (1) of the Companies Act 2013, the financial statements
shall give a true and fair view of the state of affairs of the company or
companies, comply with the accounting standards notified under section 133
and shall be in the form or forms as may be provided for different class or
classes of companies in Schedule III (discussed hereinafter in detail along with
general instructions and forms).
However, the above provisions contained in Sec.129 (1) shall not apply to any
insurance or banking company or any company engaged in the generation or
supply of electricity, or to any other class of company for which a form of
financial statement has been specified in or under the Act governing such class
of company. Accordingly, preparation of Financial Statements of an insurance
company, must comply with the requirements of the Insurance Act, 1938, or the
Insurance Regulatory & Development Authority Act, 1999 and the specified

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Regulations on preparation of financial statements which have been discussed
elaborately in chapters 10, 11 & 12.
Hereinafter we will discuss the statutory provisions as set out by the companies
Act 2013, which are to be followed for preparation of financial statements for
companies other than insurance company, banking company and few others
which are subject to specific law, rules and regulations.

Sec. 129 (2) of the Act provides that at every annual general meeting of a
company, the Board of Directors of the company shall lay before such meeting
financial statements for the financial year.
Further, section 129 (3) provides that where a company has one or more
subsidiaries or associates companies it shall, in addition to financial statements
provided under sub-section (2), prepare a consolidated financial statement of
the company and of all the subsidiaries and associates in the same form and
manner as that of its own which shall also be laid before the annual general
meeting of company along with the laying of its financial statement under sub-
section (2):

As per Sec 133 of the Act which provides for requirement of compliance of
Accounting Standards the Central Government may prescribe the standards of
accounting or any addendum thereto, as recommended by the Institute of
Chartered Accountants of India, constituted under section 3 of the Chartered
Accountants Act, 1949, in consultation with and after examination of the
recommendations made by the National financial Reporting Authority.
4.2 Financial Statements and Board’s Report
Sec. 134 (1) of the Act provides that:
1. The financial statement, including consolidated financial statement, if any,
shall be approved by the Board of Directors before they are signed on behalf
of the Board at least by the chairperson of the company where he is
authorised by the Board or by two directors out of which one shall be
managing director and the Chief Executive Officer, if he is a director in the
company, the Chief Financial Officer and the company secretary of the
company, wherever they are appointed, or in the case of a One Person
Company, only by one director, for submission to the auditor for his report
thereon.
2. Sec 134 of the Act further requires that auditors’ report shall be attached to
every financial statement and there shall be attached to statements laid in
general meeting, a report by its Board of Directors, which shall include—

a) The extract of the annual return as provided under Sec. 92(3)

b) Number of meetings of the Board

c) Directors’ Responsibility Statement

147
d) A statement on declaration given by independent directors under
Sec.149 (6)

e) In case of a company covered under Sec. 178 (1), company’s policy on

directors’ appointment and remuneration including criteria for
determining qualifications, positive attributes, independence of a
director and other matters provided und sec.178(3) of the Act 2013.

f) Explanations or comments by the Board on every qualification,

reservation or adverse remark or disclaimer made by i) the auditor in
his report; and (ii) by the company secretary in practice in his
secretarial audit report;

g) Particulars of loans, guarantees or investments under section 186;

h) Particulars of contracts or arrangements with related parties referred to

sec.188(1)

i) The state of the company’s affairs;

j) The amounts, if any, which it proposes to carry to any reserves;

k) The amount, if any, which it recommends should be paid by way of

dividend;

l) Material changes and commitments, if any, affecting the financial

position of the company which have occurred between the end of
financial year of the financial statements and the date of the report;

m) The conservation of energy, technology absorption, foreign exchange

earnings and outgo, in such manner as may be prescribed;

n) A statement indicating development and implementation of a risk

management policy for the company including identification therein of
elements of risk, if any, which in the opinion of the Board may threaten
the existence of the company;

o) The details about the policy developed and implemented by the

company on corporate social responsibility initiatives taken during the
year;

p) In case of a listed company and every other public company having such
paid-up share capital as may be prescribed, a statement indicating the
manner in which formal annual evaluation has been made by the Board
of its own performance and that of its committees and individual
directors;

q) Such other matters as may be prescribed

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Preparation of Financial Statements

From the following Trial Balance of M/s Ma Durga Chemical Ltd for the year ended 31 st
March 2021 you are required to prepare financial statements for the year ended 31 st
March 2021 in accordance with provisions of the Companies Act,2013.

Trial Balance as on 31.03.2021

DEBIT Balances Rs. CREDIT Balances Rs.

Investment in Equity Shares 26,50,000 Share Capital 2,50,00,000

Land & Building 1,54,60,000 10% Debenture 50,00,000
Plant &Machinery 86,00,000 Bank Loan 64,50,000
Furniture &Fixtures 55,00,000 Bills Payable 12,50,000
Debtors 28,70,000 Creditors 15,60,000
Bills Receivable 1530,000 Sale of Products 4,47,90,000
Stock In Trade 68,00,000 Sale of Service 39,60,000
Tools & Equipment 26,00,000 Rent Received 5,60,000
Loans to Directors 8,00,000 Dividend Received 2,50,000
Staff Welfare 4,00,000 Profit & Loss A/c (B/F) 13,90,000
Contribution to PF 3,50,000
Advertisement &Publicity 2,00,000
Commission &Discount 12,00,000
Purchase of Raw-materials 2,31,90,000
Rent, Rates& Taxes 2,50,000
Cash at Bank 4,50,000
Cash in Hand 80,000
Interest on Bank Loan 11,60,000
Repairs & Maintenance 1,00,000
Wages & Salaries 90,00,000
Power & Electricity 8,40,000
Transit Insurance 3,00,000
Trade Expenses 9,30,000
Fuel Consumed 5,40,000
Debenture Interest 2,00,000
Excise Duty 42,10,000
TOTAL 9,02,10,000 9,02,10,000

Additional aspects to be considered in preparation of Financial Statements are;

i. Closing Stock of Finished Goods worth Rs.70,00,000 as on 31. 03.2021
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ii. Opening Stock of Finished Goods worth Rs68,00,000 as on 01. 04.2020
iii. Out of total purchase of raw-materials for Rs.2,31,90,000, unused raw-materials
amount Rs.30,000. There was no opening stock of raw-materials.
iv. Depreciation to be provided as follows; Machinery @10%, Land & Building @5%,
Furniture& Fixtures @10% and Tools & Implements @ 5%
v. Debenture Interest in Trial Balance is the amount paid.
vi. Dividend proposed @ 10%. Provision for Taxation to be made @ 30% of net profit

Solution:

Statement of Profit and Loss for the year ended 31st March 2021

Note 1) REVENUE:
1 a) Revenue from Operation 4,87,50,000
Less: Excise Duty 42,10,000
4,45,40,000
b) Other Income 8,10,000
TOTAL REVENUE 4,53,50,000
2 EXPENSES:
a) Raw Materials Consumed (2,31,90,000-30,000) 2,31,60,000
b) Purchase of Finished Goods 0
c) Changes in Inventories of Finished Goods -2,00,000
d) Employee Benefits 97,50,000
e) Depreciation & Amortization 23,13,000
f) Finance Costs 16,60,000
g) Other Expenses 43,60,000
TOTAL EXPENSES 4,10,43,000
3 PROFIT BEFORE EXCEPTIONAL ITEMS AND TAX (1 -2) 43,07,000
4 Exceptional Items 0
5 PROFIT BEFORE TAX 43,07,000
6 Taxes:
Current Tax (30% on 43,07,000) 12,92,100
Deferred Tax 0 12,92,100
7 PROFIT AFTER TAX 30,14,900

Notes to Statement of Profit & Loss for the year ended 31st March 2021
1.a) Revenue from Operation
Sale of Products 4,47,90,000
Sale of Service 39,60,000
4,87,50,000
1.b) Other Income

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Rent Received 5,60,000
Dividend Received 2,50,000
8,10,000

2.c)Changes in Inventories of Finished Goods

Closing Stock 70,00,000
Opening Stock 68,00,000
Increase in stock 2,00,000
2.d) Employee Benefits
Wages & Salaries 90,00,000
Staff Welfare 4,00,000
Contribution to PF 3,50,000
97,50,000
2.e) Depreciation & Amortization
Asset Value Dep.
Machinery @10% 86,00,000 8,60,000
Land & Building @5% 1,54,60,000 7,73,000
Furniture& Fixtures @10% 55,00,000 5,50,000
Tools & Implements @ 5% 26,00,000 1,30,000
23,13,000
2.f) Finance Costs
Interest on Bank Loan 11,60,000
Debenture Interest 2,00,000
Interest O/S(Due 10% 5,00,000 – 2,00,000 paid) 3,00,000
16,60,000
2.g) Other Expenses
Advertisement &Publicity 2,00,000
Commission &Discount 12,00,000
Rent, Rates& Taxes 2,50,000
Repairs & Maintenance 1,00,000
Power & Electricity 8,40,000
Transit Insurance 3,00,000
Trade Expenses 9,30,000
Fuel Consumed 5,40,000
43,60,000

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 Balance sheet as at 31st March, 2021

Particulars Note As on 31.03.2021

No.

I EQUITY AND LIABILITIES

1 Shareholders’ Funds
(a) Share capital 2 2,50,00,000
(b) Reserves and surplus 3 19,04,900
2 Share Appl. money pending allotment
NIL
3 Non-current liabilities
(a) long-term borrowings 4 1,14,50,000
(b) Deferred tax liabilities (Net)
(c) Other long term liabilities
(d) long-term provisions
4 Current liabilities
(a) Short term borrowings
(b) Trade payables 5 28,10,000
(c) Other current liabilities
(d) Short-term provisions 6 40,92,100
TOTAL EQUITY AND LIABILITIES 4,52,57,000

II ASSETS
1 Non-current assets
(a) Fixed Assets
i) Tangible assets 8 2,98,47,000
(ii) Intangible Assets
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-current Investments 9 26,50,000
(c) Deferred tax assets (net)
(d) Long-term Loan and Advances
(e) Other Non-current assets
2 Current assets
(a) Current investments
(b) Inventories 10 70,30,000
c) Trade receivables 11 44,00,000
(d) Cash and cash equivalents 12 5,30,000
(e) Short-term loans and advances
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 (f) Other current assets 13 8,00,000
TOTAL ASSETS 4,52,57,000

Notes to Balance Sheet:

Note 2 Share capital

Paid-up capital 2,50,00,000

Reserves & Surplus:

Note 3

General Reserve 0
Profit & Loss A/c as per last account 13,90,000
Profit After TAX (PAT) 30,14,900
Less: Proposed Dividend (10% on capital) 25,00,000
Net Balance 19,04,900

Note 4 Long Term Borrowings

Secured Loan - 10%
Debentures 50,00,000
Bank Loan
64,50,000
1,14,50,000
Note 5 Trade payables
Bills Payable 12,50,000
Creditors 15,60,000
28,10,000
Note 6 Short-term provisions
Provision for Taxation 12,92,100
Proposed Dividend 25,00,000
OS Debenture Interest 3,00,000
40,92,100
Note 8 Fixed Assets Op. WDV Depreciation Clg. WDV
Land & Building 1,54,60,000 7,73,000 1,46,87,000
Plant &Machinery 86,00,000 8,60,000 77,40,000
Furniture &Fixtures 55,00,000 5,50,000 49,50,000
Tools & Implements 26,00,000 1,30,000 24,70,000
3,21,60,000 23,13,000 2,98,47,000

9 Non-current Investments
Investment in Equity Shares 2650000
10 Inventories

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 Clg. Stock of Finished Goods 70,00,000
Clg. Stock of Raw Materials 30,000
70,30,000
11 Trade Receivables
Debtors 28,70,000
Bills Receivable 15,30,000
44,00,000
12 Cash and cash equivalents
Cash at Bank 4,50,000
Cash in Hand 80,000
5,30,000
13 Short-term loans and advances
Loans to Directors 8,00,000

3.3 Certain Special items in Trial Balance

1. Calls in-Arrear: When this item generally appears in the Trial Balance, it
represents the amount not paid by the shareholders on the calls made by
the company on shares. This needs adjustment to be shown in Balance
sheet. In the liability side this amount is deducted from the Called-Up and
Paid Up Capital.

2. Unclaimed Dividend; It represents the amount of dividend not collected by

the shareholders. It is to be shown on the liability side of Balance Sheet
under the head “Current Liabilities”

3. Interim Dividend: Under Sec.81 of the Companies Act 2013 the Board may
from time to time pay to the members such interim dividends as appear to it
to be justified by the profits of the company Subject to the provisions of
section 123.

Under Sec. 123(3), the Board of Directors of a company may declare interim
dividend during any financial year out of the surplus in the profit and loss
account and out of profits of the financial year in which such interim
dividend is sought to be declared, provided that in case the company has
incurred loss during the current financial year up to the end of the quarter
immediately preceding the date of declaration of interim dividend, such
interim dividend shall not be declared at a rate higher than the average
dividends declared by the company during the immediately preceding three
financial years.

4. Proposed Dividend: This item represents dividend proposed and declared by

the company in the General Meeting, which is to be paid in accordance with
the provisions of the Companies Act 2013. Till now, it was shown on the
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 liability side of Balance Sheet under the heading “provisions”. Since there is
no Profit & Loss Appropriation under the provisions of Sec.129 and Schedule
III, all appropriations interim dividends, proposed Dividends are shown as
movement in Reserves and Surplus Account.

As per the amendment made in accounting standard 4, proposed dividend

for a year is not a liability till it has been approved by the shareholders. As
per AS 4 (revised) / Ind-AS 10 and schedule III, the dividend does not
become a liability to the company till the time it is approved by the
shareholders. Once the dividend is declared /approved by the shareholders,
it becomes a liability of the company and has to be paid within 30 days of
declaration. From the above, it is apparent that ‘Proposed Dividend’ is not a
liability. Therefore, proposed dividend shall be shown under the ‘Notes to
Accounts’ and not under the Balance Sheet in the financial statements.

5. Dividends Received: This represents dividend received on company’s

investments in shares.

6. Interest Received: An adjustment entry is required to be passed for

“Interest Received A/C if shown in Trial balance for the net amount (net of
tax) for Rs15,800. Under sec.194A of the Income Tax Act 1961, banks are
required to deduct tax on interest payable to a domestic company.

For example X Ltd. received Interest from bank deposits for Rs15,800 after
deduction of Tax at source for Rs.4,200. X Ltd is required to pass the
following adjustment entry to show the gross amount of Interest Received
A/C in the final accounts if Trial Balance shows the net amount of Rs15,800.

Bank a/c Dr. 15,800

Tax Deducted at Source A/c Dr. 4,200
Interest Received A/C Cr. 20,000

With this adjustment entry, Interest Received A/c will be Rs. 20,000, which
will be shown in the profit and loss account and Tax Deducted at Source A/c
for Rs. 4,200 will appear on the asset side of the Balance Sheet till the same
is adjusted against total tax liability of the company.
7. Interest on Debentures Issued: When a company pays interest on
Debentures, it is required to deduct tax at source. Suppose TDS on interest
is @20%.
If X Ltd pays interest on debenture for Rs.1,00,000, it is required to deduct
tax for Rs20,000 which is to be deposited by the company as per the
provisions of the Income Tax Act. The accounting entry for payment of
debenture interest for Rs.100,000 will be as under:

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 Interest on debenture A/c Dr. 1,00,000
Tax Deducted at Source A/c Cr. 20,000
Bank a/c Cr. 80,000

With this entry, Interest on Debenture A/c will be Rs.1,00,000, which will be
shown in the profit and loss account as Expenses and Tax Deducted at
Source A/c for Rs. 20,000 will appear on the liability side of the Balance
Sheet till the same is deposited.

8. Discount & Cost of Issue of Debenture A/c: This represents Discount,

Commission and other expenses incurred on issue of debentures. This
appears on the asset side of the Balance Sheet under the head
“Miscellaneous Expenditure” till the same is fully written off. This
expenditure is written off prudently over the period of the life of
debentures. This expenditure written off is shown in the Profit & Loss
Account with the following adjustment entry:

The balance amount unwritten off will appear in the balance sheet.

The form and contents of Balance Sheet and Statement of Profit and loss is for
companies are prescribed by:

A Schedule III & Section 129 of the Companies Act, 2013

B Accounting Standards issued by ICAI
C Reserve Bank of India
D No format prescribed

5. Understand taxation and its accounting treatment in Final Accounts

[Learning Outcome e]

Taxation and Accounting Treatment: We generally come across the following

items of taxation in the books of accounts of a company. The students should
understand the implication of the same and necessary accounting treatments or
adjustments thereof:

a) Tax Deducted at Source

b) Advance Payment of Tax
c) Income Tax (Corporate Tax)
d) Provisions for Taxation
e) Deferred Tax

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These items are explained below to show as to how they will be dealt with in
the preparation of the final accounts;

5.1 Tax Deducted at Source

As mentioned in point no. 5 for Dividends Received and point no.6 for Interest
Received, Dividend or Interest Received are to be entered for the gross amount.
Debit balance of Tax Deducted at Source A/c for Rs. 4,200 will appear on the
debit side of the Trial Balance and will be adjusted against the income tax
payable after the assessment is over.

5.2 Advance Payment of Tax

Under Sec 208 of the Income Tax Act 1961, the assessee is liable to pay advance
tax when the income exceeds a certain limit. In case of companies, advance tax
is payable during a financial year, only when the amount of such advance tax
payable during that year is Rs.10,000- or more.

Advance Tax must be paid on or before due dates as per the table given below.
(Section 211 of Income Tax Act, 1961) (Applicable for the FY 2021-22)

Due date % of amount of advance tax payable.

15th Jun. Not less than 15% of Advance Tax liability.
15th Sep. Not less than 45% of Advance Tax liability, less already paid
15th Dec. Not less than 75% of Advance Tax liability, less already paid
15th Mar. Total Advance Tax liability, less already paid

For payment of advance tax, companies have to estimate their income tax
liability for the financial year in the beginning of the year while paying each
instalment of advance tax.

5.3 Income Tax

This represents the amount of tax payable on the assessed income. As

mentioned earlier, Advance Payment of Tax and Tax Deducted at source are
adjusted deducted from the total tax payable on the assessed income and then
the net amount is paid.
For example; The tax payable on the assessed income of the X Ltd. for the
financial year is Rs. 1,00,000 while it has already paid advance tax for Rs.
70,000 and has proof of TDS certificate for Rs. 10,000. Now the company will
pay the balance amount of Rs. 20,000. When this Rs. 20,000 is paid, the
following entry will be passed:

Income Tax A/c Dr. 1,00,000

Advance Tax A/C Cr. 70,000
Tax Deducted at Source A/C Cr. 10,000
Bank a/c Cr. 20,000
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 Both Advance Payment of Tax A/C and Tax Deducted at Source A/C will appear
in the Balance Sheet under the head ‘Loans & Advances’ till assessment is
completed.

5.4 Provisions for Taxation

As it takes time to get income assessed in consideration of admissibility of all

payments and taxability of all incomes, company is required to provide for tax
liability on the profits at the current rates.

Provision for Taxation appears in the liability side of the balance sheet under
the head “Provisions” in the broad head “Current Liabilities and Provisions”

5.5 Deferred Taxes – Assets and Liabilities

a) Current Tax

As mentioned earlier after preparation of profit and Loss Account, Tax on profit
is estimated and provided in the profit and loss account on accounting income,
ie, Profit Before Tax. Accounting income is the net profit for a period as
reported in Profit and Loss Account.

Taxable income is the income determined in accordance with the tax laws
(Income Tax Act 1961 and Income Tax Rules), based on which income tax is
payable for a period.

Thus, Accounting income is different from taxable income.

b) Tax Expenses and Deferred Tax

The difference between tax on accounting income and taxable income is called
‘Deferred tax’. Deferred tax is the effect of timing differences. The tax to be
charged to Profit and loss account is ‘Tax Expenses’ which include Current Tax
plus Deferred Tax. Deferred Tax arising out of timing difference included in the
tax expenses is shown in the Balance Sheet as ‘Deferred Tax Assets or Deferred
Tax Liabilities, as the case may be.

Eg. When we calculate accounting income, we charge depreciation rates as per

Companies Act. When we calculate taxable income, we charge depreciation
rates as per Income Tax Act. Thus, there will be a difference between
accounting income and taxable income.

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c) Deferred Tax Assets

A deferred tax asset comes into existence when taxable income is more than
accounting income and this is due to time difference. There could be many
reasons for such difference.

One of the major reasons is expenses deducted as per accounting principles and
practice, but not considered by tax authorities as deductible or admissible
expenditure.

The most common example is Provision for doubtful debts showing the
accounting income, but such item is not deductible as per Income tax laws
unless and until it crystallizes.

Following example will clarify the accounting treatment of deferred tax asset.

Accounting income of a company after making provision for bad debt of Rs.
10,00,000 is Rs. 90,00,000 in 2015-16, while taxable income at the end of the
financial year will be Rs. 1 crore. Tax authorities will allow Bad Debt as
Admissible Expenses when it will be actually established or crystallized. Tax
rate is 35%. The workings for provisions for taxation for the year 2020-21 is as
below.

Solution:

Particulars 2015-16 2020-21

Profit 1,00,00,000 1,00,00,000
Less: Bad debt - 10,00,000
Taxable profit 1,00,00,000 90,00,000
Less Tax at 35% 35,00,000 31,50,000

This difference of Rs. 3,50,000 (35 lakhs – 31.50 lahks) is called as deferred tax.

d) Deferred Tax Liability; Deferred Tax Liability arises when taxable income is
less than accounting income. There could be many reasons for Taxable
income to be less than accounting income. One of the major reasons is
depreciation on assets. As per income tax laws, depreciation is charged on
fixed assets on WDV basis, while in accounts it may be on straight-line
method.

In the financial statement of M/S XYZ Ltd. Depreciation on Fixed assets, which
is charged to Profit & Loss A/c on straight line method is Rs.10,00,000 while
depreciation allowed on fixed assets as per tax laws at the specified rate
159
amounts to is Rs.12,00,000 in 2015-16 / 202-21. Accounting income is
Rs.20,00,000. The working is as below, assuming Tax @35%.

Accounting income is Rs.20,00,000; Tax on Accounting income is Rs.7,00,000.

Taxable income is Rs.18,00,000; Current Tax is Rs.6,30,000. Thus current tax is
Rs.630,000, while tax expense is Rs.7,00,000.

This time difference of Rs.70,000 is Tax liability for future.

e) Deferred Tax - Situations and treatment

Deferred tax due to time difference originates in the current year and reverses
in the subsequent years when the difference ceases to exist. There are many
situations where such time difference arises. Following are the few instances of
such situations or cases

i) Depreciation accounting

 Difference in rates of depreciation in Financial accounting and tax laws

 Difference in depreciation methods in Financial accounting and tax laws
 Difference in consideration of costs of Asset in Financial accounting and
tax laws

ii) Difference in recognition and treatment of expenditure: Certain expenses

are debited to Profit & Loss Account on accrual basis, but allowed by tax
authorities for the purpose of computation of tax liability in subsequent
years as and when the expenses are paid. (Examples Excise duty, cess, fees
etc.)

iii) Difference in recognition and treatment of Income: Sometimes incomes

are recognized in accounts over the years according to periodicity of earning
and expenditure applying matching principles, but for taxation purpose, it is
considered and recognized in the year of receipt. Sometimes certain
incomes are credited to Profit & loss A/c, but taxed in the subsequent
years.

iv) Provisions for contingencies: Provisions for contingencies such as provision

for bad debts are debited in the profit & loss Account, but they are
considered admissible as and when crystallized.

v) Amortization of expenses: Certain expenditure like expenditure on

research and development are fully considered in one year, while in
financial accounting it is spread over a period.

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When taxable income is more than accounting income it gives rise to
A Deferred tax asset
B Deferred tax liability
C Current tax
D Extraordinary income

Summary
 Schedule III to the Companies Act, 2013, lays down principles for
preparation and presentation of balance sheet as well as statement of profit
and loss for Indian enterprises for the financial years commencing on or
after April 1, 2014.

 As required by the Companies Act, 2013 (Schedule III to the Act) each item
on the face of the Balance Sheet and Statement of Profit and Loss shall be
cross-referenced to any related information in the notes to accounts.

 Under Sec 2(20) of the Companies Act, 2013 “company” means a company
incorporated under this Act or under any previous company law. A company
defined in this sec. may mean either private company or public company.

 There are different types of companies such as Private Company, Public

Company, Government Company, Foreign Company, Holding company and
Subsidiary company.

 As per Sec. 2(13) books of account of a company includes records

maintained in respect of
i. all sums of money received and expended by a company and matters in
relation to which the receipts and expenditure take place;
ii. all sales and purchases of goods and services by the company;
iii. the assets and liabilities of the company; and
iv. the items of cost as may be prescribed under section 148 in the case of a
company which belongs to any class of companies specified under that
section.

 Taxable income is the income determined in accordance with the tax laws
(Income Tax Act 1961 and Income Tax Rules), based on which income tax is
payable for a period.

 The difference between tax on accounting income and taxable income is

called ‘Deferred tax’. Deferred tax is the effect of timing differences. The
tax to be charged to Profit and loss account is ‘Tax Expenses’ which include
Current Tax plus Deferred Tax.

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 A deferred tax asset comes into existence when taxable income is more than
accounting income and this is due to time difference. Deferred Tax Liability
arises when taxable income is less than accounting income.

Answers to Test Yourself

Answer to TY 1
The correct option is D. At every annual general meeting the financial
statements are presented to the shareholders by the Board of Directors.

Answer to TY 2
The correct option is C. Under Sec. 2(42) of the Companies Act “foreign
company” means any company or body corporate incorporated outside India
which: has a place of business in India whether by itself or through an agent,
physically or through electronic mode; and conducts any business activity in
India in any other manner

Answer to TY 3
The correct option is C. In case of existing companies, books of account along
with relevant vouchers must be preserved in good order for a minimum period
of 8 years.

Answer to TY 4
The correct option is A. The form and contents of Balance Sheet and Statement
of Profit and loss is for companies are prescribed by Schedule III & Section 129
of the Companies Act 2013.

Answer to TY 5

The correct option is A. When taxable income is more than accounting income,
it gives rise to Deferred Tax Asset.

Self-Examination Questions

Question 1
The maximum amount beyond which a company is not allowed to raise funds
by issue of shares is:

A. Issued Capital
B. Authorised Capital
C. Paid Capital
D. Subscribed Capital

Question 2
Nominal share capital is:
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 A. That part of the authorised capital which is issued by the company.
B. The amount of capital which is actually applied for by the prospective
shareholders.
C. The maximum amount of share capital which a company is authorised to
issue.
D. The amount actually paid by the shareholders.

Question 3
A public company means a company which:

1. is not a private company

2. is a foreign company
3. is a private company which is a subsidiary of a company which is not a
private company

A. Only (i)
B. (i) and (ii)
C. (ii) and (iii)
D. (i) and (iii)

Answers to Self-Examination Questions

Answer to SEQ 1.

The correct option is B. The maximum amount beyond which a company

is not allowed to raise funds by issue of shares is the authorised capital

Answer to SEQ 2.

The correct option is C. Nominal share capital is the maximum amount of

share capital which a company is authorised to issue.

Answer to SEQ 3.

The correct option is D. All the three points are applicable for a public
company

163
 CHAPTER 3
NON-LIFE INSURANCE BUSINESS ACCOUNTING
METHODS, TECHNIQUES & PROCESS

UNIT-10
GENERAL INSURANCE ACCOUNTING PROCESS &
TECHNIQUES
Chapter Introduction

Accounting Process & Techniques of General Insurance Business comprise

regulatory aspects and technical aspects of accounting. This unit deals with the
fundamentals of general insurance accounting with special emphasis on
accounting framework, certain definitions and interpretations of various terms
and techniques used in the accounting process. The regulatory aspects have
been discussed specifically in the next unit.

a) Discuss the accounting framework with reference to insurance business.

b) Explain the definition and interpretations of various terms and
techniques used in the insurance accounting process.
c) Discuss what is meant by Co-insurance.
d) Discuss the financial reporting requirement for non-life insurance
business, including the requirement to prepare consolidated financial
statements.

164
1. Discuss the accounting framework with reference to insurance
business [Learning Outcome a]

1.1 Accounting Framework in General Insurance Business

The legal aspects of insurance accounting in India are addressed by the primary
legislations which include:
Primary Legislations and Regulations:

1. The Insurance Act, 1938

2. The Insurance (Amendment) Act, 2021(to amend the Insurance Act,
1938)
3. The Insurance Laws (Amendment) Act, 2015 dated 20.03.2015 (to amend
the Insurance Act, 1938 and the General Insurance Business
(Nationalisation) Act, 1972 and to amend the Insurance Regulatory and
Development Authority Act, 1999)
4. The Companies Act, 2013
5. The Companies (Amendment) Act, 2020 (to amend The Companies Act,
2013)
6. The Insurance Regulatory and Development Authority Act, 1999 (as
amended by The Insurance Laws (Amendment) Act, 2015)
7. IRDA (Preparation of Financial Statements and Auditors’ Report of
insurance companies) Regulations, 2002
8. IRDAI (Re-Insurance) Regulations, 2018

The technical aspects of insurance accounting are addressed by the Accounting

Standards, Accounting Conventions, Accounting Process discussed earlier.

The aforesaid legal and technical aspects are taken together for forming the
Accounting Framework or Indian GAAP (Generally Accepted Accounting
Principles) for insurance accounting in India. Accounting Standards mentioned
here are Accounting Standards issued by the Institute of Chartered Accountants
of India. Pertinently, the Accounting Standards issued by the ICAI are being
converged with International Financial Reporting Standards. The accounting
standards, converged with IFRS are called Indian Accounting Standards (Ind-AS).

Section 11 of the Insurance Act 1938 as amended by the Insurance

(Amendment) Act 2021 provides that every insurer, on or after the
commencement of the IRDAI Act, 1999 in respect of insurance business
transacted by him and in respect of his shareholders’ funds, shall at the
expiration of each financial year, prepare:
 Balance Sheet,
 a Profit and Loss account,

165
 Revenue Accounts in accordance with the regulations
 a separate Account of Receipts and Payments (Cash Flow Statement).

Every Insurer shall keep separate accounts relating to funds of shareholders and
policyholders.

The IRDAI (Preparation of Financial Statements and Auditor’s Report of

Insurance Companies) Regulations, 2002 provide that an insurer carrying on
general insurance business shall prepare financial statements in compliance
with the requirements of Schedule ‘B’ to the said regulations. They must
thoroughly understand the requirements of the Regulations before they proceed
to prepare financial statements of a general insurance company.

The format of financial statements as prescribed by Schedule B of IRDAI

(Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002 is covered in detail in Unit 11.

In accordance with the Indian GAAP, the basis adopted for insurance accounting
for determination of underwriting results is:

A Fund Basis
B Annual Basis
C Either Fund Basis or Annual Basis
D None of the above.

2. Explain the definitions and interpretations of various terms and

techniques used in the insurance accounting process.
[Learning Outcome b]

2.1 Underwriting Results

The prime consideration of the insurer, also called the underwriter, is

underwriting results of his insurance business. Underwriting results are
determined on an annual basis by deducting all costs or expenses incurred for
the particular year from the ‘Earned Premium’ in the year.

Costs include:
 Incurred Claim Net
 Commission Net (Acquisition Costs) and
 Operating Expenses

For knowing the underwriting results for each department, revenue accounts
are separately prepared for Fire, Marine and Miscellaneous departments.

166
Revenue Account determines underwriting results as well as Revenue Account
Surplus after adjustment of Investment Income on Policyholders’ fund.

The Fire Department of ABC General Insurance Co Ltd gives the following details
for 2020-21:
Earned Premium is Rs. 900 cr.; Incurred Claim Net Rs. 600 cr.; Commission Net
Rs. 100 cr.; Operating Expenses Rs.190 cr.; Investment Income on Policyholders’
funds (fire) Rs. 210 cr.
Compute Underwriting Results and Revenue Account Surplus for Fire Dept.

Computation of Underwriting Results and Revenue Account Surplus

Rs in Cr. Rs in Cr.
Earned Premium 900
Less: Incurred Claim Net 600
Commission Net 100
Operating Expenses 190 890
Underwriting Results 10
Add: Investment Income on Policyholders’ fund (fire) 210
Revenue A/c Surplus 220

Note: Underwriting Results and Revenue Account Surplus are determined from
the Revenue Account forming part of Financial Statements, discussed in unit 12.

2.2 Premium Income

Premium income is the consideration received from the insured by the

insurance company in accordance with the contract of insurance. This forms a
primary source of income for any insurance company.

In accordance with Part I of Schedule B of IRDAI (Preparation of Financial

Statements and Auditor’s Report of Insurance Companies) Regulations, 2002,
“Premium shall be recognised as income over the contract period or the
period of risk, whichever is appropriate”

Premium income means Net Premium Earned which is determined after

necessary adjustments shown in the below table. Earned premium is the
proportion of written premiums (including, where relevant, those of prior
accounting periods) attributable to the risks borne by the insurer during the
accounting period.

Net Premium Earned is determined after adjustment for ‘Reinsurance Premium’

and ‘unearned premium’ from Written Premium in the year. Written premiums
under annual basis comprise all premiums relating to policies incepted in the
167
accounting period, though they would expire during or after the accounting
period.

They will include the premium for the whole of the period of risk covered by
the policies. Written premiums are also subject to adjustments for the premium
pertaining to unexpired risks.

Gross Direct Premium GDP

Add: Reinsurance premium accepted
Gross Written Premium GWP
Less: Reinsurance Premium Ceded
Net Written Premium NWP
Adj: Change in unexpired risk reserve ( + / - )
Net Earned Premium NEP

2.3 Technical Reserves –

1. Unearned premium reserve (UPR):

Technical reserves are also referred to as reserves for Unearned premium /

Unexpired Risk. Most of the general insurance policies are annual policies,
which are issued throughout the year. The technical reserves are created in
respect of such policies that extend beyond the reporting date into the
following years during which the coverage of risk continues. In other words, this
reserve is created to meet the claims which arise when the policies mature in
the subsequent years.

Policy period: 01.07.2020 to 30.06.2021; Accounts closing date: 31.03.2021

Earned Period (9/12) Unearned Period (3/12)

01.07.2020 31.03.2021 30.06.2021

Per Section 64 V(1) (ii) (b) of The Insurance Act 1938, as amended by the
Insurance Laws (Amendment) Act 2015 on the reporting date, a liability for
unexpired risk reserve is created for the policies which extend beyond the
reporting date.

A provision for unearned premium is made normally at 50% in the case of Fire
and Miscellaneous insurance and 100% of in the case of Marine Insurance. This
reserve is based on the net premium income earned by the insurance company
during the year.

168
However, in this context, IRDAI has issued a circular Ref.:
IRDA/F&A/CIR/CPM/056/03/2016 dated April 4, 2016 for providing unearned
premium reserve (UPR). As per said circular the unearned premium reserve
(UPR) shall be computed as under.

Marine Hull: 100% of Net written premium during the preceding 12 months.
Other 50% of net written premium of preceding 12 months
segments: or
1/365th method on the unexpired period of respective policies

Accordingly, an option is given by IRDAI to insurance / Reinsurance companies

to follow either ‘Percentage method’ or ‘1/365 method’ for computation of UPR
of the other segments (excluding marine hull where 100% of net written
premium is required to be provided).

Once a method is selected, insurers should follow the same method in a

consistent manner. Any change in the method of UPR is possible only with the
prior written approval of the authority.

2. Premium Deficiency Reserve (PDR): There may be situations where the

insurer expects that the unearned premium may not be sufficient to cover the
amount of risk perceived. Any expectation that the unearned premium reserve
(UPR) will be insufficient to cover the cost of claims and related expenses
incurred during the period of unexpired risk will required to provide for the
shortfall between unearned premium reserve and the expected claim cost. Such
deficiency shall be shown as “Premium Deficiency Reserve” (PDR).

3. Unexpired risk reserve (URR): While unearned premium reserve (UPR)

minimums are set by law, an unexpired risk reserve (URR) is voluntary.

Unexpired risk reserve is the sum total of Unearned Premium Reserve and
Premium Deficiency Reserve.

URR = UPR + PDR

The Fire Department of ABC General Insurance Co Ltd gives the following details
for 2020-21: Gross Direct Premium Income Rs. 981cr.; Premium on Reinsurance
Accepted Rs. 343 Cr.; Premium on Reinsurance Ceded Rs. 437 cr.; Net Premium
for 2019-20 Rs. 913 cr.

Calculate Net Premium Account

Solution:
Particulars (Rs. in cr.)
Gross Direct Premium Income (Fire) 981
169
 Add: Premium on Reinsurance Accepted 343
Less: Premium on Reinsurance Ceded (437)
Net Premium 887
Change in Reserve in Unexpired Risks 50% (913-887) (+)13
Net Premium Earned (2020-21) 900

The following is the information pertaining to New Imperial Insurance Co. Ltd:
i) On 31.03.2020 the reserves for unearned premium reserves were as follows:
 Marine - Rs. 22.50 cr.; Fire - Rs. 30.00 cr.; Misc. - Rs. 7.50 cr.

ii) During 2020-21, the following business was conducted: Rs. In Cr.
Premium from Marine Fire Miscellaneous
(a) Direct business 27.00 64.50 18.00
(b) Reinsurance accepted 10.50 7.50 6.00
( C) Reinsurance ceded 10.00 6.40 10.50

Show the accounting treatment of Unearned premium reserve for the year
ended 31.03.2021.

Solution:

Workings:
Premium from: Marine Fire Misc.
Direct business 27.00 64.50 18.00
Add: Reinsurance accepted 10.50 7.50 6.00
Less: Reinsurance ceded 10.00 6.40 10.50
Earned premium 27.50 65.60 13.50
Reserve (Marine 100%; Others 50%) 27.50 32.80 6.75

Unearned Premium Reserve A/c

(Rs in crores)
Marine Fire Misc. Marine Fire Misc.
To Revenue A/c - - 0.75 Balance b/d 22.50 30.0 7.50
To Balance c/d 27.50 32.80 6.75 By Revenue A/c 5.00 2.80 -
27.50 32.80 7.50 27.50 32.80 7.50

Instead of calculating the differential for the unexpired risk reserve account,
the opening balances of unexpired risk reserves may be reversed at the start of
the year by transferring the entire balance in the reserve account to the
revenue account and then providing for fresh reserve of the full required
amount at the end of the year.

170
2.4 Claim Expenses
Claim Expenses mean ‘Incurred Claim’. Incurred Claim is the major cost in a
general insurance business. Claim expenses generally amount to more than 70%
of premium income. A claim is incurred when the event giving rise to a claim
has occurred.

Under Annual Basis accounting, ‘claims incurred’ include

‘paid claims’
+ ‘outstanding claims at the end of the year’
- ‘outstanding claims at the beginning of the year’

Claim expenses also include all internal and external expenses incurred in the
handling of claims in connection with surveys, inspection, negotiation and
settlement. Outstanding claims include amounts provided to cover the
estimated ultimate cost of settling claims arising out of events which have
occurred by the balance sheet date. Incurred Claim considered in the Revenue
Account is Claims Incurred Net, which is calculated after adjustment of Claims
on Reinsurance and Outstanding Claims with Paid Claims.
Claims include all claims related expenses paid (legal fees, survey fees etc.)
The format to calculate claim expenses is:
Rs.
Claims paid during the year—direct …
Add: Claims paid during the year—re-insurance accepted …
Less: Claims received during the year—re-insurance ceded …
Net Claims paid …
Add: Outstanding claims at the end of the year (After deducting …
recoverable from co-insurers and re-insurers)
Less: Outstanding claims at the beginning of the year (after …
deducting recoverable from co-insurers and re-insurers)
Incurred claims (Net) …

The Fire Department of ABC General Insurance Co. Ltd gives the following
details for 2019-20:

 Fire Claims Paid Rs.705 crore

 Claims on Reinsurance Accepted Rs.144 crore
 Claims on Reinsurance ceded Rs.292 crore
 Claims outstanding as on 01/04/2019 Rs.756 crore
 Claims outstanding as on 31/03/2020 Rs.800 crore
Calculate Claims Incurred Net, which have been shown in the Revenue
Account for the year ended 31st March 2020.

171
Solution

Fire Claims Incurred Net

(Rs. in Crore)
Fire Claims Paid 705
Add: Claims on Reinsurance Accepted 144
Less: Claims on Reinsurance ceded 292
Net Claims Paid 557
Add: Claims Outstanding as on 31.3.2020 800
Less: Claims outstanding as on 1.4.2019 756
Claims Incurred (Net) 601

From the following, you are required to calculate the total claims incurred to
be shown in the revenue account for the year ending 31st March, 2021:

Claim intimated in Claim admitted Claim paid in Rs

the year in the year the year
2019-20 2019-20 2020-21 30,000
2020-21 2020-21 2021-22 20,000
2018-19 2019-20 2019-20 10,000
2018-19 2019-20 2020-21 24,000
2020-21 2021-22 2021-22 16,000
2020-21 2020-21 2020-21 2,04,000

Claim on account of reinsurance ceded was Rs. 50,000.

Solution:

Schedule 2: Schedule 2 is prepared in accordance with IRDA (Preparation of

Financial Statements and Auditor’s Report of Insurance Companies) Regulations,
2002. This is covered in detail in Unit 11.

Workings: We have to identify

1. the claims which are paid in 2020-21
2.the claims which are outstanding at the end of the year 31.03.2021
3.the claims which are outstanding at the beginning of the year 31.03.2020

Claims paid in 2020-21:

Claim intimated in Claim admitted Claim paid in Rs
the year in the year the year
2019-20 2019-20 2020-21 30,000
2018-19 2019-20 2020-21 24,000
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 2020-21 2020-21 2020-21 2,04,000
TOTAL 2,58,000

Claims outstanding as on 31.03.2021:

Claim intimated in Claim admitted Claim paid in Rs
the year in the year the year
2020-21 2020-21 2021-22 20,000
2020-21 2021-22 2021-22 16,000
TOTAL 36,000

Claims outstanding as on 31.03.2020:

Claim intimated in Claim admitted Claim paid in Rs
the year in the year the year
2019-20 2019-20 2020-21 30,000
2018-19 2019-20 2020-21 24,000
Total 54,000

Particulars Rs
Claims paid Direct in 2020-21 2,58,000
Add: Re-insurance accepted -
Less: Re-insurance ceded 50,000
Net claims paid 2,08,000
Add: Claims outstanding at the end of the year i.e.
intimated in 2020-21 whether accepted in 2020-21 or in
2021-22 36,000
Less: Claims outstanding at the beginning of the year i.e.
intimated in 2019-20 or earlier whether accepted in 2019-
20 or accepted in 2020-21 (54,000)
Total claims incurred 1,90,000

2.5 Acquisition Cost

Acquisition costs, if any, shall be expensed in the period in which they are
incurred. Acquisition costs are those costs that vary with, and are primarily
related to, the acquisition of new and renewal insurance contracts. The most
essential test is the obligatory relationship between costs and the execution of
insurance contracts (i.e. commencement of risk). They are also called as
Business procurement expenses.

Costs incurred for procurement of business or for conclusion of insurance

contracts with clients through agents, brokers, corporate agents, bank under
bancassurance or other intermediaries are called acquisition costs.

173
In general insurance business, acquisition costs are all direct costs incurred on
obtaining or renewing insurance contracts. They include expenses like
commission and brokerage. Furthermore, indirect costs such as advertising costs
or administrative costs also form part of acquisition costs.

'Bancassurance' is a term used to describe the relationship between a bank and

an insurance company whereby the insurance company takes the help of
banking Channels to sell insurance products.

Acquisition costs pertaining to renewal of insurance contracts shall be:

A Expensed in the period in which they are incurred

B Deferred for a period of 2 years
C Deferred for a period of 3 years
D Capitalised in the period in which they are incurred

2.6 Insurance Commission

Commission includes agency commission, brokerage, and corporate agency
commission. Commission/ brokerage becomes payable as soon as business is
underwritten. For the purpose of preparation of Revenue Account, Commission
Net is considered. Commission Net is calculated in the following manner:

Commission paid on Rs.

Direct business …
Add: Re-insurance Accepted …
Less: Commission on Re-insurance Ceded …
Net Commission …

The applicable GST (Goods & Services Tax) on commission paid is borne by the
insurer and paid timely to the authorities. Tax needs to be deducted at source
in accordance with the provisions of the Income Tax Act and is deposited in the
Government account within the prescribed time limit.

Note:
i) No payment of any kind, including “administration or servicing charges” is
permitted to be made to the agent or the broker in respect of the business
in respect of which he is paid agency commission or brokerage.
ii) No brokerage can be paid in respect of an insurance where agency
commission is payable and likewise, no agency commission can be paid in
respect of an insurance where brokerage is payable.

174
2.7 Operating Expenses
Operating expense is a major cost component related to insurance business.
These are generally accounted for under the following heads separately, before
they are clubbed together for the purpose of the Revenue Account. They are
shown under the heads: Employees’ remuneration and welfare expenses,
Travel, conveyance and vehicle running expenses, Training Expenses, Rent,
Rates & Taxes, Repairs & maintenance, Printing & Stationery, Communication
Expenses, Legal & Professional Charges, Auditor’s fees and expenses,
Advertisement & Publicity, Interest & Bank Charges, IT & EDP Expenses,
Depreciation, Provision for Bad & Doubtful Debts, Goods & Services Tax
Expenses (GST expenses) and Others.

Any major expenses in excess of ‘Rs.5 Lakhs’ or in excess of ‘1% of net

premium’, whichever is higher, are required to be shown as a separate line
item.

Incurred Expenses are expenses paid plus expenses outstanding minus prepaid
expenses

These expenses are first aggregated and then apportioned to each class of
business in the ratio of Net Written Premium (NWP) among:
 Fire revenue account
 Marine revenue account
 Miscellaneous revenue account

Section 40C of the Insurance Act, 1938 as amended by the Insurance Laws
(Amendment) Act 2015 prohibits an insurer to incur expenses of management
in excess of the limits prescribed in the Act.

An adequate provision for outstanding expenses is made in the accounts. A

provision for pension, leave encashment, gratuity etc. is made on actuarial
basis.

2.8 Outstanding Claims

A liability for outstanding claims is provided by the insurer at the reporting date
for the estimated cost of all claims outstanding at that date including claims
handling expenses, less amounts already paid.

The provision for claims outstanding at the end of the period would include:
1. Claims intimated
2. Claims related expenses, like survey fees, investigation fees, advocate fees
3. Claims Incurred But Not Reported (IBNR)
4. Inadequate reserves, referred to as Claims Incurred But Not Enough
Reported (IBNER)]

175
Whilst general insurance policies will normally specify the type of risks insured
against and the cover provided, the amount of a claim under such a policy will
not be certain but will depend upon the circumstances giving rise to the claim.
In the interim period, it will be necessary to make estimates, and the provision
for claims outstanding will necessarily be the result of a series of estimates
which would be based on surveyors’ assessment and recommendations,
statistical calculations and management decisions as considered appropriate.
The provision would be determined as accurately as possible, having regard to
prudent assumptions about the final amount for which claims are expected to
be settled.

The factors considered in estimation of outstanding claims are:

 previous experience in claims notification patterns
 changes in the nature and amount of business written
 trends in claims frequency and severity
 inflation rate and
 other relevant data available from post-claim inspection report.

At the end of each financial year, as required by IRDAI, the actuarial valuation
of the claims liability of an insurer is made by the appointed actuary, and the
shortfall, if any, is provided as IBNR/IBNER

2.9 Reinsurance

An arrangement where one party called the ‘re-insurer’, in consideration for a

premium, agrees to indemnify another party called the ‘cedant’ or ‘reinsured’
against an agreed part of the liability assumed by the cedant in the event of
claim admissible under a policy or policies of insurance.

Reinsurance may be decided by the Insurer and the Re-insurer on the basis of
Facultative arrangement for individual risks or under Treaty Arrangement for
groups of risks. Re-insurance accounting has been discussed separately in Unit
13 for better understanding of the students.

2.10 Investment Accounting

Investments are treated as assets held by an insurer for earning income by way
of dividends, rent and interest or for capital appreciation or for other benefits
to both policyholders and shareholders.

An insurance company makes investment for the following purposes:

176
In an insurance company there are mainly two sources of investible funds viz.
(i) surplus funds arising out of the business and
(ii) funds arising from income, being interest and dividends on existing
investments.

IRDAI Regulations on Investments and the Insurance Act, 1938 as amended by

the Insurance Laws (Amendment) Act 2015 provide specific rules and norms
for investment of funds by an insurance company. The procedure and norms as
laid down in the IRDAI (Preparation of Financial Statements and Auditor’s
Report of Insurance Companies) Regulations, 2002, Regulations for valuation of
investments have been discussed in Unit 11.
Furthermore, the IRDAI has also issued detailed guidelines under IRDAI (Re-
Insurance) Regulations, 2018 for investments by the insurer, which have been
discussed in Unit 14.
Accounting entries involved for buying/selling investments, receipts / accrued
and outstanding interest, dividends, rent, and recording impairments, write off
and write down of certain investments etc. have been discussed in Unit 15 for
better analysis.

3. Discuss what is meant by co-insurance.

[Learning Outcome c]

3.1 Co-insurance

An arrangement whereby two or more insurers enter into a single contract with
the insured to cover a risk in agreed proportions at a specified premium. At
times, it may happen that the risk being insured is large and therefore such
large risks are shared between two or more insurers at agreed percentages
under co-insurance arrangements.

177
The insurer having the prime share shall be called as Leader and the other co-
insurers are called as followers. Under a co-insurance arrangement, the leading
insurer issues the documents, collects premium and settles claims on behalf all
other co-insurers. Statements of Account are rendered by the leading insurer to
the other co-insurers.

The accounting treatment of premium, claims, commission, etc. under co-

insurance arrangement is done in the same manner as that of the direct
business.

Process of co-insurance

In Co-insurance, the lead insurer collects the full premium along with Goods &
Services Tax (GST) and pays it to the Government authorities. The lead insurer
accounts for its own share as premium income and balance is shown as payable
to other co-insurers. Similarly in case of a claim, the entire claim amount is
paid by the lead insurer to the insured (claimant), but only his own share is
accounted for as ‘claims expense’ and the balance is shown as amount due from
the co-insurer.

Coinsurance account balances are finally settled as per the agreement between
the co-insurers. The lead insurer charges an ‘Administrative charges’ towards
the service being rendered by it on policy issuance, claim processing etc. It is
normally fixed as 1% on the share of premium of the co-insurer.

At the end of the financial year, if a provision for outstanding claims is required
to be made, the lead insurer accounts for its own share and informs the co-
insurers of their respective share of outstanding claim provisions to be booked
by them. At the end of each financial year, balance confirmation certificates
are exchanged by all co-insurers for accounting records and verification by
auditors.

178
Accounting in a co-insurance arrangement

A fire insurance policy was issued by NIAC to M/S ABC Automobile Co Ltd on
01/04/2020 for a sum insured (SI) of Rs.400 crore with a premium @ Re
0.50/Rs.1000 SI under an arrangement that NIAC is the lead insurer with 40%
share of business and other three PSUs (NIC, UIIC and OIC) are co-insurers with
20% shares each.

On 01/04/2020, New India collected the entire premium. The Co-insurers’ share
was paid on 15.04.2020. A fire accident occurred and the surveyor assessed the
loss as Rs. 99 lakhs on 31/08/2020. New India paid the entire claim and also
survey fees for Rs.1 lakh on 15/09/2020.

Required:

Pass journal entries in the books of NIAC and show the Co-insurance Account as
on 30/09/2020 assuming that Co-insurance balance has been settled on
15/10/2020, 16/10/2020 and 18/10/2020 by NIC, UIIC and OIC respectively.

Solution:
Premium = 400,00,00,000 x 0.50/1000 = 20,00,000

179
Date Particulars Debit Credit
Amount Amount
01/04/20 Bank A/c Dr. 20,00,000
To Premium Control A/c 20,00,000
(Being fire insurance premium collected under co-insurance)
01/04/20 Premium Control A/c Dr. 20,00,000
To Fire Premium A/c (60%) Cr. 8,00,000
To NIC A/c (20%) Cr. 4,00,000
To UIIC A/c (20%) Cr. 4,00,000
To OIC A/c (20%) Cr. 4,00,000
(Being fire insurance premium booked under co-insurance)
15/04/20 NIC A/c (20%) Dr. 4,00,000
UIIC A/c (20%) Dr. 4,00,000
OIC A/c (20%) Dr. 4,00,000
To Bank A/c 12,00,000
31/08/20 Fire Claims A/c Dr. 40,00,000
NIC A/c Dr. 20,00,000
UIIC A/c Dr. 20,00,000
OIC A/c Dr. 20,00,000
To Claims Payable A/c Cr. 99,00,000
To Survey fees Payable A/c Cr. 1,00,000
(Being claims and survey fees payable as per survey report)
15/09/20 Claims Payable Dr 99,00,000
To Bank Cr. 99,00,000
(Being claim paid in full and final settlement)
15/09/20 Survey fees payable A/c Dr 1,00,000
To Bank A/c Cr. 1,00,000
(Being survey fees paid)
15/10/20 Bank A/c Dr. 16,00,000
To NIC A/c Cr. 16,00,000
(Being co-insurance balance settled by NIC)
16/10/20 Bank A/c Dr. 16,00,000
To UIIC A/c Cr. 16,00,000
(Being co-insurance balance settled by UIIC)
18/10/20 Bank A/c Dr. 16,00,000
To OIC A/c Cr. 16,00,000
(Being co-insurance balance settled by Oriental Ins)

Co-Insurance A/c
Rs in Lakhs
National United Oriental National United Oriental
15.04.20 4 4 4 01.04.10 4 4 4
To Bank By
A/c Premium
Control
180
 A/c

31.08.10 20 20 20 30.09.10 20 20 20
To By
Claim Balance
Payable c/d
A/c
24 24 24 24 24 24

Such Co-Insurance balances will appear in the Balance Sheet as at 30/09/2020

on the Asset Side under the head “Amount Due from Other Insurers”.

An arrangement whereby two or more insurers enter into a contract with the
insured to cover a risk in agreed proportions at a specified premium is termed:
A Co-insurance
B Bancassurance
C Re-insurance
D Joint assurance

4. Discuss the financial reporting requirement for non-life insurance

business, including requirement to prepare consolidated financial
statements.
[Learning Outcome d]

4.1 Financial Statements

Preparation and presentation of financial statements are in accordance with
IRDAI (Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002. The students must have thorough knowledge of
the regulations on insurance accounts to appreciate the legal aspects of
financial accounting in general insurance business.

As per the said regulation, the financial statements of an insurer include

Revenue Accounts, Profit & Loss Account, Balance Sheet and Cash Flow
Statements.

The regulatory requirements for Presentation and preparation of financial

statements are discussed in the following unit, Unit 11, and the illustrations on
Presentation and preparation of financial statements are given in Unit 12.

Along with the regulatory aspects of Presentation and preparation of financial

statements, we need to know certain fundamental aspects on financial
statements for insurance business with reference to international practice.

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4.2 Income statement and Revenue Account

i) Details of the underwriting results for the reporting period would be

presented in the Revenue Account, with the net underwriting result being
transferred to the income statement (i.e. Profit and Loss Account).

ii) It is necessary that a revenue account is prepared for specified class of

business.

iii) The net underwriting result would be combined with the net result from
investments and other shareholder activities to determine the net profit
(loss) of the insurer.

iv) An allocation of the investment results is required to be made between the

revenue account and the income statement, distinguishing the investment
results derived from the investment of policyholders’ funds from those
derived from shareholders' funds.

v) The following additional disclosures are made on the face of the income
statement:

a) Underwriting results transferred from the revenue account (if separately

prepared);
b) Expenses not related to underwriting activities; and investment income
arising from investments not supporting technical provisions.
c) If the income statement and revenue accounts are to be prepared on a
combined basis, the disclosure set out below relating to the revenue
account would be included on the face of the income statement.

In relation to the revenue account, separate disclosure would be made on the

following:

 Gross written Premiums, Premiums on Reinsurance Ceded &Accepted, and

Net written Premiums;
 Movement in the unearned premiums, as an addition to or deduction from
net written premiums;
 Net earned premiums;
 Acquisition costs incurred relating to gross written premiums, commissions
earned on business ceded and net acquisition costs;
 Movement in deferred acquisition costs, as an addition to or deduction from
net acquisition costs;
 Gross claims paid, and reinsurance and other recoveries receivable;
movement in claims outstanding, as an addition to or deduction from the
net claims paid;
 Net claims incurred;
 Indirect claims handling costs incurred in the period;
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 Maintenance costs and other underwriting expenses;
 Investment income (net of investment expenses) attributable to the
investments that have been allocated to support the technical provisions;
 Underwriting result;
 Income and expenses relating to non-underwriting activities; and
 Net investment income relating to the assets held, which is not supporting
the technical provisions.

4.3 Disclosure Requirement for Balance sheet

In relation to the balance sheet, separate disclosure would be made of the

following:

 Amount of unearned premium;

 Amount of deferred acquisition costs;
 Provision for premium deficiency;
 Liability for claims outstanding which includes claims incurred but not
reported
 Provision for claims handling expenses;
 Reinsurance amount applicable
 Reinsurance recoveries receivable
 Premiums receivable (net of commission receivable)
 Insurance balances receivable;
 Premium payables; and
 Insurance balances payable.

4.4 Foreign Operations and Insurance Accounting

Foreign branch accounts of insurance companies are merged with the Indian
operations to present a global financial position and the state of affairs in the
financial statements.
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In addition to the Indian statutory or regulatory requirements, these offices
have to comply with the local laws for preparation of financial statements and
get the accounts audited by the Indian firms of auditors. These accounts which
are prepared in local currencies are converted in Indian currency as per the
specific Accounting Standard -AS11 (The effects of changes in Foreign Exchange
rates), and merged with Indian accounts.

4.5 Consolidation

The accounts of a large insurance company having a number of offices in India

and abroad are consolidated at the head office level of the company.

i) The accounts of the operating offices in India are prepared by the respective
offices as per corporate guidelines and are audited by the branch auditors.

ii) These are consolidated at various regional / zonal offices and the
consolidated accounts for the whole region are submitted to the head
office.

iii) At the head office, separate accounts are prepared for the re-insurance and
investment operations.
iv) If the company has foreign branches, their accounts are prepared at their
level and are audited by the local statutory auditors or the central statutory
auditors. These accounts which are prepared in local currencies are
converted in Indian currency as per the specific Accounting Standard -AS11
(The effects of changes in Foreign Exchange rates), and merged with Indian
accounts.
v) The Corporate Finance department at the head office is responsible for the
consolidation of all regional / zonal office accounts and preparation and
reconciliation of reinsurance accounts, investment accounts and foreign
operation accounts.
vi) The consolidation is done through appropriate consolidation software for
preparation of financial statements including Fire Revenue Account, Marine
Revenue Account, Miscellaneous Revenue Account, Profit and Loss Account
and Balance Sheet along with all required schedules in specified forms and
formats given in Part V of the IRDAI Regulations for the financial statements.

vii) The final accounts are audited by the statutory auditors appointed by the
shareholders (by C&AG in case of a Government company) and presented in
the Annual General Meeting for approval.

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While preparing final accounts with consolidation at the head office level, the
following aspects are globally determined and accounted for:

Sr.
Head Description
No
Unexpired risk reserve (URR) means the reserves in
Unexpired respect of the liabilities for unexpired risks and
1 Risk determined as the aggregate of unearned premium
Reserve reserve and premium deficiency reserve.

Premium deficiency reserve(PDR) means the reserve

held in excess of the unearned premium reserve,
which allows for any expectation that the unearned
premium reserve (UPR) will be insufficient to cover
Premium
the cost of claims and related expenses incurred
2 Deficiency
during the period of unexpired risk.
Reserve
If the sum of expected claim costs, related expenses
and maintenance cost exceeds the related unearned
premium reserve, the difference is to be accounted
as “Premium Deficiency” in books of Account.
In view of requirements of AS 15 for recognition of a
Provision
liability for employee benefits to be paid in future,
for
provision for leave encashment, gratuity, pension and
terminal
3 terminal benefits payable to the employees on
benefits of
superannuation is made on actuarial basis at the head
the
office.
employees
Reserve for
After doing age-wise analysis of the debtors, a
Bad and
4 suitable provision is made at the Head Office.
Doubtful
Debts
Tax liability of an insurance company is governed by
Provision the special provisions contained in section 44 of the
5 for Income tax Act. Adequate provision for tax liability is
taxation made at Head Office.

An adequate provision is made for proposed dividend

Provision
as per the board resolution at head office keeping in
for
6 view the relevant provisions of the Companies Act,
proposed
2013.
dividend
Such provision is made as per the report/certificate
IBNR/IBNER of the appointed actuary by increasing/decreasing
7
provision the outstanding claims reserve.

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 Unearned Premium Reserve means an amount
Unearned
representing that part of the premium written which
8 Premium
is attributable and to be allocated to the succeeding
Reserve
accounting periods.

Provision of IBNR/IBNER is based on the advice of:

A Management
B Actuary
C Shareholders
D Auditors

Summary

 The legal aspects of insurance accounting in India is addressed by The

Insurance Act, 1938, The Insurance (Amendment) Act, 2021, The Insurance
Laws (Amendment) Act, 2015, The Companies Act, 2013, The Companies
(Amendment) Act, 2020, The Insurance Regulatory and Development
Authority Act, 1999 and IRDA (Preparation of Financial Statements and
Auditors’ Report of insurance companies) Regulations, 2002.
 In India, only annual basis is adopted for insurance accounting for
determination of underwriting results for Fire, Marine and Miscellaneous.
 Premium income is the consideration received from the insured by the
insurance company in accordance with the contract of insurance.
 A provision for unexpired risks is made normally at 50% in case of Fire and
Misc. Insurance and 100% in case of Marine Insurance which is in accordance
with Section 64 V(1) (ii) (b) of The Insurance Act 1938 as amended by the
Insurance Laws (Amendment) Act 2015.
 Under Annual Basis accounting, ‘claims incurred’ include paid claims plus
outstanding claims at the end of the year minus outstanding claims at the
beginning of the year.
 Acquisition costs, if any, shall be expensed in the period in which they are
incurred.
 Section 40C of the Insurance Act, 1938 as amended by the Insurance Laws
(Amendment) Act 2015. prohibits an insurer to spend as expenses of
management in excess of the limits prescribed in the Act.
 At the end of each financial year, as required by IRDAI, the actuarial
valuation of the claims liability of an insurer is made by the appointed
actuary, and the shortfall, if any, is provided as IBNR/IBNER.
 Discounting refers to an accounting practice which places a present day
value on a claim outstanding provision. Discounting requires compliance of
certain mandatory conditions.

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 Co-insurance is an arrangement whereby two or more insurers enter into a
single contract with the insured to cover a risk in agreed proportions at a
specified premium.
 Presentation and preparation of financial statements are in accordance with
IRDAI (Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002.
 Consolidated financial statements of Indian and Foreign operations are
prepared in accordance with IRDAI regulations which are then audited by
the statutory auditors.

Answers to Test Yourself

Answer to TY 1
The correct option is B. In accordance with the Indian GAAP, the basis adopted
for insurance accounting for determination of underwriting results is Annual
Basis.

Answer to TY 2
The correct option is A. Acquisition costs pertaining to renewal of insurance
contracts shall be expensed in the period in which they are incurred.

Answer to TY 3
The correct option is A. An arrangement whereby two or more insurers enter
into a contract with the insured to cover a risk in agreed proportions at a
specified premium is termed Co-insurance.

Answer to TY 4
The correct option is B. Provision of IBNR/IBNER is based on the advice of the
actuary.

Self-Examination Questions

Question 1
At the end of each financial year, the actuarial valuation of the claims liability
of an insurer is made by:
A An accountant
B An auditor of the company
C Management
D An actuary

Question 2
In case of a Government Insurance company, the accounts are audited by:

A Statutory auditors
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B Comptroller and Auditor General (C&AG) in addition to statutory auditors
C Insurance and Regulatory Development Authority
D None of the above

Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is D. At the end of each financial year, the actuarial
valuation of the claims liability of an insurer is made by an actuary.

Answer to SEQ 2
The correct option is B. In case of a Government Insurance company, the
accounts are audited by the Comptroller and Auditor General (C&AG) also, in
addition to statutory auditors.

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 CHAPTER 3
NON-LIFE INSURANCE BUSINESS ACCOUNTING
METHODS, TECHNIQUES & PROCESSES

UNIT-11
INSURANCE ACCOUNTING REGULATIONS
Chapter Introduction

In 1999, the IRDAI Act was passed, the Insurance Regulatory and Development
Authority was established and conferred upon the powers to regulate and
promote orderly growth of the insurance sector.

With the advent of private players in the business of insurance, regulation was
needed with respect to the financial statements and audit reports being
prepared by the insurance companies, to protect the interests of policyholders
and all other stakeholders involved. With the above objective, the IRDAI passed
the IRDAI (Preparation of Financial Statements and Auditor's Report of Insurance
Companies) Regulations in 2002.

In this unit, we will discuss the various provisions of this regulations.

a) Discuss the accounting regulations pertaining to non-life insurance

methods, techniques and processes, along with the formats of financial
statements.
b) Prepare financial statement extracts for a non-life insurance business in
accordance with the appropriate regulatory requirements.

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1. Discuss the accounting regulations pertaining to non-life insurance
methods, techniques and processes, along with the formats of
financial statements.
[Learning Outcome a]

1.1 Indian GAAP on Insurance Accounting

Indian GAAP on Insurance Accounts comprises specific regulations which
include:

 Relevant provisions of the Insurance Laws (Amendment) Act, 2015

 The Companies Act 2013
 Relevant Accounting Standards issued by the Institute of Chartered
Accountants of India.

In this regard, the IRDAI has issued a detailed accounting and audit regulation
called the Insurance Regulatory and Development Authority (Preparation of
Financial Statements and Auditor’s Report of Insurance Companies) Regulations,
2002.

The following financial statements of an insurance company are required to be

prepared as per specified formats and in accordance with the Accounting
Principles and General Instructions for preparation of financial statements
specified in the said regulations over and above compliance of the requirements
of Companies Act, 2013 and the Insurance laws (Amendment) Act, 2015 and
applicable Accounting Standards (AS).
 Balance Sheet
 Revenue Accounts
 Profits and Loss Account
 Receipts and Payments Account (Cash flow statement)

1.2 Regulations for Insurance Accounting

In exercise of the powers conferred by section 114A of the Insurance Act, 1938,
as amended by the Insurance Laws (Amendment) Act 2015, the Insurance
Regulatory and Development Authority in consultation with the Insurance
Advisory Committee, has framed the Regulations called “IRDAI (Preparation of
Financial Statements and Auditor’s Report of Insurance Companies) Regulations,
2002” for the purpose of accounting of insurance business. These regulations
superseded the regulations made in the year 2000.

The said Regulations provide that:

1. An insurer carrying on general insurance business, after the

commencement of these Regulations, shall comply with the requirements of
Schedule B.
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2. The report of the auditors on the financial statements of every insurer and
reinsurer shall be in conformity with the requirements of Schedule C, or as
near thereto as the circumstances permit.

3. The Authority may, from time to time, issue separate directions/

guidelines in the matter of appointment, continuance or removal of
auditors of an insurer or reinsurer, as the case may be, and such
directions/ guidelines may include prescriptions regarding qualifications and
experience of auditors, their rotation, period of appointment, etc. as may
be deemed necessary by the Authority.

This Unit provides the relevant extract of the Schedule B to Regulations for
Preparation of financial statements, management report and auditor’s report
in respect of general insurance business. Schedule B deals with accounting
regulations under the following heads:

Part I- Accounting Principles for Preparation of Financial Statements

Part II- Disclosures forming part of Financial Statements
Part III- General Instruction for preparation of Financial Statements
Part IV- Contents of Management Report
Part V- Preparation of Financial Statements

Section 2(6B) of the Insurance Act defines “General insurance business as fire,
marine or miscellaneous insurance business whether carried on singly or in
combination with one or more of them.”

Some common types of miscellaneous insurance includes automobile insurance,

health insurance, burglary insurance, fidelity insurance, cash in transit
insurance, workmen’s compensation insurance, exchange risk insurance, etc.

1.3 Extracts of financial statements

In accordance with Regulation 3 of the Insurance Regulatory and Development

Authority of India Regulations, 2002, an insurer carrying on general insurance
business shall comply with the requirements of Schedule B of the IRDAI
(Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002. This pronouncement issued by the IRDAI gives
extensive guidance on the formats to be adhered to by insurance companies
while preparing their financial statements.

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Which part of Schedule B of The Insurance Regulatory and Development
Authority (Preparation Of Financial Statements and Auditor’s Report Of
Insurance Companies) Regulations, 2002 deals with “Contents of management
Report”?

A Part I
B Part II
C Part III
D Part IV

PART I - Accounting principles for preparation of financial statements

1. Applicability of Accounting Standards

Every Balance Sheet, Receipts and Payments Account [Cash Flow statement] and
Profit and Loss Account [Shareholders’ Account] of the insurer shall be in
conformity with the Accounting Standards (AS) issued by the ICAI, to the extent
applicable to the insurers carrying on general insurance business, except that:

i) Accounting Standard 3 (AS 3) – Cash Flow Statements – Cash Flow

Statements shall be prepared only under the Direct Method.
ii) Accounting Standard 13 (AS 13) – Accounting for Investments, shall not be
applicable.
iii) Accounting Standard 17 (AS 17) - Segment Reporting– shall apply to all
insurers irrespective of the requirements regarding listing and turnover
mentioned therein.

2. Premium Recognition

Premium shall be recognised as income over the contract period or the period
of risk, whichever is appropriate.

A reserve for unexpired risks shall be created as the amount representing that
part of the premium written which is attributable to, and to be allocated to the
succeeding accounting periods and shall not be less than as required under
section 64 V(1) (ii) (b) of the Act.

In accordance with the provisions of section 64 V(1) (ii) (b) of The Insurance Act
1938, as amended by the Insurance Laws (Amendment) Act, 2015 reserve for
unexpired risks shall be created in respect of:
i) Fire and Miscellaneous business – 50%
ii) Marine cargo business – 50%

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iii) Marine hull business – 100% of the premium, net of re-insurances, during the
preceding 12 months

Premium Received in Advance, which represents premium received prior to the

commencement of the risk, shall be shown separately under the head ‘Current
Liabilities’ in the financial statements.

3. Premium Deficiency: Premium deficiency shall be recognised if the sum of

expected claim costs, related expenses and maintenance costs exceeds
related reserve for unexpired risks.

4. Acquisition Costs: Acquisition costs, if any, shall be expensed in the period

in which they are incurred.

Acquisition costs are those costs that vary with, and are primarily related
to, the acquisition of new and renewal insurance contracts. The most
essential test is the obligatory relationship between costs and the execution
of insurance contracts (i.e. commencement of risk).

5. Claims: The components of the ultimate cost of claims to an insurer

comprise the claims under policies and specific claims settlement costs.
Claims under policies comprise the claims made for losses incurred, and
those estimated or anticipated under the policies following a loss
occurrence.

A liability for outstanding claims shall be brought to account in respect of

both direct business and inward reinsurance business. The liability shall
include:

i) Future payments in relation to unpaid reported claims;

ii) Claims Incurred But Not Reported (IBNR) including inadequate reserves
[sometimes referred to as Claims Incurred But Not Enough Reported
(IBNER)],

Which will result in future cash/asset outgo for settling liabilities against
those claims. Change in estimated liability represents the difference
between the estimated liability for outstanding claims at the beginning and
at the end of the financial period.

The accounting estimate shall also include claims cost adjusted for
estimated salvage value if there is sufficient degree of certainty of its
realisation.

Actuarial Valuation of claim liability

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 All the General Insurance Companies registered with IRDAI to carry on
insurance business in India are required to appoint an Actuary known as
“Appointed Actuary”. The Appointed Actuary is required to work-out the
liability for the claims incurred but not reported (IBNR) and claims incurred
but not enough reported (IBNER) and issue the certificate for IBNR/IBNER as
on date of finalizing the accounts for a particular period. The amount
certified by the appointed actuary shall be accounted as IBNR/IBNER in
financial statements. Actuarial assumptions shall be suitably disclosed by
way of notes to the accounts.

6. Procedure to determine the value of investments: An insurer shall

determine the values of investments in the following manner:

i) Real Estate: Investment Property: Investment Property shall be measured

at historical cost less accumulated depreciation and impairment loss,
residual value being considered zero and no revaluation being permissible.

The Insurer shall assess at each balance sheet date whether any impairment
of the investment property has occurred.

An impairment loss shall be recognised as an expense in the Revenue/Profit

and Loss Account immediately.

Fair value as at the balance sheet date and the basis of its determination
shall be disclosed in the financial statements as additional information.

ii) Debt Securities: Debt securities including government securities and

redeemable preference shares shall be considered to be “held to maturity”
securities and shall be measured at historical cost subject to amortisation.

iii) Equity Securities and Derivative Instruments that are traded in active
markets: shall be measured at fair value as at the balance sheet date. For
the purpose of calculation of fair value, the lowest of the last quoted closing
price of the stock exchanges where the securities are listed shall be taken.

The insurer shall assess on each balance sheet date whether any impairment
of listed equity security / derivative instruments has occurred.

An active market shall mean a market where the securities traded are
homogenous, availability of willing buyers and willing sellers is normal and
the prices are publicly available.

Unrealised gains/losses arising due to changes in the fair value of listed

equity shares and derivative instruments shall be taken to equity under the
head ‘Fair Value Change Account’. The ‘Profit on sale of investments’ or
‘Loss on sale of investments’, as the case may be, shall include accumulated
changes in the fair value previously recognised in equity under the heading
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 Fair Value Change Account in respect of a particular security and being
recycled to Profit and Loss Account on actual sale of that listed security.

For the removal of doubt, it is clarified that balance or any part thereof
shall not be available for distribution as dividends. Also, any debit balance
in the said Fair Value Change Account shall be reduced from the profits/free
reserves while declaring dividends.

The insurer shall assess, at each balance sheet date, whether any
impairment has occurred. An impairment loss shall be recognised as an
expense in Revenue/Profit and Loss Account to the extent of the difference
between the re-measured fair value of the security/ investment and its
acquisition cost as reduced by any previous impairment loss recognised as
expense in Revenue/Profit and Loss Account. Any reversal of impairment
loss earlier recognised in Revenue/Profit and Loss Account shall be
recognised in Revenue/Profit and Loss Account.

iv) Unlisted and other than actively traded Equity Securities and Derivative
Instruments: Unlisted equity securities and derivative instruments and listed
equity securities and derivative instruments that are not regularly traded in
active market will be measured at historical costs. Provision shall be made
for diminution in value of such investments. The provision so made shall be
reversed in subsequent periods if estimates based on external evidence show
an increase in the value of the investment over its carrying amount. The
increased carrying amount of the investment due to the reversal of the
provision shall not exceed the historical cost.

For the purposes of this regulation, a security shall be considered being not
actively traded, if as per guidelines governing mutual funds laid down from
time to time by SEBI, such a security is classified as “thinly traded”.

7. Loans: Loans shall be measured at historical cost subject to impairment

provisions.

The insurer shall assess the quality of its loan assets and shall provide for
impairment. The impairment provision shall not be lower than the amounts
derived on the basis of guidelines prescribed from time to time by the
Reserve Bank of India that apply to companies and financial institutions.

8. Catastrophe Reserve: Catastrophe reserve shall be created in accordance

with norms, if any, prescribed by the Authority. Investment of funds out of
the catastrophe reserve shall be made in accordance with prescription from
the Authority.

PART II - Disclosures forming part of Financial Statements

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A The following shall be disclosed by way of notes to the Balance Sheet:

1. Contingent Liabilities:
a) Partly-paid up investments
b) Underwriting commitments outstanding
c) Claims, other than those under policies, not acknowledged as debts
d) Guarantees given by or on behalf of the company
e) Statutory demands/liabilities in dispute, not provided for
f) Reinsurance obligations
g) Others (to be specified).

2. Encumbrances to assets of the company in and outside India.

3. Commitments made and outstanding for Loans, Investments and Fixed

Assets.

4. Claims, less reinsurance, paid to claimants in/outside India.

5. Actuarial assumptions for determination of claim liabilities in the case of

claims where the claims payment period exceed 4 years.

6. Ageing of claims – distinguishing between claims outstanding for more than 6

months and other claims.
7. Premiums, less reinsurance, written from business in/outside India.
8. Extent of premium income recognised, based on varying risk pattern,
category-wise, with basis and justification therefore, including whether
reliance has been placed on external evidence.

9. Value of contracts in relation to investments, for:

(a) Purchases where deliveries are pending;
(b) Sales where payments are overdue.
10. Operating expenses relating to insurance business: basis of allocation of
expenditure to various classes of business.

11. Historical costs of those investments valued on fair value basis.

12. Computation of managerial remuneration.

13. Basis of amortisation of debt securities.

14.
a) Unrealised gain/losses arising due to changes in the fair value of listed
equity shares and derivative instruments are to be taken to equity under the
head ‘Fair Value Change Account’ and on realisation reported in profit and
loss Account.

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b) Pending realisation, the credit balance in the ‘Fair Value Change Account’ is
not available for distribution.

15. Fair value of investment property and the basis therefor.

16. Claims settled and remaining unpaid for a period of more than 6 months as
on the balance sheet date.

B The following accounting policies shall form an integral part of the

financial statements:

1. All significant accounting policies in terms of the accounting standards

issued by the ICAI, and significant principles and policies given in Part I of
Accounting Principles and any other accounting policies followed by the
insurer shall be stated in the manner required under Accounting Standard 1
issued by the ICAI.

2. Any departure from the accounting policies as aforesaid shall be separately

disclosed with reasons for such departure.

C The following information shall also be disclosed:

1. Investments made in accordance with any statutory requirement should be

disclosed separately together with its amount, nature, security and any
special rights in and outside India.
2. Segregation into performing/ non performing investments for purpose of
income recognition as per the directions, if any, issued by the Authority.
3. Percentage of business sector-wise.
4. A summary of financial statements for the last 5 years, in the manner as
may be prescribed by the Authority.
5. Accounting Ratios as may be prescribed by the Authority.
6. Basis of allocation of Interest, Dividends and Rent between Revenue Account
and Profit and Loss Account.

Part III - General Instruction for Preparation of Financial Statements

1. The corresponding amounts for the immediately preceding financial year for
all items shown in the Balance Sheet, Revenue Account and Profit and Loss
Account should be given.

2. The figures in the financial statements may be rounded off to the nearest
thousands.

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3. Interest, dividends and rentals receivable in connection with an investment
should be stated at gross value, the amount of income tax deducted at
source being included under 'advance taxes paid'.

4. Income from rent shall not include any notional rent.

5.
a) For the purposes of financial statements, unless the context otherwise
requires –

i) the expression ‘provision’ shall, subject to note II below mean any amount
written off or retained by way of providing for depreciation, renewals or
diminution in value of assets, or retained by way of providing for any known
liability or loss of which the amount cannot be determined with substantial
accuracy;

ii) the expression "reserve" shall not, subject to as aforesaid, include any
amount written off or retained by way of providing for depreciation,
renewals or diminution in value of assets or retained by way of providing for
any known liability;

iii) the expression capital reserve shall not include any amount regarded as free
for distribution through the profit and loss account; and the expression
"revenue reserve" shall mean any reserve other than a capital reserve;

iv) The expression "liability" shall include all liabilities in respect of expenditure
contracted for and all disputed or contingent liabilities.

b) Where:

i) any amount written off or retained by way of providing for depreciation,

renewals or diminution in value of assets, or
ii) any amount retained by way of providing for any known liability is in excess
of the amount which in the opinion of the directors is reasonably necessary
for the purpose, the excess shall be treated for the purposes of these
accounts as a reserve and not as a provision.

6. The company should make provisions for damages under lawsuits where the
management is of the opinion that the award may go against the insurer.

7. Extent of risk retained and reinsured shall be separately disclosed.

8. Any debit balance of Profit and Loss Account shall be shown as deduction
from uncommitted reserves and the balance if any, shall be shown
separately.

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PART IV - Contents of Management Report:

There shall be attached to the financial statements, a management report

containing, inter alia, the following duly authenticated by the management:

1. Confirmation regarding the continued validity of the registration granted by

the Authority;

2. Certification that all known and undisputed dues payable to the statutory
authorities have been duly paid;

3. Confirmation to the effect that the shareholding pattern and any transfer of
shares during the year are in accordance with the statutory or regulatory
requirements;

4. Declaration that the management has not directly or indirectly invested

outside India the funds of the holders of policies issued in India;
5. Confirmation that the required solvency margins have been maintained;
6. Certification to the effect that the values of all the assets have been
reviewed on the date of the Balance Sheet and that in his (insurer’s) belief
the assets set forth in the Balance-sheets are shown in the aggregate at
amounts not exceeding their realisable or market value under the several
headings – “ Loans”, “ Investments”, “Agents balances”, “Outstanding
Premiums”, “Interest, Dividends and Rents outstanding”, “Interest,
Dividends and Rents accruing but not due”, “Amounts due from other
persons or Bodies carrying on insurance business”, “ Sundry Debtors”, “ Bills
Receivable”, “ Cash” and the several items specified under “Other
Accounts”;
7. Disclosure with regard to the overall risk exposure and strategy adopted to
mitigate the same;
8. Operations in other countries, if any, with a separate statement giving the
management’s estimate of country risk and exposure risk and the hedging
strategy adopted;

9. Ageing of claims indicating the trends in average claim settlement time

during the preceding 5 years;

10. Certification to the effect as to how the values, as shown in the balance
sheet, of the investments and stocks and shares have been arrived at, and
how the market value thereof has been ascertained for the purpose of
comparison with the values so shown;
11. Review of asset quality and performance of investment in terms of
portfolios, i.e., separately in terms of real estate, loans, investments, etc.
199
12. A responsibility statement indicating therein that:

i) in the preparation of financial statements, the applicable accounting

standards, principles and policies have been followed along with proper
explanations relating to material departures, if any;

ii) the management has adopted accounting policies and applied them
consistently and made judgements and estimates that are reasonable and
prudent so as to give a true and fair view of the state of affairs of the
company at the end of the financial year and of the operating profit or loss
and of the profit or loss of the company for the year;

iii) the management has taken proper and sufficient care for the maintenance
of adequate accounting records in accordance with the applicable provisions
of The Companies Act 2013/ Insurance Laws (Amendment) Act, 2015 for
safeguarding the assets of the company and for preventing and detecting
fraud and other irregularities;

iv) the management has prepared the financial statements on a going concern
basis;

v) the management has ensured that an internal audit system commensurate

with the size and nature of the business exists and is operating effectively.

13. A schedule of payments, which have been made to individuals, firms,

companies and organisations in which Directors of the insurer are
interested.

PART V - Preparation of Financial Statements

1. An insurer shall prepare the Revenue Account, Profit and Loss Account
[Shareholders’ Account] and the Balance Sheet in Form B-RA, Form B-PL,
and Form B-BS, or as near thereto as the circumstances permit.

Provided that an insurer shall prepare Revenue Accounts separately for fire,
marine, and miscellaneous insurance business and separate schedules shall
be prepared for Marine Cargo, Marine – Other than Marine Cargo and the
following classes of miscellaneous insurance business under miscellaneous
insurance and accordingly application of AS 17 – Segment Reporting - shall
stand modified.

a) Motor
b) Workmen’s Compensation/Employers’ Liability,
c) Public/Product Liability,

200
 d) Engineering
e) Aviation ,
f) Personal Accident,
g) Health Insurance,
h) Others

2. An insurer shall prepare separate Receipts and Payments Account in

accordance with the Direct Method prescribed in AS3 – “Cash Flow
Statement” issued by the ICAI.

FORM B-RA
Name of the Insurer:
Registration No. and Date of Registration with the IRDAI

REVENUE ACCOUNT FOR THE YEAR ENDED 31ST MARCH 20___.

Particulars Schedule Current Previous

Year Year
(Rs.’000) (Rs.’000)
1. Premiums earned (Net) 1
2. Profit/ Loss on sale/redemption of
Investments (Policyholders)
3. Others (to be specified)
4. Interest, Dividend & Rent – Gross
TOTAL (A)

1. Claims Incurred (Net) 2

2. Commission (Net) 3
3. Operating Expenses related to Insurance 4
Business
4. Premium deficiency
5. Others – Amortisation, write off, provisions -
Investments
TOTAL (B)
Operating Profit/(Loss) from
Fire/Marine/Miscellaneous Business C= (A -
B)
APPROPRIATIONS

Transfer to Shareholders’ Account

Transfer to Catastrophe Reserve
Transfer to Other Reserves (to be specified)
TOTAL (C)

Note: See Notes appended at the end of Form B-PL

201
FORM B-PL

Name of the Insurer:

Registration No. and Date of Registration with the IRDAI

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH 20___.

Particulars Schedule Current Previous

Year Year
(Rs.’000) (Rs.’000)
1. OPERATING PROFIT/(LOSS)
(a) Fire Insurance
(b) Marine Insurance
(c) Miscellaneous Insurance
2. INCOME FROM INVESTMENTS
(a) Interest, Dividend & Rent – Gross
(Shareholders)
(b) Profit on sale of investments
(Shareholders)
Less: Loss on sale of investments
(Shareholders)
3. OTHER INCOME (Misc. receipts, Credit
balances written back)
TOTAL (A)
4. PROVISIONS (Other than taxation)
(a) For diminution in the value of
investments (Shareholders)
(b) For doubtful debts – Investments
(Shareholders)
(c) For doubtful debts – Operations
(d) Others (to be specified)
5. OTHER EXPENSES
(a) Expenses other than those related to
Insurance Business
(b) Contributions to Policyholders’ fund
towards excess EOM
(c) Others – Expenses on Corporate Social
Responsibility
(d) Profit / Loss on sale of assets
(e) Penalty
(f) Others (To be specified)
TOTAL (B)
Profit Before Tax
Provision for Taxation – Current tax
Provision for Taxation – Deferred tax
Profit After Tax
202
 APPROPRIATIONS
(a) Interim dividends paid
(b) Proposed final dividend
(c) Dividend distribution tax
(d) Transfer to any Reserves
Balance carried forward to Balance Sheet
Basic and diluted Earnings Per Share

Notes: to Form B-RA and B- PL

a) Premium income received from business concluded in and outside India shall
be separately disclosed.
b) Reinsurance premiums whether on business ceded or accepted are to be
brought into account gross (i.e. before deducting commissions) under the
head reinsurance premiums.
c) Claims incurred shall comprise claims paid, specific claims settlement costs
wherever applicable and change in the outstanding provision for claims at
the year-end,
d) Items of expenses and income in excess of 1 % of the total premiums (less
reinsurance) or Rs.5,00,000 whichever is higher, shall be shown as a
separate line item.
e) Fees and expenses connected with claims shall be included in claims.
f) Under the sub-head "Others” shall be included items like foreign exchange
gains or losses and other items.
g) Interest, dividends and rentals receivable in connection with an investment
should be stated as gross amount, the amount of income tax deducted at
source being included under 'advance taxes paid and taxes deducted at
source”.
h) Income from rent shall include only the realised rent. It shall not include any
notional rent.

FORM B-BS

Name of the Insurer:

Registration No. and Date of Registration with the IRDAI

Balance Sheet As At 31ST March 20___

Particulars Schedule Current Previous

Year Year
(Rs.’000) (Rs.’000)

Sources of Funds

1.Share Capital 5

2.Reserves and Surplus 6

203
3.Fair value change account
(i) Shareholders’ Fund
(ii) Policyholders’ Fund
4.Borrowings 7

5.Deferred Tax Liability

Total
Application of funds
1.Investments
8
(i) Shareholders
8A
(ii) Policyholders
2.Loans 9

3.Fixed Assets 10

4.Deferred Tax Assets

5.Current Assets
a.Cash and Bank Balances 11

b.Advances and Other Assets 12

Sub-Total (a+b)
c.Current Liabilities 13

d.Provisions 14

Sub-Total (c+d)
Net Current Assets (a+b-c-d)
6.Miscellaneous Expenditure (to the extent not 15
written off or adjusted)
Total

The schedules 1 to 15 referred to above form integral part of the revenue

accounts and Balance Sheet.

SCHEDULES FORMING PART OF FINANCIAL STATEMENTS

SCHEDULE 1 – PREMIUM EARNED [NET]

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
Premium from direct business written - In India
- Outside India
Add: Premium on reinsurance accepted
Less : Premium on reinsurance ceded
Net Premium
Adjustment for change in reserve for unexpired risks
Total Premium Earned (Net)

204
Notes: Reinsurance premiums whether on business ceded or accepted are to be
brought into account, before deducting commission, under the head of
reinsurance premiums.

SCHEDULE 2 - CLAIMS INCURRED [NET]

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
Claims paid - Direct
Add: Claims on Re-insurance accepted
Less: Claims on Re-insurance Ceded
Net Claims paid
Add: Claims Outstanding at the end of the year (Net)
Less: Claims Outstanding at the beginning of the year(Net)
Foreign exchange fluctuation relating to Non-integral
foreign operations
Total Claims Incurred (Net)

Notes:
a) Incurred But Not Reported (IBNR), Incurred but not enough reported [IBNER]
claims should be included in the amount for outstanding claims.
b) Claims includes specific claims settlement cost but not expenses of
management
c) The surveyor fees, legal and other expenses shall also form part of claims
cost.
d) Claims cost should be adjusted for estimated salvage value if there is a
sufficient certainty of its realisation.

SCHEDULE 3 - COMMISSION (NET)

Particulars Current Previous

Year Year
(Rs.’000) (Rs.’000)
Commission Direct
Add: Commission on Re-insurance Accepted
Less: Commission on Re-insurance Ceded
Commission (Net)

Break-up of Commission
Direct commission
Direct brokerage
Direct Corporate Commission
Others – Other channels

Note: The profit/ commission, if any, are to be combined with the Re-insurance
accepted or Re-insurance ceded figures.

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SCHEDULE 4 - OPERATING EXPENSES RELATED TO INSURANCE BUSINESS
Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)

1. Employees’ remuneration & welfare benefits

2. Travel, conveyance and vehicle running expenses
3. Training expenses
4. Rents, rates & taxes
5. Repairs and maintenance
6. Printing & stationery
7. Communication expenses
8. Legal & professional charges
9. Auditors' fees, expenses etc.
(a) as auditor
(b) as adviser or in any other capacity, in respect of
(i) Taxation matters
(ii) Insurance matters
(iii) Management services; and
(c) in any other capacity
10. Advertisement and publicity
11. Interest & Bank Charges
12. Others – Exchange gain / loss
- Provision for doubtful dents
- IT expenses
13. Depreciation
14. Service Tax / GST expenses
TOTAL
Apportioned to Fire segment
Marine segment
Miscellaneous segment

1. Items of expenses and income in excess of one percent of the total premiums
(less reinsurance) or Rs.5,00,000 whichever is higher, shall be shown as a
separate line item.

2. The expenses are apportioned in the ratio of Net Written Premium.

SCHEDULE 5 - SHARE CAPITAL

Particulars Current Year Previous

Year
(Rs.’000) (Rs.’000)
1. Authorised Capital
Equity Shares of Rs..... each
206
 2. Issued Capital
Equity Shares of Rs. .....each
3. Subscribed Capital
Equity Shares of Rs.......each
4. Called-up Capital
Equity Shares of Rs. .....each
Less : Calls unpaid
Add: Equity Shares forfeited (Amount originally
paid up)
Less: Par Value of Equity Shares bought back
Less: Preliminary Expenses - Expenses
including commission or brokerage on
Underwriting or subscription of shares
TOTAL

Notes:
a) Particulars of the different classes of capital should be separately stated.
b) The amount capitalised on account of issue of bonus shares should be
disclosed.
c) In case any part of the capital is held by a holding company, the same
should be separately disclosed.

SCHEDULE 5A - SHARE CAPITAL

PATTERN OF SHAREHOLDING
[As certified by Management]

Shareholder Current Year Previous Year

Number of % of Number % of
Shares Holding of Shares Holding
Promoters
(a) Indian
(b) Foreign
Others
TOTAL

SCHEDULE 6 - RESERVES AND SURPLUS

Particulars Current Previous

Year Year
(Rs.’000 (Rs.’000)
)
1. Capital Reserve
2. Capital Redemption Reserve
3. Share Premium
4. General Reserves
Less: Debit balance in Profit and Loss Account
Less: Amount utilized for Buy-back
207
5. Catastrophe Reserve
6. Other Reserves
Foreign currency translation reserve
Equalization / Contingency reserves for foreign branches
7. Balance of Profit in Profit & Loss Account
TOTAL

Note:
Additions to and deductions from the reserves should be disclosed under each of
the specified heads.

SCHEDULE 7 - BORROWINGS
Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
1. Debentures/ Bonds
2. Banks
3. Financial Institutions
4. Others (to be specified)
TOTAL

Notes:

a) The extent to which the borrowings are secured shall be separately

disclosed stating the nature of the security under each sub-head.
b) Amounts due within 12 months from the date of Balance Sheet should be
shown separately

SCHEDULE 8 – INVESTMENTS (Shareholders’ Fund)

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
Long Term Investments
1. Government securities and Government guaranteed
bonds including Treasury Bills
2. Other Approved Securities
3. Other Investments
(a) Shares
(i) Equity
(ii) Preference
(b) Mutual Funds / ETF
(c) Derivative instruments
(d) Debentures/ Bonds
(e) Other securities – foreign shares
(f) Subsidiaries
(g) Investment property-Real Estate
(h) Other Securities (to be specified)
4. Investments in Infrastructure and Housing
208
 5. Other than approved investments
Total

Short Term Investments

1. Government securities and Government guaranteed
bonds including Treasury Bills
2. Other Approved Securities
3. Other Investments
(a) Shares
(i) Equity
(ii)Preference
(b) Mutual Funds / ETF
(c) Derivative instruments
(d) Debentures/ Bonds
(e) Other securities
(f) Subsidiaries
(g) Investment properties
4. Investments in Infrastructure and Housing
5. Other than approved investments
TOTAL:
Grand Total

SCHEDULE 8A – INVESTMENTS (Policyholders’ Fund)

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
Long Term Investments
1. Government securities and Government guaranteed
bonds including Treasury Bills
2. Other Approved Securities
3. Other Investments
a)Shares
(aa)Equity
(ab)Preference
b)Mutual Funds / ETF
c)Debentures/ Bonds
d)Investment property-Real Estate
e)Other securities – other than approved
4. Investments in Infrastructure and Housing
Total
Short Term Investments
1. Government securities and Government guaranteed
bonds including Treasury Bills
2. Other Approved Securities
3. Other Investments
a)Shares
(aa)Equity
(ab)Preference
b)Mutual Funds / ETF
209
 c)Debentures/ Bonds
d)Other securities – other than approved
4. Investments in Infrastructure and Housing
Total
Grand Total

Notes:
a) Investments in subsidiary/holding companies, joint ventures and associates
shall be separately disclosed, at cost.
i) Holding company and subsidiary shall be construed as defined in the the
Companies Act 2013
ii) Joint Venture is a contractual arrangement whereby two or more parties
undertake an economic activity, which is subject to joint control.

iii) Joint control - is the contractually agreed sharing of power to govern the
financial and operating policies of an economic activity to obtain benefits
from it.
iv) Associate - is an enterprise in which the company has significant influence
and which is neither a subsidiary nor a joint venture of the company.
v) Significant influence (for the purpose of this schedule) - means participation
in the financial and operating policy decisions of a company, but not control
of those policies. Significant influence may be exercised in several ways, for
example, by representation on the board of directors, participation in the
policymaking process, material inter-company transactions, interchange of
managerial personnel or dependence on technical information.

Significant influence may be gained by share ownership, statute or agreement.

As regards share ownership, if an investor holds, directly or indirectly through
subsidiaries, 20 % or more of the voting power of the investee, it is presumed
that the investor does have significant influence, unless it can be clearly
demonstrated that this is not the case. Conversely, if the investor holds,
directly or indirectly through subsidiaries, less than 20 % of the voting power of
the investee, it is presumed that the investor does not have significant
influence, unless such influence is clearly demonstrated. A substantial or
majority ownership by another investor does not necessarily preclude an
investor from having significant influence.

b) Aggregate amount of company's investments other than listed equity

securities and derivative instruments and also the market value thereof shall
be disclosed.
c) Investments made out of Catastrophe reserve should be shown separately.
d) Debt securities will be considered as “held to maturity” securities and will
be measured at historical cost subject to amortisation.
e) Investment Property means a property [land or building or part of a building
or both] held to earn rental income or for capital appreciation or for both,
rather than for use in services or for administrative purposes.
210
f) Investments maturing within 12 months from balance sheet date and
investments made with the specific intention to dispose of within 12 months
from balance sheet date shall be classified as short-term investments.

SCHEDULE 9 – LOANS
Particulars Current Year Previous Year
(Rs.’000) (Rs.’000)
1. SECURITY-WISE CLASSIFICATION
Secured
(a) On mortgage of property
(aa)In India
(bb) Outside India
(b) On Shares, Bonds, Govt. Securities
(c) Others (to be specified)
Unsecured
TOTAL
2. BORROWER-WISE CLASSIFICATION
(a) Central and State Governments
(b) Banks and Financial Institutions
(c) Subsidiaries
(d) Industrial Undertakings
(e) Others (to be specified)
TOTAL
3. PERFORMANCE-WISE CLASSIFICATION
(a) Loans classified as standard
(aa) In India
(bb) Outside India
(b) Non-performing loans less provisions
(aa) In India
(bb) Outside India
TOTAL
4. MATURITY-WISE CLASSIFICATION
(a) Short Term
(b) Long Term
TOTAL

Notes:

a) Short-term loans shall include those, which are repayable within 12 months
from the date of balance sheet. Long term loans shall be the loans other
than short-term loans.

b) Provisions against non-performing loans shall be shown separately.

211
c) The nature of the security in case of all long term secured loans shall be
specified in each case. Secured loans for the purposes of this schedule,
means loans secured wholly or partly against an asset of the company.

d) Loans considered doubtful and the amount of provision created against such
loans shall be disclosed.

SCHEDULE 10 – FIXED ASSETS

Cost/ Gross Block Depreciation Fund Net Block

Particular
s Deleti
Closi Openi
Opening Deletions / Cl. Op. Addit ons / Cl.
Additions ng ng
Bal. adjustments Bal. bal. ions adjust Bal.
bal. bal.
ments
Goodwill

Intangibles
(software)
Land-
Freehold
Leasehold
Property
Buildings

Furniture &
Fittings
Information
&
Technology
Equipment
Vehicles

Office
Equipment
Others
(Specify
nature)
TOTAL
Work in
progress
Grand
Total
PREVIOUS
YEAR

Note: Assets included in land, building and property above exclude Investment
Properties as defined in note (e) to Schedule 8.

212
SCHEDULE 11 - CASH AND BANK BALANCES
Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
1. Cash (including cheques, drafts and stamps)
2. Bank Balances
(a) Deposit Accounts
(aa) Short-term (due within 12 months)
(bb) Others
(b) Current Accounts
(c) Others (to be specified)
3. Money at Call and Short Notice
(a) With Banks
(b) With other Institutions
4. Others (to be specified)
Total
Balances with non-scheduled banks included in 2 and
3 above

Note: Bank balance may include remittances in transit. If so, the nature and
amount should be separately stated.

Cash / bank balance within India / outside India are to be shown separately.

SCHEDULE 12 - ADVANCES AND OTHER ASSETS

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
A. Advances
1. Reserve deposits with ceding companies
2. Application money for investments
3. Prepayments
4. Advances to Directors/Officers
5. Advance tax paid and taxes deducted at source (Net of
provision for taxation)
6. Others (to be specified)
Total (A)
B. Other Assets
1. Income accrued on investments
2. Outstanding Premiums
3. Agents’ Balances
4. Foreign Agencies Balances
5. Due from other entities carrying on insurance business
(including reinsurers)
6. Due from subsidiaries/ holding co.
7. Deposit with RBI [Pursuant to section 7 of Insurance
Act, 1938]
8. GST unutilised credit
213
 9. Others (to be specified)
Total (B)
Total (A+B)

Notes:
The items under the above heads shall not be shown net of provisions for
doubtful amounts. The amount of provision against each head should be shown
separately.

SCHEDULE 13 - CURRENT LIABILITIES

Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
1. Agents’ Balances
2. Balances due to other insurance companies
3. Deposits held on re-insurance ceded
4. Premiums received in advance
5. Unallocated Premium
6. Sundry creditors
7. Due to subsidiaries/ holding company
8. Claims Outstanding
9. Due to Officers/ Directors
10. GST Liability
11. Others – Sundry debtors
Total

SCHEDULE 14 - PROVISIONS
Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
1 a)Reserve for Unexpired Risk
b)Premium deficiency reserve
2 Provision for taxation (less advance tax paid and
taxes deducted at source)
3 Provision for proposed dividend
4 Provision for dividend distribution tax
5 Others - Reserve for bad & doubtful debts
Total

SCHEDULE 15 - MISCELLANEOUS EXPENDITURE (To the extent not written off

or adjusted)
Particulars Current Previous
Year Year
(Rs.’000) (Rs.’000)
1. Discount Allowed in issue of shares/ debentures
2. Others – Deferred expenses to the extent not written off
Total
214
Notes:
a) No item shall be included under the head “Miscellaneous Expenditure” and
carried forward unless:
i) Some benefit from the expenditure can reasonably be expected to be
received in future, and
ii) The amount of such benefit is reasonably determinable.

b) The amount to be carried forward in respect of any item included under the
head “Miscellaneous Expenditure” shall not exceed the expected future
revenue/other benefits related to the expenditure.

CONTINGENT LIABILITIES

Particulars Current Previous

Year Year
(Rs.’000) (Rs.’000)

1. Partly paid-up investments

2. Claims, other than against policies, not
acknowledged as debts by the company
3. Underwriting commitments outstanding (in
respect of shares and securities)
4. Guarantees given by or on behalf of the
Company
5. Statutory demands/ liabilities in dispute,
not provided for
6. Reinsurance obligations to the extent not
provided for in accounts
7. Others (to be specified)
TOTAL

215
 SCHEDULE C
(See Regulation 3)
AUDITOR’S REPORT

The report of the auditors on the financial statements of every insurer shall
deal with the matters specified herein:

1.
a) That they have obtained all the information and explanations which, to the
best of their knowledge and belief were necessary for the purposes of their
audit and whether they have found them satisfactory;

b) Whether proper books of account have been maintained by the insurer so far
as appears from an examination of those books;

c) Whether proper returns, audited or unaudited, from branches and other

offices have been received and whether they were adequate for the purpose
of audit;

d) Whether the Balance sheet, Revenue account, Profit and Loss account and
the Receipts and Payments Account dealt with by the report are in
agreement with the books of account and returns;

e) Whether the actuarial valuation of liabilities is duly certified by the

appointed actuary including to the effect that the assumptions for such
valuation are in accordance with the guidelines and norms, issued by the
Authority, and/or by the Institute of Actuaries of India to its members and
has been forwarded to IRDAI.

2. The auditors shall express their opinion on:

a)
i) Whether the balance sheet gives a true and fair view of the insurer’s state
of affairs as at the end of the financial year/period;

ii) Whether the revenue accounts give a true and fair view of the surplus or the
deficit for the financial year/period;

iii) Whether the profit and loss account gives a true and fair view of the profit
or loss for the financial year/period;

iv) Whether the receipt and payment account (Cash Flow Statement) gives a
true and fair view of the receipts and payments for the financial
year/period;

216
b) The financial statements stated at (a) above are prepared in accordance
with the requirements of the Insurance Laws (Amendment) Act 2015, the
Insurance Regulatory and Development Authority Act, 1999 (41 of 1999),
IRDAI (preparation of financial statements and auditor’s report on insurance
companies) regulations, 2002 and the Companies Act 2013 to the extent
applicable and in the manner so required.

c) Investments have been valued in accordance with the provisions of the

Insurance Act, 1938 (4 of 1938) and Regulations issued on investments by
IRDAI.

d) The accounting policies selected by the insurer are appropriate and are in
compliance with the applicable accounting standards and with the
accounting principles, as prescribed in these Regulations or any order or
direction issued by the Authority in this behalf.

e) Whether adequate internal financial controls over financial reporting exist in

the company and effectiveness in such control.

f) Whether any of the directors on the board of the company is disqualified

from being appointed as director in terms of Section 164(2) of the
Companies Act.

g) Whether the financial statements comply with the accounting standards

specified under Section 133 of the Act, read with rule 7 of the companies
(Accounts) rules, 2014 and are in conformity with the Accounting principles
as prescribed in the IRDAI regulations.

h) Whether the company has disclosed the impact of pending litigations on its
Financial position in its financial statements.

i) Whether the company has made provision, as required under the applicable
law or accounting standards, for material foreseeable losses, if any, on long
term contracts including derivative contracts.

3. The auditors shall further certify that:

a) they have reviewed the management report and there is no apparent

mistake or material inconsistencies with the financial statements;

b) the insurer has complied with the terms and conditions of the registration
stipulated by the Authority.
217
4. A certificate signed by the auditors [which shall be in addition to any other
certificate or report which is required by law to be given with respect to the
balance sheet] certifying that:–
a) they have verified the cash balances and the securities relating to the
insurer’s loans, reversions and life interests (in the case of life insurers) and
investments;
b) to what extent, if any, they have verified the investments and transactions
relating to any trusts undertaken by the insurer as trustee; and
c) no part of the assets of the policyholders’ funds has been directly or
indirectly applied in contravention of the provisions of the Insurance Act,
1938 (4 of 1938) relating to the application and investments of the
policyholders’ funds.
d) There were no amounts which were required to be transferred to the
Investor Education and Protection Fund by the company.

Which of the following is/are the criterion/criteria for an item of expenditure

to be included under the head “Miscellaneous Expenditure” in accordance with
Schedule B of The IRDAI (Preparation of Financial Statements and Auditor’s
Report of Insurance Companies) Regulations, 2002?

(i) Future benefit from the expenditure can reasonably be expected.

(ii) The amount of such benefit is reasonably determinable.
A Both (i) and (ii)
B Only (i)
C Only (ii)
D Either (i) or (ii)

In accordance with Schedule B of The IRDAI (Preparation of Financial

Statements and Auditor’s Report of Insurance Companies) Regulations, 2002,
Revenue Accounts need to be separately prepared for which of the following
insurance businesses?
A Fire, marine, and miscellaneous
B Fire and marine
C Marine and miscellaneous
D Only miscellaneous

Which one of the following comes under “Miscellaneous Insurance”?

A Marine insurance
B Motor Insurance
C Fire Insurance
D None of the above
218
2. Prepare financial statement extracts for a non-life insurance
business in accordance with the appropriate regulatory
requirements.
[Learning Outcome b]

Before we actually prepare the financial statements for non-life insurance

business in accordance with Schedule B, we will discuss some important terms
used.

2.1 Reinsurance
In simple terms, reinsurance is ‘insurance of insurance’. It is a means by which
insurance companies can protect itself from the risk. The company who request
for the cover is called the cedant and the reinsurer is called the ceded. When a
risk is shared, the first insurer cannot himself retain the entire premium
collected from the policy holders. Depending upon the share of risk undertaken
by the second insurer, proportionate premium must be ceded by the first
insurer. Further, if the policy matures, the claim will also have to be shared by
both the insurers in the agreed ratio. The ceding company, which gives business
to re-insurance company is to receive commission from later – which is known as
commission on re-insurance ceded.

Note - Reinsurance accounting will be covered in detail in Unit 13.

2.2 Catastrophic reserve

A catastrophe is a momentous tragic event ranging from extreme misfortune to
utter overthrow or ruin. An earthquake is a classic example. Catastrophe losses
include losses caused due to storms, floods, tornadoes, earthquakes, tsunamis,
volcanic eruptions etc. It could cause a serious financial strain unless adequate
reserves are built systematically over a period of time to meet such
contingencies.

Catastrophic reserve is meant for meeting losses arising from entirely

unexpected set of events & not for any specific known purpose.
The IRDAI has provided for the regular creation of a catastrophe reserve in the
prescribed format of accounts. However, the norms for maximum annual
transfers to such a reserve have not been specified so far.

The following are the details of Premier Ltd, a fire insurance company for the
year ending 31 March 2021:

Particulars Rs.
Claim admitted but not paid (as on 31/03/2021) 3,30,000
Commission paid 3,15,000
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Commission on reinsurance ceded 78,000
Share transfer fees 27,000
Management expenses 4,68,000
Bad debts 16,500
Claims paid 1,35,000
Profit and loss appropriation account 58,500
Premium received less reinsurance 18,67,500
Reserve for unexpired risks as on 01/04/2020 7,05,000
Additional reserve as on 01/04/2020 1,42,500
Claims outstanding as on 01/04/2020 1,53,000
Dividend on share capital 1,05,000
Premium outstanding on 01/04/2020 2,10,000
Premium outstanding on 01/04/2021 2,25,000

The company maintains 50% of the Net Premium towards Reserve for unexpired
Risks, and 10% of the Net premium as Additional Reserve.
Required:
Prepare the Fire Insurance Revenue A/c as per IRDAI regulations for the year
ended 31st March, 2021.

Form B-RA – Fire Revenue Account for the year ended 31 March 2021

Particulars Schedule Rs.

Premium Earned (Net) 1 16,00,500
Profit / Loss on sale or redemption of Investments -
Other (to be specified) -
Interest, dividend and rent - Gross -
Total - A 16,00,500
Claim incurred (Net) 2 3,12,000
Commission 3 2,37,000
Operating expenses relating to Insurance business -
Total - B 5,49,000
Operating Profit from Fire Insurance = A - B 10,51,500

Form - B-PL- Profit and Loss Account for the year ending 31 March 2021

Particulars Schedule Rs.

1 Operating Profit from Fire Insurance 10,51,500
2 Income from investment
3 Other income - share transfer fee 27,000
Total - A 10,78,500

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 4 Provision (other than taxation)
5 Expenses of Management 4,68,000
6 Other expenses - Bad debts written off 16,500
Total - B 4,84,500
Profit before tax = A - B 5,94,000
Less: Provision for taxation -
Profit for the year before appropriation 5,94,000
Less: Appropriation - Dividend on equity share
capital (1,05,000)
Profit for the year after appropriation 4,89,000
Add: Bal. of P/L brought forward from last year 58,500
Balance carried forward to Balance sheet 5,47,500

Schedules forming part of Revenue Accounts

Schedule 1 - Premium received

Particulars Rs.
Premium received less Reinsurance premium 18,67,500
Add: Outstanding premium as on 31/03/2021 2,25,000
Less: Outstanding premium as on 31/03/2020 (2,10,000)
Net premium received before adjustment for Unexpired Risk
reserve and Additional Reserve 18,82,500

Less: Adjustment for change in unexpired Risk Reserve = 50% of

Net premium Less Opening Balance in Unexpired Risk Reserve =
‘50% of 18,82,500’, ie, 9,41,250 - 7,05,000) (2,36,250)

Less: Adjustment for change in Additional reserve = 10% of Net

Premium Less Opening Balance in Additional Reserve = ‘10% of
18,82,500’, ie, 1,88,250 - 1,42,500) (45,750)
Total Premium Earned (Net) 16,00,500

Schedule 2 - Claims incurred (Net)

Particulars Rs.
Claims Paid 1,35,000
Add: Claims outstanding at the end of the year 3,30,000
Less: Claims outstanding at the beginning of the year (1,53,000)
Total claims incurred 3,12,000

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Schedule 3 - Commission Expenses

Particulars Rs.
Commission Paid 3,15,000
Less: Commission Earned on re-insurance ceded (78,000)
Net Commission 2,37,000

The following are the balances of Zenith Insurance Co. Ltd as on 31 March 2021:
Particulars Rs.000's Particulars Rs.000's
Capital (Shares Rs 10 each) 4,80,00 Transfer fee 1,50
Funds as on 01/04/2020: Income tax refund received 45,00
- Fire Insurance 12,00,00 Reserve for bad debts 17,55
- Marine Insurance 14,25,00 Income tax paid 1,80,00
- Miscellaneous Insurance 3,27,97 Mortgage Loans (Dr) 14,62,50
Unclaimed dividend 12,75 Sundry debtors 37,50
Amount due to other Government securities
insurance companies 51,75 deposited with RBI 55,50
Sundry creditors 108,75 Government securities 15,30,00
Deposit and suspense (Cr) 34,20 Debentures 6,98,25
Profit and loss account (Cr) 1,20,60 Equity shares in Companies 3,37,50
Agent balance (Dr) 2,02,50 Claims Less Re-insurance:
Interest accrued but not due
(Dr) 33,75 - Fire Insurance 6,75,00
Due from other insurance Cos. 96,75 - Marine Insurance 5,38,35
Cash on hand 5,25 - Miscellaneous Insurance 1,02,00
Bank balance - current a/c 1,12,20 Premium Less Re-insurance
Furniture (Cost 150,00) 87,00 - Fire Insurance 26,43,75
Stationery stock 2,10 - Marine Insurance 15,33,75
Expenses of Management: - Miscellaneous Insurance 3,93,38
Interest & dividends
- Fire Insurance 4,20,00 received on investments 87,75
- Marine Insurance 2,40,00 Tax deducted on Interest 17,55
- Miscellaneous Insurance 60,00 Commission
- Others 45,00 - Fire Insurance 7,50,00
Foreign taxes - Marine 12,00 - Marine Insurance 5,25,00
Outstanding premium 1,23,00 - Miscellaneous Insurance 1,20,00
Donation – not eligible for 80G 15,00

You are required to make the following provisions:

1. Depreciation on furniture - 10% of original cost
2. Depreciation on investment of shares Rs. 15,00,000.
3. Transfer to general reserve Rs.15,00,000.
4. Outstanding claims as on 31/03/2021
- Fire - Rs. 300,00,000; Marine - Rs. 75,00,000; - Miscellaneous - Rs. 48,75,000
5. Provision for tax @ 50%; Proposed dividends @ 20%
6. Provision for unexpired risk is to be made as follows:
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 (a) On Marine Policies 100% Premium Less reinsurance
(b) On Other Policies 50% Premium Less reinsurance
7. The shares of the company are fully held by Indian promoters.

You are required to prepare Revenue and Profit and Loss Account for the year ended 31
March 2021 and Balance Sheet as on that date.

Form B - RA - Revenue account for the year ended 31 March 2021

Rs.000 Rs.000 Rs.000
Particulars Sch. Fire Marine Misc.
1 Premium earned (Net) 1 25,21,88 14,25,00 5,24,66
2 Profit/Loss on sale of Investments - - -
3 Other (to be specified) - - -
4 Interest, dividend and rent - Gross - - -
Total - A 25,21,88 14,25,00 5,24,66
1 Claims incurred (Net) 2 9,75,00 6,13,35 1,50,75
2 Commission 3 7,50,00 5,25,00 1,20,00
Op. expenses relating to Insurance
3 business 4 4,20,00 2,52,00 60,00
Total - B 21,45,00 13,90,35 3,30,75
Operating Profit from Insurance
business= A - B 3,76,88 34,65 1,93,91
Appropriations
1 Transfer to shareholder's Account 3,76,88 34,65 1,93,91
2 Transfer to Catastrophe Reserve - - -
3 Transfer to other reserves - - -
Total - C 3,76,88 34,65 1,93,91

Form B-PL - Profit and Loss account for the year ending 31 March 2021
Sch. Rs.000
1 Operating Profit
(a) Fire Insurance 3,76,88
(b) Marine Insurance 34,65
(c) Miscellaneous Insurance 1,93,91
2 Income from investment
(a) Interest, dividend and rent - Gross 87,75
(b) Profit on sale of investment -
3 Other income - Transfer fees 1,50
Total - A ( 1 + 2 + 3) 6,94,69
4 Provision (other than taxation)
(a) For decrease in value of investment -
223
 (b) For doubtful debts -
(c) Others (to be specified) -
5 Other expenses
(a) Depreciation of Furniture 15,00
(b) Depreciation on shares 15,00
(c) Expenses of Management 45,00
(d) Donations 15,00
Total - B (4 + 5) 90,00
Profit before tax (A - B) 6,04,69
Less: Provision for taxation (WN 1) (3,09,84)
Profit after tax 2,94,85
Appropriations
(a) Interim dividends paid during the year -
(b) Proposed final dividend (480,00 x 20%) 96,00
(c) Dividend distribution tax -
(d) Transfer to reserve - General Reserve 15,00
Balance after appropriations 1,83,85
Add: Balance of profit / Loss brought forward
from last year 1,20,60
Add: Income tax refund received 45,00
Balance carried forward to balance sheet 3,49,45

Form - B-BS - Balance Sheet as at 31 March 2021

Sources of funds Sch. Rs.000
Share capital 5 4,80,00
Reserve and surplus 6 3,97,00
Fair value change account -
Borrowings 7 -
Total sources of funds 8,77,00

Application of funds Rs.000

Investments 8 26,21,25
Loans 9 14,62,50
Fixed assets 10 72,00
Current assets
- Cash and Bank balances 11 1,17,45
- Advances and other assets 12 4,95,60
Sub-Total - A 47,68,80

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Current liabilities 13 6,31,20
Provisions 14 32,60,60
Sub-Total - B 38,91,80
Net current assets C = A - B 8,77,00
Miscellaneous expenditure (to the extent not written
off) 15 -
Debit balance in profit and loss account -
Total application of funds 8,77,00

Note: The corresponding amounts for the preceding financial year have not been shown
in the above case study due to lack of information in the question.

Schedules forming part of financial statements:

Schedule 1 - Premium earned

Rs.000 Rs.000 Rs.000
Particulars Fire Marine Misc.
Premium from direct business written
Add: Premium on reinsurance accepted
Less: Premium on reinsurance ceded
Net premium (given directly in question) 26,43,75 15,33,75 3,93,38
Add/ (Less): Adjustment for change in
Reserve for unexpired risk (1,21,87) (1,08,75) 1,31,28
Total premium earned (net) 25,21,88 14,25,00 5,24,66

Note: Amount to be transferred to / from Unexpired Risk Premium = Balance required

as on 31 March 2021 Less Balance in Unexpired Risk Reserve Account.

Dept. % Closing Opening Change

Fire 50 50% 0n 26,43,75 = 13,21,87 12,00,00 1,21,87
Marine 100 100% on 15,33,75 = 15,33,75 14,25,00 1,08,75
Misc. 50 50% on 3,93,38 = 1,96,69 3,27,97 - 1,31,28

Schedule 2 - Claims incurred (Net)

Rs.000 Rs.000 Rs.000
Particulars Fire Marine Misc.
Claims paid - - -
Direct - - -
Add: Re-insurance accepted - - -
Less: Re-insurance Ceded - - -
Net claims paid 6,75,00 5,38,35 1,02,00
Add: Claims outstanding at the end 3,00,00 75,00 48,75
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Less: Claims outstanding at the beginning - - -
Total claims incurred 9,75,00 6,13,35 1,50,75

Schedule 3 - Commission expenses

Rs.000 Rs.000 Rs.000
Particulars Fire Marine Misc.
Commission paid 7,50,00 5,25,00 1,20,00
Net commission 7,50,00 5,25,00 1,20,00

Schedule 4 - Operating expenses related to insurance business

Rs.000 Rs.000 Rs.000
Particulars Fire Marine Misc.
1 Rent rates and taxes (foreign taxes) - 12,00 -
2 Other expenses of management 4,20,00 2,40,00 60,00
Total operating expenses 4,20,00 2,52,00 60,00

Schedule 5 - Share capital

Particulars Rs.000
1 Authorised capital - Equity shares of Rs….each -
2 Paid up capital - 48 lakhs shares of Rs 10 each 4,80,00

Schedule 5A - Pattern of shareholding

Shareholder Current year Previous year
No of shares % of holding No of shares % of holding
1 Promoters
(a) Indian 48 lakhs 100% 48 lakhs 100%
(b) Foreign - - - -
2 Others - - - -
Total 48 lakhs 100% 48 lakhs 100%

Schedule 6 - Reserve and Surplus

Particulars Rs.000
1 General reserve 15,00
2 Other reserve
(a) Reserve for bad debts 17,55
(b) Fluctuation reserve [Depreciation of Investment in shares] 15,00
3 Balance in profit and loss account 3,49,45
Total 3,97,00

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Schedule 7 – Borrowings
Borrowings - NIL

Schedule 8 – Investments
Particulars Rs.000
Long term investments 15,30,00
Govt. securities and govt. guaranteed bonds including
1 treasury bills 55,50
2 Other approved securities deposited with RBI
3 Other investments 3,37,50
(a) Equity shares 6,98,25
(b) Debenture bonds
Short term investments -
Total investments 26,21,25

Schedule 9 – Loans
Particulars Rs.000
1 Security wise classification
Secured
(a) On mortgage of property 14,62,50
(b) On shares, bond, government securities, etc. -
(c) Others (to be specified) -
Unsecured -
Total 14,62,50
2 Borrower wise classification 14,62,50
3 Maturity wise classification 14,62,50

Note - in the absence of information, borrower-wise and maturity-wise classification is

not provided.

Schedule 10 - Fixed assets

(Rs.’000)
Particulars Cost / Gross Block Accumulated depreciation Net Block
For
Add Deduc Openin the Sales/ Closin Openi
Opening n. tion Closing g year adj. Closing g ng
Furniture and
fixture 1,50,00 - - 1,50,00 63,00 15,00 - 78,00 72,00 87,00

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Schedule 11 - Cash and bank balance
Particulars Rs.000
Cash (including cheques, drafts and stamps) 5,25
Bank balance - current account 1,12,20
Total 1,17,45

Schedule 12 - Advances and other assets

Particulars Rs.000
Other assets
1 Income accrued on investments 33,75
2 Outstanding premium 1,23,00
3 Agent's balance 2,02,50
4 Due from other entity carrying on insurance business 96,75
5 Other - stationery stock 2,10
6 Other - sundry debtor 37,50
Total 4,95,60

Schedule 13 - Current liabilities

Particulars Rs.000
1 Balance due to other insurance companies 51,75
2 Deposit and suspense account 34,20
3 Sundry creditor 1,08,75
4 Claims outstanding (Rs.3,00,00 + Rs.75,00 + Rs.48,75) 4,23,75
5 Unclaimed dividend 12,75
Total 6,31,20

Schedule 14 – Provisions
Particulars Rs.000
1 Reserve for unexpired risk
(a) Fire 13,21,87
(b) Marine 15,33,75
(c) Miscellaneous 1,96,69
2 For taxation (Less advance tax paid and TDS) (W2) 1,12,29
3 For proposed dividends 96,00
Total provisions 32,60,60

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Schedule 15 - Miscellaneous expenditure
NIL

Workings W1 - Calculation of provision for taxation:

Particulars Rs.000
Net profit before tax 6,04,69
Add: Donation not allowed as a deduction u/s 80G of Income tax act 15,00
Taxable profit 6,19,69
Provision for tax (50% on 6,19,69) 3,09,84

Workings W2 - Provision for taxation account

Particulars Rs.000 Particulars Rs.000
To Bank A/c 1,80,00 By profit and loss A/c 3,09,84
To Tax deducted at source A/c 17,55
To balance c/d – Balance figure 1,12,29
3,09,84 3,09,84

Summary

 An insurer carrying on general insurance business shall comply with the

requirements of Schedule ‘B’ to prepare financial statements.
 Insurance companies are required to maintain their financial accounts i.e.
revenue account, profit and loss account and balance sheet in accordance
with the provisions of the IRDAI (Preparation of Financial Statements and
Auditor's Report of Insurance Companies) Regulations, 2002.
 General insurance companies should comply with the requirements of
Schedule B. Schedule B is broadly divided into the following parts:
 Part l - Accounting principles for preparation of financial statements
 Part II- Disclosures forming part of financial statements
 Part III - General instructions for preparation of financial statements.
 Part IV - Contents of management report.
 Part-V - Preparation of financial statements.
 Premium shall be recognised as income over the contract period or the
period of risk, whichever is appropriate.
 Acquisition costs, if any, shall be expensed in the period in which they are
incurred.
 A liability for outstanding claims shall be brought to account in respect of
both direct business and inward reinsurance business.
 Loans shall be measured at historical cost subject to impairment provisions.
 Catastrophe reserve shall be created in accordance with norms, if any,
prescribed by the authority.
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Answers to Test Yourself

Answer to TY 1
The correct option is D.

Answer to TY 2
The correct option is A. Both the conditions need to be satisfied in order to
include an item of expenditure under the head “Miscellaneous Expenditure”.

Answer to TY 3
The correct option is A.

Answer to TY 4
The correct option is B. Marine and fire insurance are separate categories under
general insurance. Motor insurance needs to be classified under miscellaneous
insurance.

Self Examination Questions

Question 1
An item of income and expense can be shown in the Revenue Account of a Fire /
Marine insurance company as a separate line item only if:
A It is in excess of 1% of premium or Rs.50,000, whichever is higher
B It is in excess of 1% of premium or Rs.50,000, whichever is lower
C It is in excess of 1% of premium or Rs.5,00,000, whichever is higher
D It is in excess of 1% of premium or Rs.5,00,000, whichever is lower

Question 2
General insurance includes:
A Life insurance, marine insurance and fire insurance
B Marine insurance and fire insurance
C Marine insurance, fire insurance and miscellaneous insurance
D Only miscellaneous insurance

Question 3
An insurance company carrying on general insurance business is required to
prepare balance sheet, revenue account and profit and loss account in
accordance with:
A Schedule A
B Schedule B
C Schedule C
D Schedule D

230
Question 4
For a company engaged in general insurance business, premium is recognised:
A When due
B Over the contract period or period of risk
C On receipt basis
D None of the above

Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is C. In accordance with the notes to B-RA and B-PL, items of
expenses and income in excess of one per cent of the total premiums (less
reinsurance) or Rs.5,00,000 whichever is higher, shall be shown as a separate
line item.

Answer to SEQ 2
The correct option is C. General insurance includes Fire, Marine and
Miscellaneous Insurance.

Answer to SEQ 3
The correct option is B. The general insurance companies need to comply with
Schedule B of IRDAI (Preparation of Financial Statements and Auditor's Report of
Insurance Companies) Regulations, 2002.

Answer to SEQ 4
The correct option is B. In accordance with Part I of Schedule B, premium is
recognised as income over the contract period or the period of risk, whichever
is appropriate.

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 CHAPTER 3
NON-LIFE INSURANCE BUSINESS ACCOUNTING
METHODS, TECHNIQUES AND PROCESS

UNIT-12
PREPARATION AND PRESENTATION OF FINANCIAL
STATEMENTS
Chapter Introduction

In the previous unit, accounting regulations are discussed for the general
insurance business. In this unit, we discuss how and which different financial
statements are prepared and presented.

a) Explain how Revenue Accounts, Profit and Loss Account and Balance sheet are
prepared in the general insurance business.
b) Demonstrate the preparation and presentation of cash flow statement in general
insurance business.
c) Ratio analysis of financial statements.
d) Learn about solvency margin.

232
1. Explain how Revenue Accounts, Profit and Loss Account and
Balance sheet are prepared in the general insurance business.
[Learning Outcome a]

The following examples will help you to understand the preparation and the
presentation of Revenue Accounts, Profit and Loss Account and Balance Sheet in
general insurance business.

1.1 Revenue A/c

The main purpose of preparing Revenue A/c is to show a summary of income

and expenditure relating to fire insurance, marine insurance and miscellaneous
insurance during an accounting period.

General insurance companies are required to prepare separate Revenue

accounts for fire insurance business, marine insurance business and
miscellaneous insurance business.

We have already gone through the contents of Revenue account. It has both
identifiable items and unidentifiable items.

Identifiable items are those that are directly related to the revenue account of
the particular LOB (Line of business).
1. Premium earned - Schedule 1
2. Claims incurred – Schedule 2
3. Commission – Schedule 3
Unidentifiable items are those that are not directly matchable to that LOB. Such
items are allocated to the revenue account on the basis of some predefined
method.

1. Apportionment of Expenses of Management: Expenses of management

related to insurance business are apportioned to Revenue Account (Fire,
Marine and Miscellaneous departments) in the ratio of Net Written Premium
of the year.

 2. Apportionment of Income from Investments: As per accounting policy of

an insurance company, Investment Income (Net of Expenses) is apportioned
between Shareholders’ Funds and Policyholders’ funds in proportion to the
Shareholders’ and Policyholders’ funds balance at the beginning of the
year.

 Investment Income (Net of Expenses) pertaining to policyholders’ funds is

further apportioned to Fire, Marine and Miscellaneous departments in

233
 proportion to respective technical reserves balance at the end of the
year.
 Policyholders’ funds are amounts belonging to policyholders. These cannot
be taken for revenue purpose of the company, thus these are not related to
shareholders. Excess collection of premium not refunded, old balances lying
in Agents Premium Deposit (APD) account, unidentified credits normally
form part of these balances.

It is mandatory that the amounts which are due to policyholders and

remaining unclaimed are to be kept separately and a fixed deposit equalling
the amount should be kept separately. The interest arising from the fixed
deposit also is to be kept aside for policyholders.

Companies have to maintain the detailed list of unclaimed amount of

policyholders for 10 years and any amount lying more than 10 years shall be
transferred to ‘Senior citizens Welfare Fund’.

Policyholders’ Funds

 Claims outstanding at the end, including IBNR and IBNER

 Unearned Premium Reserve
 Premium Deficiency Reserve
 Catastrophe Reserve
 Unallocated premium
 Balance due to other insurance companies
 Sundry creditors – due to policyholders
 Premium received in advance

Less:

 Outstanding premium
 Balance due from other insurance companies
 Fixed deposits – Unclaimed amount of policyholders

Shareholders’ funds, naturally, are the amounts belonging to

shareholders.

Shareholders’ Funds

 Share capital
 General Reserve
 Capital Reserve
 Foreign currency translation reserve
Less:

234
  Revaluation Reserves
 Fair value change account
 Accumulated losses

Technical reserve is the sum of,

 Reserve for unexpired risk
 Premium Deficiency Reserve
 Outstanding Claims, incl. IBNR and IBNER

The books of accounts of Golden General Insurance Co Ltd show the following
closing balances as on 31st March 2021 in respect of Fire Dept.

Rs. (in
Lakhs)
Premium from Direct Business 98,139
Premium on Reinsurance Accepted 34,363
Premium on Reinsurance Ceded 43,732
Net Premium for 2019-20 1,05,292
Interest Dividend & Rent - Gross 10,619
Claim Paid Direct 70,511
Claims on Reinsurance Ceded 14,435
Claims on Reinsurance Accepted 29,228
Outstanding Claims at the end (net) 80,000
Outstanding Claims at the Beginning (net) 75,558
Commission Paid Direct 10,721
Commission on Reinsurance Accepted 6,292
Commission on Reinsurance Ceded 6,990
Fire Dept. - Foreign Taxes paid for 2
Amortisation Write off provision on Investments 8

From the above closing balances, prepare Fire Revenue Account for the year
ended 31st March 2021 in consideration of the Management Expenses
apportioned for fire dept. of Rs. 19,611 lakh.

Solution
Golden General Insurance Co Ltd
Fire Insurance Revenue Account for the year ended 31st March 2021
Particulars Sch. Rs in Lakhs
1. Premium earned (Net) 1 97,031
2. Profit on sale or redemption of investments (policyholders) 10,490
3. Others Nil
4. Interest, Dividend & Rent—Gross* 10,619
Total (A) 1,18,140

235
1. Claims Incurred (Net) 2 60,160
2.Commission 3 10,023
3. Operating Expenses related to insurance business** 19,611
4. Others:
Taxes 2
Amortisation, Write off, provisions - Investments 8
Total (B) 89,804
Operating profit/loss Business C=(A-B) 28,336
Appropriations:
Transfer to Shareholders’ A/C (P&L Account) 28,336
Transfer to Catastrophic Reserve --
Transfer to other Reserves --
Total (C) 28,336

Schedule 1: Fire Premium Earned (Net) (Rs. in Lakhs)

Particulars 2020-21
Premium From Direct Business 98,139
Add: Premium on Reinsurance Accepted 34,363
Less: Premium on Reinsurance Ceded 43,732
Net Premium 88,770
Adj. For Change in Reserve in Unexpired Risks
(‘50% of 88,770’ – ‘50% of 1,05,292’) = (44,385 -52,646) 8,261
Net Premium Earned (Net) 97,031
Schedule 2: Fire Claim Incurred (Net) (Rs. in Lakhs)

Particulars 2020-21
Claim Paid Direct 70,511
Add: Claims on Reinsurance Accepted 14,435
Less: Claims on Reinsurance Ceded 29,228
Net Claims Paid 55,718
Add: Outstanding Claims at the end (net) 80,000
Less: Outstanding Claims at the Beginning (net) 75,558
Incurred Claims Net 60,160

Schedule 3: Fire Commission (Net) (Rs. in Lakhs)

Particulars 2020-21
Commission Paid Direct 10,721
Add: Commission on Reinsurance Accepted 6,292
Less: Commission on Reinsurance Ceded 6,990
Net Commission 10,023

236
Lets understand the Revenue Account for Marine insurance business with the
help of the following example.
The books of accounts of Golden General Insurance Co Ltd show the following
closing balances as on 31st March 2021 in respect of Marine Dept.:

Rs. (in
Lakhs)
Premium from Direct Business 49,483
Premium on Reinsurance Accepted 1,536
Premium on Reinsurance Ceded 27,842
Net Premium 2019-20 18,857
Claim Paid Direct 15,380
Claims on Reinsurance Ceded 1,095
Claims on Reinsurance Accepted 3,751
Outstanding Claims at the end (net) 21,099
Outstanding Claims at the Beginning (net) 17,999
Commission Paid Direct 4,982
Commission on Reinsurance Accepted 318
Commission on Reinsurance Ceded 2,631
Profit on sale/redemption of investments 3,016
Interest, Dividend & Rent—Gross 3,053
Taxes 1
Amortisation, Write off, provisions—Investments 2
Operating Expenses relating to Marine Dept. 5,663

Prepare Marine Insurance Revenue Account for the year ended 31st March 2021
with all schedules.

Solution
Marine Insurance Revenue Account for the year ended 31st March 2021
(Rs. in Lakhs)
Particulars Schedule 2020-21
1. Premium earned (Net) 1 18,857
2. Profit on sale/redemption of investments 3,016
3. Interest, Dividend & Rent—Gross 3,053
Total (A) 24,926
1. Claims Incurred (Net) 2 15,824
2.Commission 3 2,669
3. Operating Expenses 5,663
4. Others
Taxes 1
Amortisation, Write off, provisions—Investments 2
Total (B) 24,159
Operating profit/loss Business C=(A-B) 767
Appropriations
Transfer to Shareholders’ A/c (P&L Account) 767
237
 Transfer to Catastrophe Reserve -
Total (C) 767

Schedules to Marine Insurance Revenue Account for the year ended 31st
March 2021
Schedule 1: Marine Premium Earned (Net) (Rs. in Lakhs)

Particulars 2020-21
Premium From Direct Business 49,483
Add: Premium on Reinsurance Accepted 1,536
Less: Premium on Reinsurance Ceded 27,842
Net Premium 23,177
Less: Adj. for Change in Reserve in Unexpired Risks (100%) 4,320
(23177-18,857)
Net Premium Earned (Net) 18,857
Schedule 2: Marine Claim Paid (Net) (Rs. in Lakhs)

Particulars 2020-21
Claim Paid Direct 15,380
Add: Claims on Reinsurance Accepted 1,095
Less: Claims on Reinsurance Ceded 3,751
Net Claims Paid 12,724
Add: Outstanding Claims at the end (net) 21,099
Less: Outstanding Claims at the Beginning (net) 17,999
Incurred Claims Net 15,824

Schedule 3: Marine Commission (Net) (Rs. in Lakhs)

Particulars 2020-21
Commission Paid Direct 4,982
Add: Commission on Reinsurance Accepted 318
Less: Commission on Reinsurance Ceded 2,631
Net Commission 2,669

Lets understand the Revenue Account for miscellaneous insurance business with
the help of the following example.

The books of accounts of Golden General Insurance Co Ltd show the following
closing balances as on 31st March 2021 in respect of Miscellaneous Dept.:

Rs. (in
Lakhs)
Operating Expenses 76,637
Taxes 66
Amortisation Write Off 40
238
 Premium From Direct Business 4,67,524
Premium on Reinsurance Accepted 50,278
Premium on Reinsurance Ceded 1,38,322
Net Premium for 2019-20 3,51,027
Claim Paid Direct 3,70,421
Claims on Reinsurance accepted 2,467
Claims on Reinsurance ceded 61,648
Outstanding Claims at the end (net) 5,12,889
Outstanding Claims at the Beginning (net) 4,82,365
Commission Paid Direct 46,819
Commission on Reinsurance Accepted 6,346
Commission on Reinsurance Ceded 19,934

Solution
Miscellaneous Insurance Revenue Account for the year ended 31st March 2021
Particulars Schedule 2020-21
(Rs in Lakhs)
1. Premium earned (Net) 1 3,65,254
2. Profit on sale/redemption of investments 53,827
3. Interest, Dividend & Rent - Gross 54,493
Total (A) 4,73,574
1. Claims Incurred (Net) 2 3,41,764
2.Commission 3 33,231
3. Operating Expenses 76,637
4. Others:
Taxes 66
Amortisation, Write off, provisions - 40
Investments
Total (B) 451,738
Operating profit/loss Business C=(A-B) 21,836
APPROPRIATIONS
Transfer to Shareholders’ A/c (P&L Account) 21,836
Transfer to Catastrophe Reserve
Total (C) 21,836
Schedules to Misc. Insurance Revenue Account for the year ended 31st March
2021
Schedule 1: Miscellaneous Premium Earned (Net) (Rs. in Lakhs)

Particulars 2020-21
Premium From Direct Business 4,67,524
Add: Premium on Reinsurance Accepted 50,278
Less: Premium on Reinsurance Ceded 1,38,322
Net Premium 3,79,480
Adj. For Change in Reserve in Unexpired Risks 50% on 14,226
(3,79,480-3,51,027) = (1,89,740-1,75,514)
239
 Net Premium Earned (Net) 3,65,254

Schedule 2: Miscellaneous Claim Paid (Net) (Rs. in Lakhs)

Particulars 2020-21
Claim Paid Direct 3,70,421
Add: Claims on Reinsurance accepted 2,467
Less: Claims on Reinsurance ceded 61,648
Net Claims Paid 3,11,240
Add: Outstanding Claims at the end (net) 5,12,889
Less: Outstanding Claims at the Beginning (net) 4,82,365
Incurred Claims Net 3,41,764

Schedule 3: Miscellaneous Commission (Net) (Rs. in Lakhs)

Particulars 2020-21
Commission Paid Direct 46,819
Add: Commission on Reinsurance Accepted 6,346
Less: Commission on Reinsurance Ceded 19,934
Net Commission 33,231

The following example highlights the adjustments in calculating the amount to

be shown as claims incurred (net).

Preparation of Revenue Account with the following balances extracted from the
books of Miscellaneous Dept. of DLF General Insurance Company for the year
ended 31st March 2021, show the amount of claim as it would appear in the
Revenue Account.

Rs. In (000)
Claims paid to Claimants 4,08,90,000
Survey Fess paid 2,153
Claims paid on Reinsurance Accepted 11,57,699
Claims Payable on Reinsurance Accepted as on 31.3.2021 3,00,000
Claims Payable on Reinsurance Accepted as on 31.3.2020 2,00,000
Claims Received on Reinsurance ceded 84,86,973
Claims Receivable on Reinsurance ceded as on 31.3.2021 5,00,000
Claims Receivable on Reinsurance ceded as on 31.3.2020 3,00,000
Claims outstanding as per OS Register as on 31.3.2021 5,58,06,788
Claims outstanding as per OS Register as on 31.3.2020 5,13,88,921

Solution
In the Revenue Account claims are shown as “Claims Incurred (Net)” which will
be calculated as under;
240
Claims Incurred (Net) ...Miscellaneous
Particulars Rs. In (000)
Claims Paid Direct (W1) 4,08,92,153
Add: Claims on Reinsurance Accepted 11,57,699
Less: Claims Received on Reinsurance ceded 84,86,973
Net Claims Paid 3,35,62,879
Add: Claims outstanding at the end (Net) (W2) 5,56,06,788
Less: Claims outstanding at Beginning (Net) (W3) 5,12,88,921
Incurred Claims Net 3,78,80,746

Workings:

W1 Claims Paid Direct (Rs in 000)

Claims paid to Claimants 4,08,90,000
Survey Fess paid 2,153
4,08,92,153

W2 Claims outstanding at the end (Net)

Claims outstanding as per OS Register as on 31.3.2021 5,58,06,788
Less: Claims Receivable on Reinsurance ceded as on 31.3.2021 5,00,000
Add: Claims Payable on Reinsurance Accepted as on 31.3. 2021 3,00,000
55,606,788

W3 Claims outstanding at Beginning (Net)

Claims outstanding as per OS Register as on 31.3.2020 5,13,88,921
Less: Claims Receivable on Reinsurance ceded as on 31.3. 2020 3,00,000
Add: Claims Payable on Reinsurance Accepted as on 31.3. 2020 2,00,000
5,12,88,921

From the following information, calculate the amount of Net Premium Earned in
fire insurance business.

Premium from Direct Business 1,20,000

Premium on Reinsurance Accepted 40,000
Premium on Reinsurance Ceded 50,000
Net Premium for the previous year 1,30,000

A 1,00,000
B 1,20,000
C 1,10,000
D 1,30,000

241
Profit and Loss Account / Income statement
After Revenue Accounts, the Income Statement (Profit and Loss A/c) is prepared
with net underwriting result being transferred from 3 Revenue Accounts. Net
underwriting result is combined with the net result from investments and
financing activities of the shareholders to determine the net profit or loss of the
insurer for a particular financial year.

As discussed earlier, Profit and Loss Account starts with Underwriting Profits /
Losses of 3 revenue accounts and then the investment incomes of the
shareholders are taken into consideration. Provisions and Expenses which do not
relate to any specific business are deducted from the total income to determine
the net profit.

A Profit and Loss Account is prepared in the IRDAI specified format FORM B-
PL.

Continuing with the previous example of Golden General Insurance Co., prepare
a Profit and Loss Account of Golden General Insurance Co. for the year ended
31st March 2021 in consideration of the underwriting results shown in the
previous examples for the 3 revenue accounts and the following information:

Rs. (in
Lakhs)
Operating profit - Fire 28,336
Operating profit - Marine 767
Operating profit – Misc. 21,836
Interest, Dividend and Rent (gross)—Shareholders 49,866
Profit on Sale of Investments 49,256
Misc. Receipts; Credit Balance Written Back 2,102
Amortization, Provisions for thinly traded shares 493
Doubtful Debts - Investments (-) 426
Diminution in value of investment (-) 30
Service Tax-on Interest Income 1
Loss on Sale of assets 27
Penalty for Breach of Tariff 5
Current Tax 9,179
Deferred Tax 3,040
Earlier Year Tax 1,785
Interim Dividend Paid during the year 10,000
Proposed Dividend 18,300
Dividend Distribution Tax 4,810
Transfer to General Reserve 1,08,603

242
Solution

Profit and Loss A/c for the year ended 31st March 2021
Particulars Sch. Amount
(Rs. in Lakhs)
Incomes (A)
Underwriting or Operating Profits/ Losses
Fire Insurance 28,336
Marine Insurance 767
Miscellaneous Insurance 21,836
Income from investments
Interest, Dividends & \Rents (Gross)—Shareholders
49,866
Profit on Sale of Investments —Shareholders 49,256
Other Income
Misc. Receipts; Credit Balance Written Back 2,102
Total (A) 1,52,163
Provisions & Expenses (B)
Provisions (Other than taxation) for
Amortisation, Provisions for thinly traded shares 493
Doubtful Debts - Investments (426)
Diminution in value of investment (30)
Other Expenses (other than those related to Ins.
Business )
Service Tax-on Interest Income 1
Loss on Sale of assets (27)
Penalty for Breach of Tariff 5
Total (B) 16
Profit Before Tax (A-B) 1,52,147
Provisions for Taxation
Current Tax 9,179
Deferred Tax 3,040
Earlier Year Tax (1,785)
12,032
Profit after Tax 1,41,713
Appropriations
Interim Dividend Paid during the year 10,000
Proposed Final Dividend 18,300
Dividend distribution tax 4,810
Transfer to General Reserve 1,08,603
Balance of profit / loss brought forward from last year Nil
Balance carried forward to Balance Sheet Nil

243
Balance Sheet

A Balance Sheet contains the balances of assets, liabilities and share capital
status as at the close of a particular date.

The Balance Sheet of a General Insurance Company is prepared in Form B-BS as

specified in Part V in schedule B to the IRDAI (Preparation of Financial
Statements and Auditors Report of Insurance Companies) Regulations 2002 and
also keeping in view the requirements of the Companies Act 2013 and the
following regulatory aspects as mentioned in the aforesaid Regulations:

 Accounting Principles for Preparation of Financial Statements (Part. I of

Reg.)
 Disclosures forming part of Financial Statements (Part. II of Reg.)
 General Instruction for preparation of Financial Statements (Part. III of
Reg.)

The format of Balance Sheet has also been shown earlier in this unit. It is not
out of place to mention that all financial statements are to be presented with
figures for the current year as well for the previous year. Here, all financial
statements have been illustrated with current figures only for convenience. In
the Appendix, it is presented in the correct form.

The students should also go through the financial statements in the appendix for
better understanding.

Continuing with the previous example of Golden General Insurance Co., prepare
a Balance Sheet as at 31st March 2021 of M/S Golden General Insurance Co from
the following statement of balances (Trial Balance) after preparation of
Revenue Accounts and Profit & Loss illustrated in the above example.

Statement of Balances as on 31.03. 2021

Closing Balances of Assets and Liabilities Debit Credit
Rs in Lakh Rs in Lakh
Share capital
Authorised/ Paid Up Capital 20,000
2,000lac Equity shares of Rs. 10
each
Reserves and Surplus
Capital Reserves 6
General Reserves (Balance on 5,70,214
1.4.2020)
244
 Closing Balances of Assets and Liabilities Debit Credit
Rs in Lakh Rs in Lakh
Add: Transfer from P& L Account 1,08,603 6,78,817
Catastrophe Reserves NIL
Foreign Currency as on 57
31.3.2021 (After Adjustment)
Fair Value Change Account 13,95,928
Borrowings NIL
Investments; Long Term
Government Securities
Central Govt. Securities 3,15,513
State Govt. Securities 1,18,133
Foreign Govt. Securities 19,359
Other Approved Investments 7,416
Other Investments
Equity Shares 15,55,688
Preference Shares 8,334
Debentures In India 87,015
Debentures Outside India 4,378
Investment in Subsidiaries 5,956
Investment in Infrastructure 1,65,948
Investment in Housing Bonds 66,149
Other Approved Investments 69,763 2,423,662
Investments; Short Term
Government Securities
Central Govt. Securities 3,565
State Govt. Securities 6,710
Foreign Govt. Securities
Other Approved Investments 2,023
Other Investments
Equity Shares 6,619
Preference Shares
Debentures In India
Debentures Outside India
Investment in Subsidiaries
Investment in Infrastructure
Investment in Housing Bonds 12,356
Other Approved Investments 8,252 39,625
Loans :
Secured Loans:
Housing Loan to Employees 20,000
Vehicle Loans to Employees 5,000
Computer Loans to Employees 361
25,361
Other Term Loans to Various 15,297

245
Firms
Loans to State Govt. 23,206
Unsecured Terms Loans or Bridge 1,912 65,776
Loans;
Fixed Assets: Gross Block
Land & Building 12,992
Furniture & Fixtures 6,476
I T Equipment 17,468
Vehicles 5,170
Other Equipment 1,156 43,262
Depreciation on Fixed Assets:
Land & Building 6,484
Furniture & Fixtures 5,433
I T Equipment 15,870
Vehicles 2,942
Other Equipment 1,009 31,738
Cash and Bank Balances
Cash In-hand 19,029
Bank Deposits (Short Terms & 2,27,980
Others)
Bank Balances in current 38,784 2,85,793
Accounts
Deferred Tax Assets 1,016
Advances & Other Assets:
Advances
Deposits with Ceding Companies 1,808
Application Money for 3,784
Investments
Advance Tax &TDS (Net) 1,16,636
Other Advances 7,388 1,29,616
Other Assets
Income Accrued On Investments 26,583
Outstanding Premium 274
Agents Balances 10,578
Amount Recoverable From 12,613
Various Agencies
Amount due From Others 1,61,059
Carrying on Insurance Business
Amount due From Subsidiaries 4
Deposit with RBI 1,075
Other Accrued Income 4,098
Amount due From Sundry Debtors 22,718 2,39,002
Current Liabilities
Agents Balances 3,086
Balances Due to Other Insurance 87,025

246
 Companies
Deposits with Reinsurers 632
Premium Received In Advance 7,677
Sundry Creditors 61,616
Service Tax Payable 431
Claims Outstanding 6,13,988
Others 1,753 7,76,208
Provisions
Reserves for Unexpired Risks 2,57,302
Provisions for Taxation (1,40,113 ---
adjusted with Adv. Tax)
Provision for Proposed Dividend 28,300
Provision for Proposed Dividend 4,810
Tax
Reserves for Bad & Doubtful Debt 34,336
Provisions in Diminution in value 250 3,24,998
of Thinly Traded Shares
TOTAL 32,27,752 32,27,752

Solution:
M/S Golden General Insurance Co Balance Sheet as at 31st March 2021
Sch. C.Y. (Rs. In P.Y (Rs.
Lakhs) In Lakhs)
Sources of Funds
Share capital 20,000
Reserves and surplus 6,78,880
Fair value change account 13,95,928
Borrowings Nil
TOTAL 20,94,808
Application of Funds
Investments 8 24,63,287
Loans 9 65,776
Fixed assets 10 11,524
Deferred Tax Assets 1,016
Current assets
a Cash and Bank Balances 11 2,85,793
b Advances and Other Assets 12 3,68,618
Sub-Total (A) 6,54,411
c Current liabilities 13 7,76,208
d Provisions 14 3,24,998
Sub-Total (B) 11,01,206
Net current assets (c) = (a +b-c-d) -4,46,795
Miscellaneous expenditure (Not written 15 NIL
off )
TOTAL 20,94,808
247
Note:
(i) Schedules to Balance Sheet, though numbered as per the specified
format in above balance sheet, are not prepared here. The students
should try to prepare them in the forms and with the particulars as
shown in the schedules forming the part of the balance sheet.

(ii) Fair value change account and investments are required to be shown
separately for shareholders’ fund and policyholders’ fund vide IRDAI
circular No. IRDA/F&A/CIR/CPM/010/01/2017 dt. January 12, 2017
regarding IRDA (preparation of Financial Statements and Auditors’ Report
of insurance companies) regulations, 2002(the above circular is in
continuance of IRDAI circular no. IRDA/F&A/CIR/CPM/056/03/2016 dt.
April 04, 2016)

Preparation of Balance Sheet in the forms and with the particulars as shown
in the schedules

Prepare a Balance Sheet as at 31st March 2021 of M/S Good Luck Insurance Co
from following statement of balances after preparation of Revenue Accounts
and Profit & Loss.
Statement of Balances (After P&L Account) as on 31 st March 2021
Particulars Debit Credit
Rs (000) Rs (000)
Share capital
Authorised / Paid Up shares of Rs. 10 each 20,00,000
Reserves and Surplus
Capital Reserves Nil
Op. General Reserves 6,77,22,294
Addition during the year 12,65,476 6,89,87,770
Contingency Reserves 4,49,500
Catastrophe Reserves Nil
Foreign Currency Translation Reserve (Op. 5,741) 17,84,249
Fair Value Change Account 7,41,72,943
Borrowings Nil
Investments: Long Term
Government Securities
Central Govt. Securities 2,99,85,499
State Govt. Securities 1,09,56,967
Foreign Govt. Securities 22,33,531
Other Approved Investments 3,72,474
Other Investments
248
 Particulars Debit Credit
Rs (000) Rs (000)
Equity Shares 9,45,24,937
Preference Shares 7,95,319
Debentures In India 79,87,138
Debentures Outside India 1,23,866
Investment in Subsidiaries 5,95,564
Investment in Infrastructure 1,66,73,417
Investment in Housing Bonds 47,80,646
Other Approved Investments 41,78,175 17,32,07,533
Investments; Short Term
Govt. Securities
Central Govt. Securities 3,28,001
State Govt. Securities 8,55,253
Foreign Govt. Securities 84,299
Other Approved Investments 4,73,461
Other Investments
Equity Shares 0
Preference Shares 0
Debentures In India 0
Debentures Outside India 0
Investment in Subsidiaries 0
Investment in Infra & Social Sector 11,43,322
Investment in Housing Bonds 15,83,856 44,68,192
Other Approved Investments 0
Borrowings Nil
Loans
Secured Loans
Housing Loan to Employees 24,51,200
Vehicle Loans to Employees 13,75,848
Computer Loans to Employees 6,740
Loans to State Govt. Housing 19,21,643
Unsecured Loans: Term Loans 1,83,193 59,38,624
Fixed Assets: Gross Block
Intangible 4,14,693
Land & Building (Land 14,892 13,05,406
&Building 12,90,514)
Furniture & Fixtures 6,78,682
IT Equipment 20,88,299
Vehicles 5,85,395
Other Equipment 1,16,685 51,89,160
Depr. Fund on Fixed Assets
Intangible 1,03,673
Land & Building 6,87,741
Furniture & Fixtures 5,67,219
249
 Particulars Debit Credit
Rs (000) Rs (000)
IT Equipment 18,12,730
Vehicles 3,34,516
Other Equipment 1,01,575 36,07,454
Cash and Bank Balances
Cash In-hand 14,23,502
Bank Deposits (Short Term & Others) 2,54,89,278
Bank Balances in current Accounts 39,72,118
Money at Call & Short Notice 23,23,479 3,32,08,377
Deferred Tax Assets 2,33,054
Advances & Other Assets
Advances
Deposits with Ceding Companies 1,59,704
Pre-Payments 3,17,912
Advance Tax &TDS (Net) 1,21,45,088
Other Advances 1,82,151 1,28,04,855
Other Assets
Income Accrued On Investments 25,03,584
Outstanding Premium 8,98,644
Agents Balances 7,80,800
Amount Recoverable From Agencies 11,61,296
Due from Reinsurers & Co-insurers 2,96,26,214
Amount due From Subsidiaries 524
Deposit with RBI 1,07,520
Other Accrued Income 6,10,319
Amount due from Sundry Debtors 21,76,407 3,78,65,308
Current Liabilities
Agents Balances 5,58,061
Due to Other Insurance Companies 1,22,09,338
Deposits with Reinsurers 60,224
Premium Received In Advance 7,47,151
Sundry Creditors A/c 74,12,130
Due to Subsidiaries/ Holding Co. 60,780
Claims Outstanding 6,81,84,534
Others 5,28,865 8,97,61,083
Provisions
Reserves for Unexpired Risks 2,82,40,313
Provision for Proposed Dividend 4,50,000
Provision for Proposed Dividend Tax 76,478
Reserves for Bad &Doubtful Debt 33,57,710
Provisions in Diminution in value of 27,603 3,21,52,104
Thinly Traded Shares
27,29,15,103 27,29,15,103

250
Prepare Balance Sheet as at 31st March 2021 with Schedules as per IRDAI format.

Solution
M/S Good Luck General Insurance Co Ltd
Balance sheet as at 31st March 2021
Particulars Sch. C.Y. P.Y.
Rs (000) Rs (000)
A. Sources of Funds
1. Share Capital 5 & 5A 20,00,000
2. Reserves and Surplus 6 7,12,21,519
3. Fair Value Change Account 7,41,72,943
4. Borrowings 7 0
Total A 14,73,94,462
B. Application of Funds
1. Investments 8 17,76,75,725
2. Loans 9 59,38,624
3. Fixed Assets 10 15,81,706
4. Deferred Tax Assets 2,33,054
5. Current Assets
a. Cash and Bank Balances 11 3,32,08,377
b. Advances and Other Assets 12 5,06,70,163
Subtotal (a + b) 8,38,78,540
c. Current Liabilities 13 8,97,61,083
d. Provisions 14 3,21,52,104
Subtotal (c + d) 12,19,13,187
Net Current Assets (a + b – c – d) (3,80,34,647)
6. Misc. Expenditure (not written off or 0
adjusted)
Total B 14,73,94,462

Significant accounting policies and notes to accounts are not mentioned here. Students
should refer Appendix 1. The Schedules referred to above form integral part of the
Balance Sheet are numbered as per IRDAI specified formats

Schedule 5: Share Capital

Particulars (Rs. in 000)
1. Authorised capital: 20,00,00,000 Equity shares of Rs 10 each 20,00,000
2. Issued capital: 20,00,00,000 Equity shares of Rs 10 each 20,00,000
3. Subscribed capital: 20,00,00,000 Equity shares of Rs10 each 20,00,000
4. Called up capital: 20,00,00,000 Equity shares of Rs 10 each 20,00,000

Schedule 5A: Pattern of Shareholding: (As Certified by Management)

Numbers % of Holding
Promoters - Indian 20,00,00,000 100
Foreign Nil
Others Nil
20,00,00,000 100

251
Schedule 6: Reserves and surplus
Rs in 000 Rs in 000
Capital Reserves Nil
General Reserves (As on 1.4.2020) 6,77,22,294
Addition during the year (Transferred from P&L A/c) 12,65,476 6,89,87,770
Contingency Reserves 4,49,500
Catastrophe Reserves Nil
Foreign Currency Translation Reserve 17,84,249
7,12,21,519

Schedule 7: Borrowings
Particulars Rs in 000
1. Debentures / bonds ---
2. Banks ---
3. Financial institutions ---
4. Others ---
Nil

Schedule 8: Investments
Particulars Rs in 000
Government Securities
Central Govt. Securities 2,99,85,499
State Govt. Securities 1,09,56,967
Foreign Govt. Securities 22,33,531
Other Approved Investments 3,72,474
Other Investments
Equity Shares 9,45,24,937
Preference Shares 7,95,319
Debentures In India 79,87,138
Debentures Outside India 1,23,866
Investment in Subsidiaries 5,95,564
Investment in Infrastructure 1,66,73,417
Investment in Housing Bonds 47,80,646
Other Approved Investments 41,78,175
Total long-term investments 17,32,07,533
Govt. Securities
Central Govt. Securities 3,28,001
State Govt. Securities 8,55,253
Foreign Govt. Securities 84,299
Other Approved Investments 4,73,461
Other Investments
Equity Shares 0
Preference Shares 0
Debentures In India 0
Debentures Outside India 0
Investment in Subsidiaries 0
Investment in Infrastructure 11,43,322
Investment in Housing Bonds 15,83,856
Other Approved Investments 0

252
 Total short-term investments 44,68,192
Total Investment (Long Term & Short Term) 17,76,75,725

Schedule 9: Loans
Particulars Rs in 000
Secured Loans
Housing Loan to Employees 24,51,200
Vehicle Loans to Employees 13,75,848
Computer Loans to Employees 6,740
Loans to State Govt. Housing (HUDCO) 19,21,643
Unsecured Loans
Other Term Loans, Bridge Loans etc. 1,83,193
Total 59,38,624

253
 Gross block Depreciation Net Block

Opn Bal Addition Deletion Clg Bal Opn bal Addition Deletion Clg Bal

1.4.20 During the year 31.3.21 1.4.20 During the year 31.3.21 31.3.21 31.3.20

Intangib
4,14,693 1,03,673 3,11,020
les

Land
Freehol 14,892 -- 14,892
d
Schedule10: Fixed Assets (Rs. In 000)

Building
12,90,514 6,87,741 6,02,773
s

254
Furnitur
e& 6,78,682 5,67,219 1,11,463
Fittings
IT
Equipm 20,88,299 18,12,730 2,75,569
ent

Vehicles 5,85,395 3,34,516 2,50,879

Office
Equipm 1,16,685 1,01,575 15,110
ent

51,89,160 36,07,454 15,81,706

Schedule 11: Cash and Bank Balances
Particulars Rs in 000
Cash In-hand 14,23,502
Bank Deposits (Short Terms & Others) 2,54,89,278
Bank Balances in current Accounts 39,72,118
Money at Call & Short Notice 23,23,479
Total 3,32,08,377

Schedule 12: Advances & Other Assets

Particulars Rs in 000
Advances
Deposits with Ceding Companies 1,59,704
Pre-Payments 3,17,912
Advance Tax &TDS (Net) (2,55,149 -1,40,113) 1,21,45,088
Other Advances 1,82,151 1,28,04,855
Other Assets
Income Accrued On Investments 25,03,584
Outstanding Premium 8,98,644
Agents Balances 7,80,800
Amount Recoverable From Various Agencies 11,61,296
Amount due from Reinsurers & Co-insurers 2,96,26,214
Amount due From Subsidiaries 524
Deposit with RBI 1,07,520
Other Accrued Income 6,10,319
Amount due From Sundry Debtors 21,76,407 3,78,65,308
Total 5,06,70,163

Schedule 13: Current Liabilities

Particulars Rs in 000
Agents Balances 5,58,061
Balances Due to Other Insurance Companies 1,22,09,338
Deposits with Reinsurers 60,224
Premium Received In Advance 7,47,151
Sundry Creditors A/c Service Taxes & Others 74,12,130
Amount Due to Subsidiaries/ Holding Company 60,780
Claims Outstanding 6,81,84,534
Others 5,28,865
Total 8,97,61,083

Schedule 14: Provisions

Particulars Rs in 000
Reserves for Unexpired Risks 2,82,40,313
Provision for Proposed Dividend 4,50,000
Provision for Proposed Dividend Tax 76,478
Reserves for Bad &Doubtful Debt 33,57,710
Provisions in Diminution in value of Thinly Traded Shares 27,603
3,21,52,104

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2. Demonstrate the preparation and presentation of cash flow
statement in general insurance business.
[Learning Outcome b]

2.1 Cash flow statement

Cash Flow Statement is useful in providing users of financial statements with a
basis to assess the ability of the firm to generate cash and cash equivalent,
and the needs of the firm to utilise those cash flows. The financial decisions
that are taken by users require an evaluation of the ability of the firm to
generate cash and cash equivalent and the timing and certainty of their
generation. In the insurance industry, the cash flow statement is of prime
importance to the users of the financial statements as the insurance companies
carry on risk taking business dealing with an intangible product i.e. promise to
indemnify loss in future as and when it occurs, in consideration of premium
collected. The insurer needs to have both solvency and liquidity sufficient to
pay off its liability for claims at the time of occurrence of perils. Thus an
insurer should always prepare a cash flow statement and should present it for
each period for which financial statements are presented as per regulatory
norms.

In accordance with IRDAI regulations, Cash Flow statement in an insurance

company is to be prepared using the Direct Method. Accounting Standard AS-3
will not be applicable.

A cash flow statement, if used in conjunction with other financial statements,

provides information that enables the user to evaluate the charges in the net
assets of the insurance company and its financial structure (including its
liquidity and solvency).

For the purpose of preparation of cash flow statement in an insurance company,

the following terms need to be defined for proper interpretation and use.

1. Cash comprises on hand and demand deposits with banks of the corporate
office and all operational units, including overseas ones.
2. Cash Equivalents are short term, highly liquid investments that are readily
convertible into known amounts of cash and which are subject to an
insignificant risk of changes in value.
3. Cash Flows are inflows and outflows of cash and cash equivalents.
4. Operating Activities are the principal revenue-producing activities of a firm
(insurer) and other activities that are not investing or financing activities. In
insurance company cash flow from operating activates ( insurance
activities) is a key indicator of the extent to which the operations of the
256
 enterprise have generated sufficient cash flows to maintain the operating
capability of the insurers, pay claims, commission, management expenses
and pay dividends and repay loans and borrowings
5. Investing Activities are the acquisition and disposals of long term assets and
other investments not included in cash equivalents
6. Financing Activates: are activities that result in changes in the size and
composition of the shareholders’ funds and policy holders’ funds (in case of
an insurance company) and borrowings of the firm.
7. Preparation of Cash Flow statement: The cash flow statements should be
prepared and presented by classifying and segregating Operating, Investing
and Financing activities.

An insurance company should report cash flows from operating activities using
‘Direct method’, whereby major classes of gross cash receipts and gross cash
payments are disclosed.

Under Indirect method, net profit or loss is adjusted for the effects of
transactions of a non-cash nature, any deferrals or accruals of past or future
operating cash receipts or payments, and items of income or expense associated
with investing or financing cash flows.

Receipts & Payments account (Cash flow statement) - Direct Method

Particulars CY PY

A. Cash Flows from the operating activities:

1. Premium received from policyholders, including advance receipts
2. Other receipts
3. Payments to the re-insurers, net of commissions and claims
4. Payments to co-insurers, net of claims recovery
5. Payments of claims
6. Payments of commission and brokerage
7. Payments of other operating expenses
8. Preliminary and pre-operative expenses
9. Deposits, advances and staff loans
10. Income taxes paid (Net)
11. Service tax / GST paid
12. Other payments
13. Cash flows before extraordinary items
14. Cash flow from extraordinary operations
Net cash flow from operating activities

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B. Cash flows from investing activities:
1. Purchase of fixed assets
2. Proceeds from sale of fixed assets
3. Purchases of investments
4. Loans disbursed
5. Sales of investments
6. Repayments received
7. Rents/Interests/ Dividends received
8. Investments in money market instruments and liquid mutual
funds
9. Expenses related to investments
Net cash flow from investing activities

C. Cash flows from financing activities:

1. Proceeds from issuance of share capital
2. Proceeds from borrowing
3. Repayments of borrowing
4. Interest/dividends paid (including dividend warrant returned)
Net cash flow from financing activities

D. Effect of foreign exchange rates on cash and cash

equivalents, net

E. Net increase in cash and cash equivalents:

1. Cash and cash equivalents at the beginning of the Period
2. Cash and cash equivalents at the end of the Period

Identify the classification of the following activities in order to prepare a

statement of cash flows.
(i) Issue of share capital for cash
(ii) Payment to suppliers
(iii) Depreciation
(iv) Purchase of fixed asset
(v) Dividend paid
A (ii) and (iv) are financing activities
B (i), (iii) and (v) are operating activities
C (iii) and (v) are investing activities
D None of the above statements are true

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From the following information, determine the cash flow from investing
activities.
Sale of building: carrying value Rs. 2,80,000 at a profit of Rs. 38,000.
Sale of long-term investment: carrying amount Rs. 3,40,000 at a loss of Rs.
17,000.
Purchase of car: Rs. 5,40,000 out of which Rs. 3,00,000 is outstanding
Interest paid: Rs. 45,000

A Rs. 4,01,000
B Rs. 3,56,000
C Rs. 7,01,000
D Rs. 6,41,000

Which of the following statements is correct for an insurance company?

A Cash flow from operating activities can be calculated by using the direct as
well as the indirect method
B An increase in assets is cash inflow from investing activities
C A decrease in liabilities is cash outflow from investing activities
D Depreciation should be added back to calculate the cash flow from
operating activities

3. Ratio analysis of financial statements.

[Learning Outcome c]

3.1 Analysis of Financial Statements - Why Ratio Analysis?

Users of financial statements cannot form any opinion on any of the trends of
the company for their economic decisions unless they use various ratios, trends
with comparative and classified Accounting.

Generally, two standards of comparison used by financial analysts are:

a) past performance of the company and
b) position of the company with respect to other companies or industry
performance in the country and overseas

The Insurance business is carried on with international processes, principles and

perspectives because of its very nature of international character. So, its trend
analysis or trend percentage need be compared with industry data and
259
international standard to judge the company’s position in respect of growth,
profitability, liquidity, solvency etc.

4. Ratio Analysis for Analysis of Financial statements

Ratios are the most vital tools of financial analysis in management accounting.
The corporate management will take a lot of financial decisions for their
strategic issues. With this accounting information, many more analysis like the
following can be done.

From Balance Sheet, Revenue Account and Profit & Loss Account many
Accounting Ratios can be obtained for Financial Management.

For non-life insurance companies, disclosure of the analytical ratios is

mandatory, in which the following ratios are disclosed.

1. Gross Premium Growth Rate

2. Gross Premium to Net-worth Ratio
3. Growth Rate of Net-worth
4. Net Retention Ratio
5. Net Commission to Net Written Premium ratio
6. Expense of Management to Gross Direct Premium Ratio
7. Expenses of management to net written premium ratio
8. Net incurred claims to net earned premium ratio
9. Combined Ratio
10. Technical Reserves to Net Premium Ratio
11. Underwriting Balance Ratio
12. Operating Profit Ratio
13. Liquid Assets to Liabilities Ratio
14. Net Earnings Ratio
15. Return on Net Worth Ratio
16. Solvency Margin
17. NPA Ratio (non-performing advances)

Before going through the ratios, let us recap the general presentation of the
performance of an insurance company which shall help us in understanding the
ratios in a lucid style.

Gross Direct Premium GDP

Add: Reinsurance premium accepted
Gross Written Premium GWP
Less: Reinsurance Premium Ceded
Net Written Premium NWP
Adj: Change in unexpired risk reserve ( + / - )
Net Earned Premium NEP
Less: Net Incurred Claims
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 Less: Net Commission
Less: Operating Expenses
Underwriting Profit / Loss
Add: Investment Income - Policyholders
Revenue account surplus / deficit (Policyholders)
Add: Investment income - Shareholders
Add: Other Income / Outgo
Profit Before Tax PBT
Less: Provision for Tax
Profit After Tax PAT

Ratio Description
1 Gross Direct Gross Direct Premium (CY) - Gross Direct Premium (PY)
Premium Growth ---------------------------------------------------------------------
Rate Gross Direct Premium (PY)

2 Gross Direct Gross Direct Premium

Premium to Net --------------------------
worth ratio Net worth
Net-worth = Shareholders’ funds at the end of the accounting period
= Paid up capital + Free reserves
3 Growth rate of Net-worth (CY) – Net-worth(PY)
Net worth ---------------------------------------
Net worth (PY)

4 Net Retention Net Written Premium

Ratio ------------------------------
Gross Written Premium

5 Net Commission Net Commission

Ratio ---------------------------
Net Written Premium

6 Expense of
Management to Expenses of management
Gross Direct -------------------------------
Premium Ratio Gross Direct Premium
7 Expenses of
Management to Expenses of management
net written -------------------------------
premium ratio Net Written Premium
8 Net incurred Net Incurred Claims
claims to net --------------------------
earned premium Net Earned Premium
ratio

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 9 Combined Ratio Net Incurred Claims Exp. Of management + Net commission
------------------------- + --------------------------------------------
Net Earned Premium Net Written Premium

10 Technical Technical reserves

Reserves to net ----------------------------
premium ratio Net Written Premium
Technical reserves = Reserve for unexpired risks + Premium Deficiency
Reserve + Net Outstanding claims incl. IBNR and IBNER
11 Underwriting
balance ratio Underwriting Profit / Loss
-------------------------------
Net Earned Premium

12 Operating profit Underwriting Profit/Loss + Investment income of

ratio policyholders
--------------------------------------------------------------------------
Net Earned Premium
13 Liquid Assets to
liabilities ratio Liquid assets
-------------------------------
Policyholders’ liabilities
Liquid assets = Short Term Investments+ Short Term Loans+ Cash, Bank
Balances
Policyholders’ liabilities = Technical reserve
14 Net earnings Profit After Tax
ratio -----------------------
Net Earned Premium

15 Return on Net Profit After Tax

worth ratio ---------------------
Net worth
16 Solvency margin Available Solvency Margin (ASM) at the end of the period
----------------------------------------------------------------------
Required Solvency Margin (RSM) at the end of the period
17 NPA ratio Net NPA
---------------------
Total Investment Assets

In the following examples, certain performance analysis has been done with
some hypothetical figures just to show how Accounting information is used for
trend analysis.

From the financial statements of ABC General Insurance Company Ltd, the
following data has been collected:

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 (Rs in lakhs)

Information CY PY
1 Gross Direct Premium 6,151 5,937
2 Shareholders’ funds 6,973 5,973
3 Net Premium 4,914 4,752
4 Unexpired Risks Reserves 2,573 2,470
5 Outstanding Claims 6,140 5,759
6 Risks Reinsured 2,099 1,654
7 Incurred Claims 4,177 3,644
8 Management expenses 1,019 1,153
9 Commission 459 390
10 Investment Income 2,365 2,267
11 Provision Tax 120 154
12 Net Worth 6,973 5,972

Difference in unexpired risk reserves (2,573-2,470) 103

Profit After Tax (-844+2,365) 1,521
Profit After Tax 1,401

From the above data, compute the following accounting ratios for analysis of
financial statements vis-à-vis Performance Analysis for current year.
1. Gross Premium to Net worth
2. Growth Rate of Net worth
3. Management Expenses to Gross Premium Ratio
4. Net Commission Ratio
5. Technical Reserves to Net Premium
6. Combined Ratio
7. Operating Profit Ratio
8. Net Earnings Ratio
9. Return on Net Worth

Solution

Performance Analysis based on Accounting Ratios:

Accounting Formula
Calculation Ratio
Ratios
Gross Direct Premium
6,151
Gross Premium --------------------------
1 Net worth
------------ x 100 88.21%
to Net worth 6973
GDP (CY) - GDP (PY)
Growth Rate of ---------------------- 6,973 – 5,973
2 16.74%
Net worth GDP (PY) -------------------- x 100
5,973
3 Mgmt. Expenses of management 16.57%
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 Expenses to ------------------------------- 1,019
Gross Premium Gross Direct Premium -------- x 100
Ratio 6,151
Net Net Commission 459
4 Commission --------------------------- --------- x 100 9.34%
Ratio Net Written Premium 4,914

Technical Reserve for unexpired risks +

2,573 + 0 + 6,140
Premium Deficiency Reserve +
5 Reserves to Net Net Outstanding claims
----------------------- x 100 177.31%
Premium 4,914
----------------------------
Net Written Premium
Net Incurred Claims
------------------------
Net Earned Premium 4,177 1019 + 459
Combined ------- x 100 + ------------- x 100
6 (plus) 116.89%
4811 4914
Ratio
Mgt. Exp. + Net commission
-------------------------------- = 86.82 + 30.07
Net Written Premium

U/W profit + Investment income PHrs 1,521

Operating ------------------------------------------
7 -------- x 100 30.95%
Profit Ratio Net Earned Premium 4,914

Net Earnings Profit After Tax 1,401

8 28.51%
Ratio ----------------------- -------- x 100
Net Earned Premium 4,914
Profit After Tax
Return on Net ----------------------- 1,401
9 20.09%
Worth Net worth -------- x 100
6,973

Financial Statement analysis

The balance Sheet as at 31.3.2021 of M/s XYZ General Insurance Co. Ltd is given
below along with the figures of the previous year for financial statement
analysis.
Balance Sheet as at 31.3.2021
Rs. in million)
Particulars Sch. Current year Previous year
A. Sources of Funds
1. Share Capital 200.00 150.00
2. Reserves and Surplus 4,608.03 4,166.41
3. Fair Value Change Account 12,211.27 6,846.97
4. Borrowings Nil NIL
Total (A) 17,019.30 11,163.38
B. Application of Funds
1. Investments 20,665.26 14,575.23
2. Loans 786.52 874.13
3. Fixed Assets 121.06 114.41
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 4. Deferred Tax Assets 61.75 84.07
5. Current Assets
a. Cash and Bank Balances 3,059.71 2,286.09
b Advances and Other Assets 2,230.12 1,738.56
Total Current assets (a + b) 5,289.83 4,024.65
c. Current Liabilities 7,134.74 6,085.25
d. Provisions 2,871.54 2,578.57
Total Current Liabilities (c + d) 10,006.28 8,663.82
Net Current Assets (a + b – c – d) 4,716.45 4,639.17
6. Miscellaneous Expenditure 101.16 154.72
7. Debit Balance in Profit and Loss Nil Nil …
A/c
Total (B) 17,019.30 11,163.38

The following ratio analysis and schedule of investments are prepared for
appreciation of accounts.
 Gross Premium to Net worth Ratio
 Net Retention ratio
 Ratio between Shareholders’ Fund and Policyholders’ Fund

1. Gross Premium to Net worth Ratio

2020-21 2019-20
Gross Premium 5,675.54 5,103.16
Net worth 4,161.69 3,735.22
Ratio (times) 1.36 1.37 (Growth)

The better the ratio, the greater is the capacity utilisation, and better will be
the return. However, again, this ratio must be within the permissible limits laid
down by regulators.

2. Net Retention ratio

Gross Premium Net Premium CY Retention PY Retention
Ratio Ratio
Fire 1,103.49 830.76 75.28% 78.12 %
Marine 349.33 164.38 47.05% 55.97%
Misc. 4,222.73 3,347.52 79.27% 77.46%
Total 5,675.54 4,342.65 76.52% 76.33%

3. How to calculate Shareholders’ Fund & Policyholders’ Fund

Shareholders’ Fund (2020-21)
Share Capital… 200.00
Capital Reserve 0.06
General Reserve 4622.79
Misc. Reserve (-)14.82 4808.03
Policyholders’ Fund (2005-06)
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 Unexpired Reserves 2253.51
Outstanding Claims 5505.40 7758.91
Total Funds 12566.94

Ratio between ‘Shareholders’ Fund’ and ‘Policyholders’ Fund’ =

4808.03:7758.91= 38:62

Which of the following ratios is an important indicator that helps to judge

whether an insurer is strong enough to pay claims to policy holders as
scheduled?

A Net earnings ratio

B Gross premium growth ratio
C Solvency margin ratio
D All of the above

Which of the following sections of the act requires that every insurer in respect
of all insurance business shall prepare Balance Sheet, Profit and Loss Account
and Revenue Account?

A. Section 11
B. Section 14
C. Section 15
D. Section 17

4. Learn about solvency margin.

[Learning Outcome d]

Solvency Margin: The solvency margin is a key metric used to measure an

enterprise’s ability to meet its debt obligations and is used often by prospective
business lenders. The solvency ratio indicates whether a company’s cash flow is
sufficient to meet its short and long term liabilities.

Solvency ratio of an insurance company is the size of its capital relative to all
risk it has taken. Acceptable solvency ratio varies from the Industry to Industry
but as a general rule, solvency ratio of greater than 20% is considered
financially healthy. The lower a company’s solvency ratio, the greater the
probability that the company may default on its debt obligations.

266
For a General Insurance/Reinsurance company, IRDAI has prescribed minimum
solvency margin as 1.5. The minimum solvency margin of 1.5 should be
maintained by the companies all the times.

On a general note, it is interpreted that the value of assets of a company should

be atleast 1.5 times the value of its liabilities.

As far as general insurance companies are concerned, IRDA has come out with
an exclusive regulation in arriving at the solvency margin.

IRDAI has issued notification Ref.: F.No.IRDAI/REG/7/119/2016 dated 07-04-

2016 for determination of solvency margin of general insurance companies.
These regulations are called Insurance Regulatory and Development Authority of
India (Assets, Liabilities and solvency Margins of General Business) regulations
2016. Consequent upon this, the regulation issued earlier i.e. Insurance
Regulatory and Development Authority of India (Assets, Liabilities and solvency
Margins of Insurers) regulations, 2000 shall stand superseded. The brief contents
of the same are given below for better understanding of the students.

Particulars Form Schedule

Statement of Admissible IRDAI-GI-TA Schedule I
assets
Statement of amount of IRDAI-GI-TR Schedule II
liabilities
Statement of Solvency IRDAI-GI-SM Schedule III
Margin

These forms should be furnished separately for ‘Business within India’ and
‘Total business transacted’.

VALUATION OF ASSETS:
The following assets should be placed with value ‘zero’:
 Agents’ and Intermediaries’ balances and outstanding premiums in India
to the extent they are not realized within a period of 30 days;
 Agents’ and Intermediaries’ balances and outstanding premiums outside
India, to the extent they are not realizable ;
 Premiums receivables relating to State/Central Govt. sponsored
schemes, to the extent they are not realized within a period of 180
days;
 Sundry debts, to the extent they are not realizable;
 Advances and receivables of an unrealizable character;
 Furniture, fixtures, dead stock and stationery;

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 Deferred expenses;
 Debit balance of P/L appropriation account balance and any fictitious
assets other than pre-paid expenses;
 Co-insurer’s balances outstanding for more than 90 days;
 Balances of Indian Reinsurers and Foreign Reinsurers having Branches in
India outstanding for more than 365 days;
 Other Reinsurer’s balances outstanding for more than 180 days;
 Leasehold improvements
 Service Tax Unutilized Credit outstanding for more than 90 days;
 Any other assets, which are considered inadmissible under Section 64V of
the Insurance Act, 1938.
The statement of admissible assets shall be prepared in form IRDAI –GI-TA and
shall be certified by the appointed actuary, statutory auditors and chief
executive officer of the company.

DETERMINATION OF AMOUNT OF LIABILITIES

(1) The amount of liabilities shall be determined on the Valuation Date
separately for each line of business as listed in the FORM IRDAI-GI-SM
and in accordance with this regulation
(2) The amount of liabilities for each line of business shall be determined
as the aggregate of Unexpired Risk Reserves as mentioned in clause 2
below and Claims Reserves as mentioned in clause 3 below.

2. PREMIUM RESERVES

o Unearned Premium Reserve (UPR):

UPR will be estimated as per the extant provisions and shall be
certified by the Chief Financial Officer and the Statutory Auditor .
o Premium Deficiency Reserve (PDR):
The PDR shall be calculated using sound actuarial principles.

o Unexpired Risk Reserve (URR):

Unexpired Risk Reserve is defined as sum total of UPR and PDR
3. CLAIMS RESERVE
(1) The Claims Reserve shall be determined as the aggregate amount of
Outstanding Claims Reserve and Incurred but Not Reported Claims
Reserve (IBNR) as described below:

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 (2) Outstanding Claims Reserve
The outstanding claims reserve shall be determined in the following
manner:
(a) Where the amount of outstanding claims of the insurers is known, the
amount is to be provided in full;
(b) Where the amount of outstanding claims can be reasonably
estimated according to the insurer, insurer shall follow the 'case by
case method' after taking into account the explicit allowance for
changes in the settlement pattern or average claim amounts,
expenses and inflation;
(c) For lines of business, where the Appointed Actuary is of the view
that the statistical method is most appropriate for the estimation of
Outstanding claims, the Appointed Actuary may use the appropriate
statistical method of claims reserving instead of following case by
case method. In such cases, the claims outstanding reserve shall be
certified by Appointed Actuary.

(3) Incurred But Not Reported (IBNR) Claims Reserve

(a) The incurred but not reported (IBNR) claims reserve shall be
determined using actuarial principles and methods detailed in
clause 4 below
(b) The IBNR shall be estimated using appropriate actuarial principles
and shall be certified by the Appointed Actuary.
(c) The Appointed Actuary shall estimate IBNR on both net of reinsurance
and gross of reinsurance basis.
(d) The Appointed Actuary shall estimate the provision for IBNR for
each year of occurrence and the figures shall be aggregated to
arrive at the total amount to be provided.
(e) If estimate of IBNR provision for any year of occurrence is negative,
the Appointed Actuary shall re- examine the underlying
assumptions. Even after re-examination, if the mathematics
produces negative value, the Appointed Actuary shall ignore the
IBNR provision for that year of occurrence.
(f) The estimation process shall not discount the estimated future
development of paid claims to the current date.

269
 4. DETERMINATION OF OTHER LIABILITIES
The general insurer shall place a proper value in respect of the following
items:
(1) provision for bad and doubtful debts; reserve for dividends
declared or recommended, and outstanding dividends in full;
(2) amount due to insurance companies carrying on insurance business,
in full;
(3) amount due to sundry creditors, in full;
(4) provision for taxation, in full; and
(5) foreign exchange reserve
Every general insurer shall prepare a statement of liabilities in FORM IRDA-GI-TR
and shall be certified by the Appointed Actuary and the Statutory Auditor.

The statement shall be furnished to the Authority along with the returns
mentioned in section 15 of the Act.

SCHEDULE III - DETERMINATION OF SOLVENCY MARGIN

To determine the solvency margin, we need to calculate the ASM – Available
Solvency Margin and the RSM – Required Solvency Margin.

Available Solvency Margin (ASM) = Value of Assets – Value of Liabilities

As per Statement of Admissible As per Statement of amount of

assets in Form IRDAI-GI-TA liabilities in Form IRDAI-GI-TR

Table 1 A - Required Solvency Margin (RSM):

Gross Net
Item Line of Gross Net Incurred Incurred RSM1 RSM2 RSM Factor Factor
No. Business Premiums Premiums claims claims A B

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
01 Fire 0.50 0.50
02 Cargo 0.60 0.60
03 Hull 0.50 0.50
04 Motor 0.75 0.75
05 Engg. 0.50 0.50
06 Aviation 0.50 0.50
07 Liability 0.75 0.75
08 Health 0.75 0.75
09 Misc. 0.70 0.70
Total
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  Gross Premium = Gross Written Premium including Reinsurance accepted
 Net Premium = Net Written Premium
 Incurred Claims include IBNR and IBNER
 ‘Premium’ is based on the trailing 12 months data
 ‘Claims’ based on Maximum of ‘Trailing 12 months data’ and ‘Trailing 36
months data / 3’
(Students may note down the ‘factor’ is more for LOBs like Motor, Liability
and Health.)

RSM1 (LOB wise) RSM2 (LOB wise)

 Gross Premium x Factor A  Gross Incurred Claims x Factor A
 Net Premium  Net Incurred Claims
 Higher of the above  Higher of the above
 20% on the Higher value  30% on the Higher value
RSM (LOB wise) = Higher of RSM1 and RSM2

Table 1 B – Available Solvency Margin & Solvency Ratio

Policyholders’ Funds: Available Assets …

Less: Current Liabilities …
Less: Provisions …
Less: Other liabilities …
Shareholders’ Funds: Available Assets …
Less: Other liabilities …

Total ASM …

Available Solvency Margin should be maintained at a higher of

1. 50% of Minimum Capital
2. 100% of Required Solvency Margin

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 Available Solvency Margin
Solvency Ratio = ………………………………………………….
Required Solvency Margin

“Control level of Solvency” shall mean the level of solvency margin specified
by the Authority in accordance with sub-section (3) of Section 64VA of the Act
on the breach of which the Authority shall act in accordance with sub- section
(4) of section 64VA of the Act without prejudice to taking any other remedial
measures as deemed fit.
The control level of solvency is hereby specified as a minimum solvency
ratio of 150 %.

Students are advised to thoroughly go through Insurance Regulatory and

Development Authority of India (Assets, Liabilities and solvency Margins of
General Business) regulations 2016 for better understanding.

What is the minimum solvency margin prescribed by IRDAI for General Insurance
Companies ?
A. Not less than higher of 20% of the amount of minimum capital and 100%
of required solvency margin
B. Not less than higher of 30% of the amount of minimum capital and 100%
of required solvency margin
C. Not less than higher of 40% of the amount of minimum capital and 100%
of required solvency margin
D. Not less than higher of 50% of the amount of minimum capital and 100%
of required solvency margin

Summary

 General insurance includes:

 Fire insurance,
 Marine insurance and
 Miscellaneous insurance
 An item of expense to be shown in the Revenue Account of a fire / marine
insurance company separately if it is in excess of 1% of premium or Rs.
5,00,000 whichever is higher.

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 Premium, a primary source of income, is the consideration received by the
insurance company from the insured as per the insurance contract. Net
premium earned is calculated as follows:

Particulars Amount
Premium From Direct Business X
Add: Premium on Reinsurance Accepted X
Less: Premium on Reinsurance Ceded (X)
Net Premium X
Add: Adj. For Change in Reserve in Unexpired Risks X
(50% of the net premium of the last year – 50% of the
net premium of current year)
Net Premium Earned (Net) X

 Any amount payable by the insurance company is regarded as claim. Net

claim payable is calculated as follows:

Particulars Amount
Claim Paid Direct X
Add: Claims on Reinsurance Accepted X
Less: Claims on Reinsurance Ceded (X)
Net Claims Paid X
Add: Outstanding Claims at the end (net) X
Less: Outstanding Claims at the Beginning (net) X
Incurred Claims Net X

 When an insurer insures the risk undertaken by him with another insurer, it
is called reinsurance.
 The premium payable by the original insurer to the reinsurer is called
reinsurance premium ceded and the premium receivable by the reinsurer
from the original insurer is known as premium on reinsurance accepted.
 Commission on re-insurance ceded is an income to the company, which has
ceded or transferred the reinsurance business, so it should appear on the
credit side of the concerned revenue account. Commission on re-insurance
accepted is an expense for the company which has accepted the re-
insurance business. So it should be entered on the debit side of the
concerned revenue account.
 In other words, Commission, being an expense, commission on reinsurance
ceded is deducted from the commission paid and commission on
reinsurance accepted is added to derive the net amount of commission
paid.
 Unearned premium reserve shall be created as the amount representing
that part of premium written which is attributable to, and allocated to the
succeeding accounting periods shall not be less than as required under
64V(1)(ii)(b) of the Act.
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 The direct expenses and incomes applicable to a particular business (i.e.
fire, marine or misc.) are recorded in the respective Revenue A/c, whereas
common / general expenses and incomes are recorded in the Profit and Loss
A/c.
 Cash flow statement can be prepared using either the direct method or the
indirect method. It classifies cash receipts and payments as operating,
investing and financing activities.
 In accordance with IRDAI regulations, Cash Flow statement in an insurance
company is to be prepared using the Direct Method.
 There are several specialised ratios used to analyse an insurance company’s
financial condition. Some of them are:

 Gross Premium and Growth Rate

 Gross Premium to Net worth Ratio
 Growth Rate of Net worth
 Net Retention Ratio
 Net Commission Ratio
 Management Expenses to Gross Premium
 Expenses of Management to Net Written Premium Ratio
 Net Incurred Claims To Net Earned Premium Ratio
 Combined Ratio
 Technical Reserves to Net Premium Ratio
 Underwriting Balance Ratio
 Operating Profit Ratio
 Liquid Assets to Liabilities Ratio
 Net Earnings Ratio
 Return on Net Worth
 Solvency ratio
 NPA ratio

Answers to Test Yourself

Answer to TY 1
The correct option is B.

Particulars 2009-10
Premium From Direct Business 1,20,000
Add: Premium on Reinsurance Accepted 40,000
1,60,000
Less: Premium on Reinsurance Ceded 50,000
Net Premium 1,10,000
Adj. for Change in Reserve in Unexpired Risks (55,000- 10,000
65,000)
Net Premium Earned (Net) 1,20,000

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Answer to TY 2
The correct option is D.

Transactions Classification
(i) Issue of share capital for cash Financing activities
(ii) Payment to suppliers Operating activities
(iii) Depreciation It is a non-cash item. Not
included in the cash flow.
(iv) Purchase of fixed asset Investing activities
(v) Dividend paid Financial activities
(vi) Taxes on income Operating activities

Answer to TY 3
The correct option is A.
Rs.
Sale of building (2,80,000 + 38,000) 318,000
Sale of long-term investment (3,40,000 - 17,000) 323,000
Purchase of car (5,40,000 – 3,00,000) (240,000)
Net cash flow from investing activities 401,000

Interest paid will come under financing activities.

Answer to TY 4
The correct option is C. A decrease in liabilities is a cash outflow from investing
activities.

Answer to TY 5
The correct option is C. Solvency margin ratio is an important indicator that
helps to judge whether an insurer is strong enough to pay claims to policy
holders as scheduled. It results from the division of net assets by the required
retained earnings.

Answer to TY 6
The correct option is A. Section 11(1) of the Act requires that every insurer in
respect of all insurance business shall prepare Balance Sheet, Profit and Loss
A/c and Revenue A/c.

Answer to TY 7
The correct option id D. As per IRDAI notification no. 7/119/2016 dated 07th
April, 2016, every insurer all time shall maintain its available solvency margin at
a level which is not less than higher of 50% of the amount of minimum capital as
stated under section 6 of the act and one hundred percent of required solvency
margin.

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Self Examination Questions

Question 1
From the following information, calculate the amount of Net Claims Incurred for
marine insurance:

Rs.
Claim Paid Direct 20,000
Claims on Reinsurance Ceded 1,500
Claims on Reinsurance Accepted 4,500
Outstanding Claims at the end (net) 25,000
Outstanding Claims at the Beginning (net) 16,000

A Rs. 17,000
B Rs. 23,000
C Rs. 26,000
D Rs. 32,000

Question 2
Which of the following statements are correct?
(i) In general insurance business, separate Profit and Loss Accounts are
prepared for fire insurance, marine insurance and miscellaneous insurance.
(ii) In general insurance business, separate Revenue Accounts are prepared for
fire insurance, marine insurance and miscellaneous insurance.
A Only (i)
B Only (ii)
C Both (i) and (ii)
D None of the above

Question 3

Survivor General Insurance Co Ltd provides the following information relating to

re-insurance business.
Rs.
Commission received during the year 2020-21 27,000
Commission receivable on 1 April 2020 2,000
Commission receivable on 31 March 2021 1,000

Which of the following amounts will reflect in the Revenue A/c of Survivor as
Commission on re-insurance ceded for the year ended 31 March 2021?

A Rs. 26,000

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B Rs. 27,000
C Rs. 28,000
D None of the above

Question 4
Which of the following statements are incorrect in regards of the amendments
made by the IRDAI Act, 1999 in the Insurance Act, 1938 as amended by the
Insurance Laws (Amendment) Act 2015?

(i) Every insurer shall keep separate accounts relating to funds of shareholders
and policy holders
(ii) In section 28A and 28B in sub-section (1), for “31st day of March,” the IRDAI
Act has substituted “31st day of December”

A Only (i)
B Only (ii)
C Both (i) and (ii)
D None of the above

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is C.
Particulars 2009-10
Claim Paid Direct 20,000
Add: Claims on Reinsurance Accepted 1,500
Less: Claims on Reinsurance Ceded 4,500
Net Claims Paid 17,000
Add: Outstanding Claims at the end (net) 25,000
Less: Outstanding Claims at the Beginning (net) 16,000
Incurred Claims Net 26,000

Answer to SEQ 2
The correct option is B. Statement (i) is incorrect because, in general insurance
business, separate Revenue Accounts are prepared for fire insurance, marine
insurance and miscellaneous insurance but only one Profit and Loss A/c is
prepared at the end of the period in the prescribed form B given in schedule B
of the Insurance Act, 1938.

Answer to SEQ 3
The correct option is A. Rs. 26,000 will be credited to Revenue A/c.

Rs.
Commission received during the year 2020-21 27,000
Less: Commission receivable on 1 April 2020 2,000
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 25,000
Add: Commission receivable on 31 March 2021 1,000
26,000
Answer to SEQ 4
The correct option is B. Statement (ii) is incorrect as in section 28A and 28B in
sub-section (1), for “31st day of December,” the IRDAI Act has substituted “31st
day of March”.

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 CHAPTER 3
NON-LIFE INSURANCE BUSINESS ACCOUNTING
METHODS, TECHNIQUES & PROCESS

UNIT-13
REINSURANCE ACCOUNTING
Chapter Introduction

This unit aims to provide a fundamental understanding about the process of

reinsurance, various types of reinsurance arrangements, need for reinsurance
and the accounting for reinsurance arrangement.

a) Explain what is meant by reinsurance, along with the various terms and
definitions used.
b) Discuss the various types of reinsurance arrangements.
c) Learn about reinsurance accounting.
d) Discuss surplus treaty reinsurance and excess loss treaty reinsurance.
e) Discuss the reinsurance regulations in India.

Introduction

Just as individuals transfer risk to insurance companies, insurance companies

can also transfer some of their risk to other insurance companies. Insurance
companies have to pay claims as and when they occur. They cannot be certain
as to when claims would occur and how big the claims would be. They do have
estimates based on probabilities, but there can be huge variances between the
estimates and the actual amount of claims as there can be no certainty
regarding perils. Insurers normally have enough funds to pay claims, however,
events such as earthquakes or tsunamis can put a strain on the funds of the
insurer as there would be thousands of claims amounting to extremely large
sums of money. In the same way, an individual transfers their risk, insurers too
can transfer their risk to other insurers.

However, insurers do not transfer all the risk. They retain some of it themselves
(up to a certain level) and transfer the rest to another insurance company
known as the reinsurer. These transfers of risk are called “Reinsurance” and this
allows the burden of paying claims to be shared by the primary insurer and the
reinsurer.

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1. Explain what is meant by reinsurance, along with the various terms
and definitions used.
[Learning Outcome a]

1.1 Definition

An arrangement where one party (the reinsurer or assuming company), in

consideration for a premium, agrees to indemnify another party (the cedant or
reinsured) against part or all of the liability assumed by the cedant under a
policy or policies of insurance. Reinsurance may be on the basis of individual
risks (facultative) or groups of risks (treaty).

In other words, reinsurance is insurance for insurance companies. Reinsurance is

the practice whereby insurers transfer portions of their risk portfolios to other
parties by some form of agreement to reduce the likelihood of paying a large
obligation resulting from an insurance claim. Reinsurance broadens the risk
sharing pool thereby diluting the impact of losses on insurance companies. It is
a transfer of part of the risks that a direct insurer assumes by way of primary
insurance contract, to a second insurance carrier called Re-insurer.

For such transfer of risks, the reinsured and the reinsurer share premium and
claims as per the treaty or facultative arrangements.

Reinsurance is a contract of indemnity between the insurer and the reinsurer.

The principle of ‘follow the fortune’ clause is applicable here, whereby if the
insurer is safe, the reinsurer is also safe.

1.2 Advantages of Reinsurance

 It increases the capacity to handle larger risks.

 It maintains financial stability.
 It helps keeping claims ratio under control.
 It supports protecting the solvency margin.

Reinsurance programme benefits the direct insurer in many ways, which

include:
 stabilizing the direct insurer’s balance sheet by transferring a major part
of risks,
 reducing the probability of his insolvency by assuming catastrophic risks,
 enlarging his underwriting capacity by accepting a proportional share of
risks and
 enhancing his efficiency with the reinsurer’s services such as compiling
and presenting underwriting data from sources around the world,
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 evaluating and assessing special risks, providing loss adjustment support
etc.
 Ability to self-direct part of the investment portfolio.
 Maximize participation in potential investment income on reserves.

M/S XYZ Ltd (referred to as insured) insured its textile operations with the
Insurer M/S Fortune General Insurance Company for Rs.100 million. However,
currently M/S Fortune can sustain risks of up to Rs.10 million only in view of its
financial capacity (capital and reserves & surplus).

Therefore it is decided to transfer any risks beyond Rs.10 million to some other
company. M/S Fortune enters into an arrangement that any fire policy beyond
Rs.10 million will be transferred to M/S RI International.

In this scenario, RI International is the re-insurer. The total risks assumed by

M/S Fortune are Rs.100 million, its retention is Rs.10 million and transfer to M/S
RI International is Rs.90 million, which is referred to as “Cession”. The contract
between M/S Fortune General Insurance Company and M/S RI International is a
contract of reinsurance.

1.3 Reinsurance fundamentals

The transfer of risk from one insurance company to another is called
reinsurance. Catastrophic events such as earthquakes or oil tankers spilling oil
into the sea can generate claims that could place a considerable financial
burden on the insurer. To ensure that they can fulfil their promise to pay
claims, insurers transfer a part of their risk to another insurer. Should one of
the above events happen, the primary insurer would pay a part of the claim and
the reinsurer would pay the rest.

Insurers retain risk up to a certain limit (retention limit) and transfer the rest to
the reinsurer. There are insurance companies that deal exclusively in
reinsurance although reinsurance can be done with any insurer.

Reinsurance is not a simple business; it is complex and can be arranged in

numerous ways. Some of which are:

 Reinsurance brokers act as intermediaries and find a reinsurer willing to

accept the risk.
 Treaties between the insurance company and the reinsurer specify retention
limits for various risks and agree to reinsure any amount above the retention
limit on terms specified in the treaty.
 Treaties may specify that reinsurance would be a certain proportion of the
risk underwritten by the insurance company.

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 The reinsurer may or may not have the option to refuse particular risks.
 In some treaties, when the loss exceeds a certain limit the reinsurer gets
involved.

Reinsurance Brokers
Reinsurance brokers act as an intermediary between the primary insurer and
reinsurers. The percentage commission paid by the reinsurers to the reinsurance
brokers is relatively small in comparison to the commission paid to the
insurance brokers.

When there are reinsurance brokers, the premium payments and loss payments
as well as premium refunds pass through them. The primary insurer may take
help from the reinsurance brokers when they do not have the expertise to place
reinsurance directly. Reinsurance brokers obtain their commission from the
reinsurers. They have a duty to observe the principle of utmost good faith,
which means they must reveal to the reinsurers all material facts concerning
the risks after obtaining business from the primary insurers.

Forms of reinsurance:

1. Treaty
 Proportional Treaty
o Quota share Treaty
o Surplus Treaty

 Excess of Loss Treaty

o Per Risk (Working XL)
o Per Occurrence
o Aggregate Excess

2. Facultative
 Proportional
 Excess of Loss

1.4 Specific terms used in reinsurance

When the primary insurer passes risk on to a reinsurer,
and the reinsurer accepts the business, the primary
Ceding insurer is called the ‘ceding company’ or ‘cedant’ and
the company that takes on the risk is called the
‘reinsurer’.
A reinsurer reinsures the risk ceded to them with another
Retrocession reinsurer or insurance company. Such process of transfer
is called ‘retrocession’.
Treaties Agreements between the ceding company (primary
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 insurer) and the reinsurer containing terms and
conditions on which risks shall be reinsured. Such treaties
are valid for a specific period and can be renewed on the
same or different terms based on experience.
This is when the reinsurer has the right to decide
Facultative whether they should accept the risk or not. In other
reinsurance words, the reinsurer negotiates with each risk, whether
to take it on or not.
Surplus Agreement requires reinsurance beyond the retention
reinsurance limit of the primary insurer.
Quota share A proportion of all businesses to be reinsured.
An arrangement wherein the reinsurer steps in only if
there is a loss that exceeds the specified limit.
Insurance companies may have several excess of loss
Excess of
treaties with second and third reinsures set at different
loss
limits that come into effect when the loss is in excess of
the limit for the primary insurer and the first reinsurer.
These are called “first”, “second” etc. excess of loss.
When net claims ratios of the insurer exceed specified
Excess of
limits in a financial year, excess of loss ratio becomes
loss ratio
operational.
A number of insurers agree to pool all premiums received
Pool
and claims are paid from that pool. Expenses and profits
arrangement
are shared as per agreed interests of the pool members.

Accounting for reinsurance arrangements

Reinsurance accounting is directly associated with methods and forms of

reinsurance contracts which are either Facultative or Treaty in nature and
character.

An accountant handling reinsurance accounting must have thorough knowledge

about each and every reinsurance contract and its terms and conditions, which
provides the basis of reinsurance accounting.

The various types of reinsurance arrangements and their accounting have been
discussed in detail in the subsequent Learning Outcomes.

In reinsurance terms, a treaty condition stating that the insurer’s loss must
exceed a certain limit for the reinsurer to get involved is called
________________.

A Excess of loss
B Quota share
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C Ceding
D Pool arrangement

2. Discuss the various types of reinsurance arrangements.

[Learning Outcome b]

Reinsurance arrangements are broadly divided into:

1. Facultative reinsurance and

2. Treaty Reinsurance.

1. Facultative Reinsurance
Under this method, risks are reinsured on an individual basis where the insurer
has no obligation but has the option to cede the risk, and the reinsurer has the
option of accepting or declining each proposal.

This has a strategic use to reinsure heavy risks not protected by treaty
arrangements. This needs expertise to handle the risk as there is an exposure of
potential loss.

2. Treaty Reinsurance

Treaty reinsurance is an obligatory arrangement between an Insurance Company

(ceding company) and Reinsurance Company. There is an agreement that
reinsurer accepts certain liabilities of all risks covered under the agreement and
the reinsurer accepts all such risks.

A treaty expresses in writing the monetary limits, mode of operation, class of

business, territorial scope, excluded risks, premium and claims workings,
underlying basis and the period of agreement. The treaty wordings may change
according to the line of business.

Underlying basis may be

o Risk attaching basis – any claim occurred on the policies issued during
the treaty period is covered
o Loss occurring basis – any claim occurred during the treaty period is
covered, though the policy is issued prior to treaty period.

Generally, treaty shall be for a specific period, with automatic renewal unless
otherwise mentioned.

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They do not normally have standard wordings but the general conditions are
uniform in nature. Treaties re drafted on the basis of underwriting philosophy,
practice, experience, insurers’ attitude, expertise and claims management.

There are two basic types of treaty reinsurance:

a) Proportional treaty is one whereby the reinsurer receives a predetermined

proportion or share of the premium and pays the same proportion or share
of loss. It is also referred to as pro-rata insurance. In proportional
reinsurance, the insurer and the reinsurer share the risks and premiums pro-
rata.

Proportional reinsurance helps stabilizing the ‘Net retained Loss’ ratio and
to have a better combined ratio.

The two common types of proportional reinsurance are:

Quota share Treaty: Under quota share, the retention is fixed as a

PERCENTAGE of Sum Insured.

Example:
If there is a loss of Rs. 1,00,000 under a 40 % quota share reinsurance treaty,
o the reinsurer will bear Rs.40,000 of the loss (40%) and
o the cedant will bear Rs. 60,000 of the loss (60%).
Surplus Treaty: Here, the ceding insurer retains a limit (fixed sum insured) and
reinsures the balance on each risk.

The retention portion of Sum Insured is called as a ‘line’. Thus, a line is a

ceding company’s retention limit.

Line surplus treaty: eg. 3 line surplus treaty.

If a line equals 10 Crores, insurer retains 10 Crores and reinsures upto 3 lines,
ie, 3 x 10 Crores = 30 Crores.

Second surplus treaty: If the Sum Insured exceeds the lines of the treaty, the
balance shall be given to the reinsurer as Second surplus.

Limits are generally fixed on Sum Insured, though in some cases, it may be
based on Probable Maximum Loss (PML). PML is the probable maximum damage
that would probably occur in the event of an accident. This helps increasing the
retention capacity.

Example of Surplus share treaty:

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Where the policy limit is Rs.1,50,000, and the cedant’s retention is Rs.25,000,
the amount ceded to the reinsurer is Rs.125,000 and the ratio of what is ceded
to what is retained is 5:1. Losses, therefore, will be shared in that proportion.
Therefore, in the case of claim of Rs.1,00,000,
o the reinsurer pays Rs.83,333 ie, ( 5/6) and
o the cedant is responsible for Rs.16,667 ie, (1/6).

Quota share treaties are especially suitable for young emerging insurance
companies or for those companies who are new to a certain class of business. As
their loss experience is limited, they often face difficulties in defining the
correct premium to be collected from the insurance written. With quota share
treaties, the insurer takes the risk of any incorrect estimates.

Reinsurers limit the amount of risk ceded to them which is described in terms of
“No. of lines”. The amount of the insurer’s retention is considered one line. A
reinsurer may be said to accept, for example, a five-line surplus reinsurance
contract, meaning risks up to five times the primary insurer’s retention.

b) Non-proportional Treaty

In non-proportional treaty reinsurance, there is no such pre-determined ratio

for dividing the premiums and losses between the direct insurer and the
reinsurer.

The re-insurer is liable to only those losses which have exceeded the specified
amount, called the attachment point or excess point e.g. excess of loss treaty.

There are different types of reinsurance treaties. Reinsurance accounting

process and preparation of accounting statements follow the nature and type of
reinsurance and reinsurance policy wording in the treaty.
Let us summarise this learning outcome by understanding the basic differences
between facultative and treaty reinsurance:

Facultative Reinsurance Treaty Reinsurance

It is a contract only covering all It involves a pre-existing
or part of a single specific policy commitment by the reinsurer to
of insurance cover a predetermined class and
amount of coverage that will be
sold by the primary insurer.

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 The reinsurance company is not The reinsurance company is under
under any obligation to provide an obligation to provide
reinsurance protection. reinsurance protection.
Commonly purchased for large, Generally purchased to cover risks
unusual or catastrophic risks. which are pre-determined and are
out of scope of the Primary
Insurer
Generally entered for short term Generally treaties are long term
and for a specified period of contracts or risks pertaining to
time. certain risky business segments.
Facultative reinsurance is costly Treaty reinsurance is less costly
due to administrative procedure than ‘Per Risk/Individual Risk
for each case. based reinsurance i.e. Facultative
Reinsurance’

When the business is not covered by the insurer’s reinsurance treaty, or the
amount of insurance needed exceeds the net treaty capacity of the primary
insurer, the primary insurer can transfer that excess to a facultative reinsurer.

Orion Insurance Company has purchased from Artis Reinsurance Company a

quota share treaty with retention of 20 % and a cession of 80 % with a limit of
Rs. 10,00,000. The details of 3 policies to be ceded are as follows:

Policy No Sum Insured Premium Loss

111 4,00,000 1,600 100,000
112 6,00,000 3,000 160,000
113 8,00,000 3,400 180,000

Required:
Show how the sum insured, premiums and losses under these policies will be
divided between the insurer and the reinsurer under a quota share treaty.

Orion insurance company has purchased from Artis Reinsurance Company a 10

line surplus share treaty with retention of Rs.4,00,000 and a limit of Rs.
40,00,000. Use the details of the policies to be ceded given in Test Yourself 2.

Required: Show how the sum insured, premiums and losses under these policies
will be divided between the primary insurer and the reinsurer under a surplus
share treaty.

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3. Learn about reinsurance accounting.
[Learning Outcome c]

In this section we will discuss the following broad areas:

3.1 Characteristics of reinsurance accounting

3.2 Need for reinsurance accounting
3.3 Basis of Reinsurance Programme
3.4 Principles & Prerequisites of reinsurance accounting
3.5 Provisions for Reinsurance Recoverable

3.1 Characteristics of reinsurance accounting

Reinsurance accounting is a process of identifying, analyzing and reporting

financial data and results for the various groups of people interested in
reinsurance transactions for their various decisions.

Characteristics:

1. Reinsurance accounting deals with not only financial aspects but also
technical and legal aspects of reinsurance.

2. Reinsurance Accounting process and methods are based on class of business,

types & methods of reinsurance, types of arrangements or treaties i.e.
Quota Share Treaties, Surplus Treaties or excess of Loss treaties.

3. Reinsurance Accounts are maintained mainly to provide important statistical

analysis of financial as well as technical data such as premium, incurred
claims, commission, premium reserves, Claims Reserves, Cash calls, various
commissions (normal, profit or overriding commission), Taxes &
management expenses.

4. Performance of reinsurance business can be ascertained separately by

maintaining separate set of reinsurance accounts.

3.2 Need for reinsurance accounting

1. Commissions and settlements

The reinsured earns commission from reinsurers for ceding premium with
reinsurers at various rates and terms. Reinsurance accounting forms the basis

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for determining the commissions to be received / paid between the ceding
company and the reinsurer during the year.

2. Profitability

With reinsurance accounts, the reinsured and reinsurer determine profitability

for each and every reinsurance treaty or facultative transactions so that they
can decide the future reinsurance cover with the best possible rates and terms.

3. Periodical settlement

It facilitates all periodical reconciliations and settlement of quarterly or

periodical balances to avoid undue gains or losses due to fluctuations of
exchange rates.

4. Ageing analysis

It also provides proper mechanism for age-wise analysis of the recoverables.

5. Decision making

Appreciation and analysis Reinsurance Accounting gives rise to the following

queries, which need to be considered before forming any opinion or taking any
decision.

 Is profit earned on insurance business is really profit?

 Is Profit on Reinsurance Accounts not a reserve against some future
catastrophic liability?
 If one major catastrophic loss in 30 years wipes out the entire profits, what
should be the treatment of taxes?

3.3 Basis of Reinsurance Programme

A reinsurance programme cannot be standardised for each and every insurance

company. Every insurance company is in a unique situation with regard to loss
exposure, financial standing, management culture and future plans. Thus each
company needs a unique reinsurance programme, which is tailored to suit the
requirements of the company.

The service provided by the reinsurer is only possible due to the availability of
accounting records of financial and technical data identified which are analysed
and reviewed for reinsurance treaty formation, renewal and settlement.
Therefore, without proper reinsurance accounts, reinsurance service that is
international in character, practice and perspectives in risk transfer technology
cannot be properly utilized. Furthermore, management decisions in framing
reinsurance policy and programme and choosing the method to account for
reinsurance treaties depend on reinsurance accounting and results analysis.
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3.4 Principles & Pre-requisites of reinsurance accounting
There is neither any accounting principle, nor any accounting standard that is
internationally accepted for reinsurance. Principally, reinsurance accounting
and its procedures follow the foundation of reinsurance treaty. This includes
learning the following fundamental areas of reinsurance accounts:
1. Reinsurance Accounting format
2. Reinsurance Accounting systems
3. Reinsurance portfolios
4. Accounting entries with reference to general accounts and final statement
of accounts.
5. Reinsurance Commission and Profit Commission

1. Reinsurance Accounting Formats

There is no standard format for reinsurance accounts that has been globally
accepted. Over the years, a number of attempts have been made to standardize
the reinsurance accounts to a global acceptance, but limited success has been
achieved so far. Certain examples of accounts are shown hereinafter in regard
to various Accounts formats commonly followed for reinsurance accounting all
over the world. The reinsurance accounts formats include various treaty
accounts, Profit and Loss Statement or Profit Commission Statement, which are
discussed in the latter part of the material.
2. Reinsurance Accounting Systems
It is said that “Treaty is blind” because everything is decided based on the
results revealed by the Accounts. The Accounting System is one of the
fundamental aspects that help to analyze and interpret the reinsurance results
through reinsurance accounts. The type of reinsurance accounting system plays
an important role in accounting for reinsurance arrangement. It forms the basis
in each specific case before we proceed to prepare accounts and statistics.
Generally, the account system chosen is specified in the reinsurance treaty
concerned. If the accounting system is not specified in the treaty, an accounting
system, which is common in the relevant class of business, will have to be
selected. But once an accounting system is chosen, it should not be changed in
order to maintain uniformity and consistency.
Need for accounting systems

 Accounting systems help to determine the amount and manner of

recognizing premiums or losses, which should go into accounts in accordance
with the reinsurance treaty.
 While preparing accounting statements such as Reinsurance Treaty Account,
Profit Commission Statement etc., the accounting system determines as to

290
 how premium reserves, loss reserves and profit commissions should be
determined.
There are three major reinsurance accounting systems:
Diagram 3: Reinsurance accounting system

a) Reinsurance Accounting Year System

In this system, the premiums and losses are entered in the accounts according
to the treaty criteria for the relevant accounting year without any break up of
income (premium) and expenditure (claims/commission) by year of occurrence
or underwriting year.
Premium is booked as per the due date or premium paid, and claims as per the
date of payment. While preparing Profit Commission Statement and Reinsurance
Treaty Accounts on accounting year basis, all transactions are accounted for in
the same treaty period with the following debits and credits without reference
to the underwriting year:
Debit Items Credit Items
Claims, Commissions Premium Reserve B/F
Miscellaneous Charges Loss Reserve B/F
Loss Reserve C/f Premiums etc.
Premium Reserve C/f
Allowance for Re-insurer’s Expenses B/f
Allowance for Re-insurer’s Expenses B/f
The reserves mentioned here are not cash reserves, but technical reserves that
the ceding insurer may retain from the reinsurer although the same may be
replaced by portfolio transfers. Losses payable to the reinsured company are
divided between losses already paid by the ceding company and loss reported
but unpaid by ceding company. Unearned premium reserves held by the
reinsured are similar to loss recoverable from the reinsurer. If reinsurer cancels
treaty or becomes insolvent, the unearned premium reserves must be adjusted
by ceding company against loss.

b) Reinsurance Accounting -Occurrence System

In this system, premiums and losses are recorded in the accounts according to
treaty terms for the relevant year of occurrence with breakdown of losses by
year of occurrence. Here, premium is booked as per due date or premium paid,
291
but losses are booked according to the date of occurrence, which is clearly
defined for each class of business in the treaty.

c) Reinsurance Accounting- Underwriting Year System

Under this system, the premiums and losses are entered in the accounts
according to the treaty terms for the relevant underwriting years (breakdown
of premium and losses by underwriting years). For calculation of profit for profit
commission of the underwriting year and determination of closing balances for
periodical settlement, all transactions of an underwriting year are accounted
for in the same u/w year without reference to accounting year. Premium and
paid losses are accounted according to the policy period. Generally the
preparation of the first statement is deferred until at least one year after the
end of the u/w year.

Readjustment statements are then rendered in accordance with treaty terms

until all liabilities have expired and been accounted for. Sometimes, the treaty
may provide for closing of accounts after a specified period in order to account
for liability and transfer of any outstanding liability to the next open
underwriting year.

Thus, all subsequent transactions for claims or liabilities relating to the

preceding underwriting years are then included in the profit commission
statement and for settlement of periodical balances under Underwriting Year
System. Pertinently, no premium reserve or no loss reserve will be brought
forward or carried forward unlike calculation of profit commission under
accounting year basis to determine the profit commission.

3. Reinsurance Portfolio
Direct insurers minimize their risk by ceding certain risks in the form of
facultative reinsurance. However, some direct insurers may opt to cede a
portfolio of risk - for example, all the risk contained in business segment of fire,
motor or marine insurance policies written. These insurance portfolios may be
covered by blanket agreements (also referred to as obligatory reinsurance
treaties). Insurance portfolios based on the reinsurance treaty include huge
individual risks of distinct classes covered by the treaty. Different portfolios are
constructed for different classes of business such as motor, fire, marine,
engineering etc. The said portfolio that provides data on premium, risk, risk
date, loss, date of loss and date of payments is the basic foundation of
reinsurance accounting. An insurance portfolio is constructed in many ways. It
may be a Balanced or an Un-balanced portfolio.

292
a) Balanced Portfolio

Balanced portfolio is one based on many similar and equivalent risks, balancing
of portfolio losses collectively and distributing proportionately as per terms of
treaty.

To be considered a balanced portfolio, an insurance portfolio should include

many similar and equivalent risks. In this way, losses can be balanced
collectively, meaning that the direct insurer will need little or no reinsurance.

One of the business lines for Lumini Ltd is the insurance of motor vehicles. If
such a portfolio includes enough individual risks (say 200,000 automobiles) the
law of large numbers should apply, meaning that the loss ratio (the ratio of
claims to premiums) should fluctuate only minimally from year to year.

b) Unbalanced portfolio
Examples of such unbalanced portfolios are those of nuclear power or aviation
insurance risks. Here, huge risk exposures arise from a relatively small number
of objects insured through accumulation of sums insured under property, hull,
liability and accident coverage. Such risks cannot be possibly borne by a single
insurance or reinsurance company. It necessitates setting up national pools,
which retain part of risk exposures for national insurance companies,
collectively enabling the balance to be reinsured. The following example of a
marine portfolio gives some basic ideas and concepts about how reinsurance
portfolio serves as basis for reinsurance accounts.

Table 1 - Reinsurance Portfolio (Marine)

Vessels Sum Period Due date Premium Loss Loss Payment

Insured Date date
Asoke 2,00,000 1/1/20 1/1/20 5,000 - NIL -
to 1/10/20 5,000
31/12/20
Victor 4,00,000 1/2/20 01/02/20 20,000 7/4/20 5,000 2/8/20
to
31/1/21
Calcutta 7,50,000 1/4/20 01/04/20 37,500 6/12/20 7,500 1/2/21
to
31/3/21
Bombay 10,00,000 1/7/20 01/07/20 25,000 8/10/20 20,000 20/10/20
to 01/10/20 25,000
293
 31/12/20
Madrid 14,00,000 1/9/20 01/09/20 28,000
to
31/08/21
Madras 18,00,000 1/1/21 1/1/21 36,000 7/4/21
to
30/6/21
Singapore 20,00,000 1/1/21 1/1/21 40,000
to 1/7/21 10,000
31/12/21
Hongkong 20,00,000 1/1/21 1/1/21 10,000 4/3/21 40,000 4/7/21
to 1/7/21 40,000
31/12/21
Total Rs2,81,500 Rs2,22,50
0

Note: Table 1 will also be used below to understand further examples.

4. Accounting entries with reference to general accounts and final

statement of accounts

Accounting entries vary with Methods and Types of reinsurance. Methods are
two - Facultative and Obligatory. The types are also two - Proportional and Non-
proportional. Let us examine the standard accounting entries to be passed for
reinsurance accounts.

Accounting Entries for Reinsurance Transactions

Accepted /
Transaction Debit A/c Credit A/c
Ceded
Premium for Current Year Accepted Cedant Premium
Premium for Current Year Ceded Premium Reinsurer
Commission Accepted Commission Cedant
Commission Ceded Reinsurer Commission
Brokerage Accepted Brokerage Broker
Brokerage Ceded Brokerage Broker
Claims Paid Accepted Claims Cedant
Claims Paid Ceded Reinsurer Claims
Portfolio reinsurance
Portfolio Premium Entry Accepted Cedant Premium
Portfolio Premium Entry Ceded Premium Reinsurer
Outstanding
Portfolio Loss Entry Accepted Cedant
Claims
Outstanding
Portfolio Loss Entry Ceded Reinsurer
Claims
Portfolio Premium Accepted Premium Cedant
294
Withdrawal
Portfolio Premium
Ceded Reinsurer Premium
Withdrawal
Outstanding
Portfolio Loss Withdrawal Accepted Cedant
Claims
Outstanding
Portfolio Loss Withdrawal Ceded Reinsurer
Claims
Profit Commission Accepted Commission Cedant
Profit Commission Ceded Reinsurer Commission

c) Facultative Reinsurance Accounting

Under Facultative Reinsurance, the risks are reinsured on individual basis,
where the insurer has no obligation to cede a risk in a primary insurance
contract and the reinsurer also has the option of accepting or declining each
proposal. When reinsuring facultatively, the insurer may obtain reinsurance
coverage before accepting risks of the insured. Facultative reinsurance may be
either proportional or non-proportional. Accounting entries will be the same,
irrespective of the methods and types of reinsurance.

What is to be specially considered in facultative reinsurance is the distribution

of premium and claims as per arrangement. Generally, premium is booked
under this method on net of commission basis. However, Facultative Obligatory
treaty may provide for some commission, which is substantially less than the
quota share and surplus treaty because of the simple fact that premium paid
under this treaty is very less compared to the loss exposure.

d) Quota Share Treaty and Reinsurance Accounting

The quota share treaty is an automatic reinsurance whereby the ceding
company is bound to part with a fixed percentage of every risk written by it.
The same percentage is applied to each and every risk to determine cession in
the class of insurance as reinsured. It is immaterial how large or small is the
sum insured or how good or bad the risk is. This is different from surplus
method where the percentage reinsured varies with each risk according to the
underwriter’s decision in determining the surplus for reinsurance.

Distribution of Premium
Primary Insurer (PI) entered into 80% Quota Share Treaty with Reinsurer (RI)
with respect of all the fire businesses written by the company in India. A treaty
is agreed to distribute premium between PI and RI for the following fire
businesses written in India. A premium of Re1 per Rs.1000 (Sum Insured) is
charged for all business written in India.

During the year the following businesses were written:

295
 Business Date Sum Insured
(Rs.)
A 01/09/21 5,00,000
B 02/09/21 10,00,000
C 03/09/21 20,00,000
D 04/09/21 40,00,000
Required:

Prepare a statement showing the distribution of Premium.

Solution
Statement showing distribution of Premium

Business A B C D
Sum-insured 100% 5,00,000 10,00,000 20,00,000 40,00,000
Premium Total 100% 500 1000 2,000 4,000

Ceding 20% 100 200 400 800

Company
Reinsurer 80% 400 800 1600 3,200

Let us now examine how claims will be distributed in a Quota Share treaty.

Distribution of Sum Insured, Premium and Claims in Quota Share Treaty

Primary Insurer (PI) entered into a 20% quota share treaty with reinsurer (RI) for
2019 with maximum cession of Rs. 90,00,000.
The following are the details of premium rate and business written during the
year:

(i) Premium rate 1%

(ii) Sum insured of Rs. 50,00,000 with claim of Rs. 44,00,000
(iii) Sum insured of Rs. 110,00,000 with claim Rs. 1,000 only
(iv) Sum insured of Rs. 600,00,000 with claim Rs. 6,00,000
Required:

Calculate retention and reinsurance cessions.

Solution
Accounting Statement showing distribution of SI, Premium and Claims

296
1. SI Distribution

SI Retention Quota Cession Fac SI

a) 50,00,000 40,00,000 80% 10,00,000 20% NIL
b) 110,00,000 88,00,000 80% 22,00,000 20% NIL
c) 600,00,000 480,00,00 80% 90,00,000 15% 30,00,000 5%
0

2. Premium Distribution

SI Retention Quota Cession Fac SI

a) 50,000 40,000 80% 10,000 20% NIL
b) 1,10,000 88,000 80% 22,000 20% NIL
c) 6,00,000 4,80,000 80% 90,000 15% 30,000 5
%

3. Claim Distribution

Total Claim Retention Quota Cession Fac SI

a) 40,00,000 32,00,000 80% 8,00,000 20% NIL
b) 1,000 800 80% 200 20% NIL
c) 6,00,000 4,80,000 80% 90,000 15% 30,000 5%

Quota Share Reinsurance Accounting

Let us now prepare Quota Share Reinsurance Accounting of XYZ Insurer Ltd.
Mumbai, for the accounting transactions with Bharat Reinsurer Ltd, Mumbai (as
reflected in Reinsurance Portfolio specified in Table 1 shown earlier) using
following Quota Share Treaty

Marine Quota Share Treaty

Portfolio As per Insurance Portfolio specified in Table 1

Treaty Inception 01/01/2020
Reinsurance 40% with Bharat Reinsurer, 40% others; 20%
share retention by XYZ
Proportional Sum-insured 20,00,000; Bharat Reinsurer max.
Cover liability 8,00,000
Management 5%
Exp.
Commission 22.5%
Profit Sliding Scale Profit Commission

297
 Commission 30% Profit Commission on profit upto 10% of
premium booked
40% Profit Commission on profit 10% - 20% of
premium booked
50% Profit Commission on rest of profit.
Losses carried forward to extinction
Accounts Underwriting Year Basis; Half-yearly account’s
Statement
Closing of books on 31 December
Deadlines- 60 days; Confirmation – 30 days
Settlement; 30 days by both parties;
Accounting Currency and Payment Currency- INR
Set-off permitted with all balances
Loss Reserves 100%
Solution
A statement of account for the 1st half year of 2020 may be prepared in the
following format taking premium and claims specified in earlier Table 1
In the books of XYZ Insurance Co Ltd (insurer)
A statement of account for the 1st half year of 2020 for Reinsurance Treaty with
Bharat Reinsurer Ltd, Mumbai (Reinsurer)
Reinsurance Treaty Marine Quota Share
Accounting Period 1st Half Year, 2020
Accounting System Underwriting Year
Accounting Currency INR
100% figures accounted for
Particulars Treaty Debit Credit
Year Amount Amount
Premiums 2020 - 62,500.00
(5,000+20,000+37,500)
Commission 22.5% 2020 14,062.50
Paid Claims
48,437.50 -
62,500.00 62,500.00
Bharat’s 40% share on 48,437.50 19,375.00
In the books of XYZ Insurance Co. Ltd
A statement of Account for the 2nd half year of 2020 for Reinsurance Treaty with
Bharat Reinsurer Ltd, Mumbai, Reinsurer
Re-insurer Bharat Reinsurer Ltd, Mumbai
Reinsurance Treaty Marine Quota Share
Accounting Period 2nd Half Year, 2020
298
 Accounting System Underwriting Year
Accounting Currency INR

100% figures accounted for

Particulars Treaty Debit Credit
Year Amount Amount
Premiums 2020 - 83,000
(5,000+25,000+25,000+28,000)
Commission 22.5% 2020 18,675
Paid Claims (Payment-2.8.05 & 2020 25,000
11.10.05) (5,000+20,000)
Balance 39,325 -
83,000 83,000
Bharat’s 40% reinsurance Share on 39,325 15,730
In the books of XYZ Insurance Co. Ltd
A statement of account for the 1st half year of 2021 for Reinsurance Treaty with
Bharat Reinsurer Ltd, Mumbai, Reinsurer
Re-insurer Bharat Reinsurer Ltd, Mumbai
Reinsurance Treaty Marine Quota Share
Accounting Period 1st Half Year, 2021
Accounting System Underwriting Year
Accounting Currency INR
100% figures accounted for
Particulars Treaty Debit Credit
Year Amount Amount
Premiums (36,000+40,000+10,000) 2021 - 86,000
Commission 22.5% 2021 19,350
Paid Claims (On 1.2.21) 2020 7,500
Balance 59,150 -
86,000 86,000
Bharat’s 40% on 59,150 23,660
In the books of XYZ Insurance Co. Ltd
A statement of Account for the 2nd half year of 2021 for Reinsurance Treaty with
Bharat Reinsurer Ltd, Mumbai, Reinsurer
Re-insurer Bharat Reinsurer Ltd, Mumbai
Reinsurance Treaty Marine Quota Share
Accounting Period 2nd Half Year, 2021
Accounting System Underwriting Year
Accounting Currency INR

299
100% figures accounted for

Particulars Treaty Debit Credit

Year Amount Amount
Premiums (10,000 + 40,000) 2021 - 50,000
Commission 22.5% on 50,000 2021 11,250
Paid Claims (4/7/21) 2021 40,000
Balance 1,250
51,250 51,250
Bharat’s 40% on 1,250 500

Prepare Profit and Loss statement

Now let us prepare Profit and Loss statement as at 31/12/2020 on the basis of
reinsurance accounts transactions recorded in the above noted Half-yearly
Accounts (following data specified in Table. 1 and Quota Share Treaty shown
above):

In the books of XYZ Insurance Co. Ltd

Profit and Loss statement as at 31/12/2020
(As per premium and claims specified in earlier Table .1)

Reinsurance Treaty Marine Quota Share

Accounting Period 2020
Accounting System Underwriting Year
Accounting Currency INR

100% figures accounted for

(Amount in Rs.)
Debit Credit
Premiums (62,500+83,000) 145,500.00
Commission (14,062.50+18,675) 32,737.50
Paid Claims 25,000.00
Loss Reserves 100% 7,500.00
Management Expenses 5% 7,275.00
Profit 72,987.50
145,500.00 145,500.00
Calculation of Profit Commission
On premium 1,45,500 Premium % of Commission
commission
Upto 10% of Premium 14,550 30 4,365
Next 10% of Premium 14,550 40 5,820
Balance on PROFIT (72,897.50 – 14,550-14,550) 50 21,994
= 43,887.50
TOTAL 32,179

Preparation of Profit and Loss statement for 2006

300
Now let us prepare Profit and Loss statement as at 31.12.2006 on the basis of
reinsurance accounts transactions recorded in the above noted Half-yearly
Accounts (following data specified in Table. 1 and Quota Share Treaty shown
above)

Profit and Loss statement as at 31/12/2021

Reinsurer Bharat Reinsurer Ltd,
Mumbai
Reinsurance Treaty Marine Quota Share
Accounting Period 2021
Accounting System Underwriting Year
Accounting Currency INR

100% figures accounted for

Dr. Amount Cr. Amount
Premiums 1,45,500.00
Commission 32,737.50
Paid Claims 40,000.00
Loss Reserves 100%
Mgmt. Expenses 5% 7,275.00
Profit 65,487.50
1,45,500.00 1,45,500.00
Calculation of Profit Profit Debit Credit
Commission
30% profit commission upto 14,550 4,365.00
10% of Premium
40% profit commission for 14,550 5,820.00
another 10% of premium
50% profit commission for 36,387.50 18,194.00
the balance profit
Profit Commission 28,379.00
28,379.00 28,379.00
Note: As in the 2021 transactions, there is no change other than paid claims
which correspond with the aggregate of paid claims and Loss reserves
(25,000+7,500)

Profit & Loss Statement as at 30/06/20

Reinsurer Universal Reinsurance Co Ltd

Portfolio Premium Entry (35%) Ceded Rs.80,00,000
Portfolio Loss Entry (O/S Claims) Rs.50,00,000
Premium for Current Half Rs.4,00,00,000
Reinsurance Commission 40%
Claims Paid Rs.60,00,000
301
 Expenses of Management 2.5%
Portfolio Loss Withdrawal Rs.70,00,000
Profit Commission 20%

Required:
Prepare Half Yearly Profit & Loss Statement as on 30/06/20.

Solution
Reinsurer—M/s Universal Reinsurance Co Ltd
Half Yearly Profit & Loss Statement As on 30.6.20
Reinsurance Treaty: Quota Share; Treaty Year: 1st Half ‘20
Accounting System --Underwriting Year Class of Business –Marine

Particulars % Debit Credit

Amount Amount
Portfolio Premium Entry (ceded) 35 80,00,000
Portfolio Loss Entry (OS claims) 50,00,000
Premium for Current year 4,00,00,000
Commission (on Premium 4 Cr.) 40 1,60,00,000
Claims Paid 60,00,000
Management Expenses 2.5 10,00,000
Portfolio Premium Withdrawal (on 35 1,40,00,000
premium 4Cr.)
Portfolio Loss Withdrawal (OS claims) 70,00,000
Balance being profit 90,00,000
5,30,00,000 5,30,00,000
Profit b/d 90,00,000
Profit Commission (on 90 lakhs) 20 18,00,000

*Premium: Refer Table 1 for Portfolio. Total of first four items

5. Reinsurance Commission and Profit Commission

a) Reinsurance commission

Reinsurance Commission is paid by the re-insurer to the ceding (direct) insurer

and is decided as a percentage of premium for reimbursement of acquisition
cost (agency commission) & management expenses.

Reinsurance Commission is calculated by applying the agreed percentage of

commission to the premium ceded less returns and cancellation. Different rates
are decided for different classes of business.

Reinsurance commission may be fixed either on a:

i) fixed scale or
ii) sliding scale
302
These are discussed below in detail:

i) Fixed scale commission

This is very easy to operate as the commission payable is calculated by applying

an agreed percentage to the premiums ceded (less returns and cancellations).
If a treaty has business emanating from different geographical areas, there may
be different rates of commission applying to different locations.

ii) Sliding scale commission

This method has been developed to allow the ceding company to receive more
commission when the treaty is profitable and to minimize the loss to the
reinsurer in unprofitable years.

The rate of commission is based on the loss ratio of the treaty during any one
treaty year or during any one underwriting year. The loss ratio is usually
calculated as the percentage that incurred losses bear to earned premiums, as
follows:
IncurredLosses
 100
EarnedPremiums
If
incurred claim is Rs. 50,000 and premium is Rs. 100,000, loss ratio is 50%. A
treaty may provide the following type of sliding scale commission:
Rate of commission 30% if Loss ratio is 65% or more
” ” 35% ” ” is below 65%
” ” 36% ” ” is below 64%
” ” 37% ” ” is below 63%
” ” 38% ” ” is below 62%
” ” 39% ” ” is below 61%
” ” 40% ” ” is below 60%
” ” 41% ” ” is below 59%. And so on.

 Commission on Reinsurance Accepted: the reinsurer generally allows

commission to the ceding company on a part of business ceded. This is
treated as expense of the reinsurer company.

 Commission on Reinsurance ceded: the ceding company generally gets

commission for giving business under a reinsurance contract. It appears as
income in the revenue account of the ceding company.

303
b) Profit Commission

Profit commission is an additional commission percentage payable to a ceding

insurer on profitable treaties in accordance with an agreed formula. It is
therefore an incentive for ceding insurers to produce profitable business.

There are two types of profit commission statements:

 Statements on Accounting Year basis and
 Statements on Underwriting Year basis

Fire and Accidental proportional treaties are usually on an accounting year basis
while Marine and aviation, on underwriting year basis. Generally, only
proportional treaties provide for profit commission and non-proportional
treaties rarely contain a profit commission clause. When a treaty provides for
profit commission, the ceding insurer must prepare profit commission statement
to see whether the treaty is showing a profit or a loss.
i) Profit Commission on Accounting Year Basis

A profit commission on Accounting Year basis requires all transactions for the
same treaty period without reference to the underwriting year, to be accounted
for in the same profit commission statement.
A typical example would include the Debit Items like Claims, Commissions,
Miscellaneous Charges, Premium Reserve Carried Forward, Loss Reserve Carried
Forward, allowance for Re-insurer’s Expenses and Credit Items like Premium
Reserve Brought Forward, Loss Reserve Brought Forward, Premiums etc. A profit
commission on an accounts year basis would not be adjusted in subsequent
years, as long as the treaty remains current.

Specimen Profit Commission statement on accounting year basis

Profit Commission statement - accounting year basis
01/01/20 - 31/12/20
First Surplus Fire Treaty with Y Re-insurer
Particulars Debit Credit
Premium Reserve B/f (Portfolio entry) on 01/01/20 80,00,000
Loss Reserve B/F (Portfolio entry) on 01/01/20 70,00,000
Premium 2,00,00,000
Commission (45% of premium 2 Cr.) 90,00,000
Claims Paid 60,00,000
Taxes & Charges 5,00,000
Management expenses (2.5% of premium 2 Cr.) 5,00,000
Premium Portfolio Withdrawal 35% on 31/12/20 70,00,000
Loss Portfolio Withdrawal 35% on 31/12/20 80,00,000
Profit for the year 2020 40,00,000
304
 3,50,00,000 3,50,00,000
Calculation of profit commission
Average Profit
Profit for 2020 40,00,000
Profit for 2019 40,00,000
Profit for 2018 10,00,000
Average Profit 90 lakhs/3 = 30,00,000
Profit Commission, say, 20% of average profit 6,00,000

ii) Profit Commission on Underwriting Year Basis

A profit commission on an underwriting year basis requires all figures for the
same underwriting year, irrespective of the account year in which these are
included, to be related back to the same year for the purposes of determining
the profit of that underwriting year.

When this sort of commission statement is considered, the preparation of the

first statement is deferred until one year after the end of the underwriting
year. Readjustment statements are then rendered in accordance with treaty
terms for various liabilities occurred. Every treaty contains detailed provisions
regarding the close of the accounting books after a specified period and transfer
of any outstanding liability to the next open underwriting year so as to cover all
subsequent transactions relating to all preceding underwriting years for
determining profit commission.

Aggregate Annual Profit: Where a treaty covers more than one currency or
class of business, it is a normal practice to combine the results of each section
of the treaty or the results of more than one treaty to determine the aggregate
annual profit for calculation of profit commission.

Specimen Profit Commission statement on underwriting year basis

X Insurance Company Ltd.
Marine Quota Share Treaty with Y Re-insurer
Profit Commission Statement for the period 01/01/20 to 31/12/20

Particulars Debit Credit

Premium Reserve B/f (Portfolio entry) as on 7,000
01/01/20
Loss Reserve B/F (Portfolio entry) as on 1,000
01/01/20
Premium 15,000
Commission (45% of premium 15,000) 6,750
Claims Paid 2,500
Taxes & Charges 500
Management exp. (5% of premium 15,000) 750
Premium Portfolio Withdrawal 50% as on 7,500
305
 31/12/20
Loss Portfolio Withdrawal as on 31/12/20 3,000
Profit for the year 2020 2,000
23,000 23,000
Statement of profit commission
30% profit commission - up to 10% of premium Rs.
10% on Premium 15,000 = 1,500; 30% on above - A 450
40% of Balance
Profit 2,000; Less : 10% Premium 1,500 = 500
40% on this balance 500 – B 200
Profit Commission (A+B) 650

Calculate profit commission from the following data:

Rs.
Premium for 2020 66,00,000
Claims paid in 2020 24,00,000
Portfolio entry:
- Premium 22,00,000
- Loss 40,00,000
Portfolio withdrawal:
- Premium 23,10,000
- Loss 40,00,000
Rate of Commission 40%
Management expenses 5%
Profit commission 25%

XYZ Insurance Ltd Market Fire insurance pool

Profit as at 31/03/2020 20,25,000

Premium 35,37,000
Profit commission terms 15% Pc on Profit Up to 10% of
Premium
& 75% of balance

Required:
Calculate profit commission.

306
3.5 Provisions for Reinsurance Recoverable

Statutory accounting imposes "provisions” for Reinsurance Recoverable in

respect of:

 Unsecured Recoverable from unauthorized reinsurers,

 Unsecured Recoverable from slow-paying (authorized) reinsurers,
 Overdue Recoverable from both authorized and unauthorized reinsurers, and
 Recoverable others in dispute from unauthorized reinsurers and from non-
slow-paying Authorized Reinsurers.

On the statutory balance sheet, Reinsurance Recoverable on paid losses and

loss adjustment expenses are shown as an asset.

Reinsurance Recoverable on unpaid losses and loss adjustment expenses are

shown as a contra-liability to gross unpaid losses and loss adjustment expenses.

Ceded unearned premium reserves are shown as a contra-liability to gross

unearned premium reserves. The provision for reinsurance is a liability that
relates to all of these items.

4. Discuss surplus treaty reinsurance and excess loss treaty

reinsurance.
[Learning Outcome d]
4.1 Surplus treaty reinsurance

Under the surplus treaty, the ceding insurer (direct insurer) decides the limit of
liability which he wants to retain on any one risk or class of risk. This limit is
called retention limit. If the sum insured under the policy is within the net
retention of the company, there will be no cession to the reinsurer. The surplus
over and above this retention is allotted to one or more insurers.

Surplus treaty insurance is usually arranged in terms of the number of lines of

retention. The amount retained by the the primary insurer (ceding company) is
also referred to as a line. The surplus treaty may thus be of ten or twenty lines
capacity. This means that the ceding company can assume cover on risks with
sums insured ten or twenty times its own retained line.

A ceding insurer’s maximum retention limit may be Rs. 2,00,000 on fire

insurance covering all cotton mills, jute mills and flour mills. Distribution of
sum insured between direct insurer & re-insurer will be as follows.
Computation of Reinsurance share under Surplus Treaty

307
 Risk Total SI Ceding company’s Reinsurance share
share
ABC 1,00,000 100.00% 1,00,000 0.00% -
BCD 2,00,000 100.00% 2,00,000 0.00% -
CDE 3,00,000 66.67% 2,00,000 33.33% 1,00,000
DEF 4,00,000 50.00% 2,00,000 50.00% 2,00,000
EFG 5,00,000 40.00% 2,00,000 60.00% 3,00,000
FGH 6,00,000 33.33% 2,00,000 66.67% 4,00,000
GHI 10,00,000 20.00% 2,00,000 80.00% 8,00,000
HIJ 20,00,000 10.00% 2,00,000 90.00% 18,00,000

Second Surplus Treaty

Generally, the amount ceded to a surplus treaty is expressed in terms of the

number of lines.

For example the ceding company’s retention limit is equal to one line. If the
ceding company eneters into a ‘5 line surplus treaty’ on the basis of a maximum
retention limit of Rs.1,00,000, it means that the total capacity of the treaty to
accept the liability over and above the retention limit would be Rs. 5,00,000 (5
lines x Rs. 1,00,000).

In other words, the ceding insurer would have the treaty protection for policy
having sum insured upto Rs. 6,00,000.

If due to any reason the sum insured exceed the limits of the treaty i.e. Rs.
6,00,000, the ceding company has the option to bear the balance on its own
account (in addition to existing retention of Rs. 1,00,000) - or it may affect
further reinsurance. This further reinsurance may be effected through
facultatively reinsurance or by any other surplus treaty automatically. This
further surplus treaty is called Second Surplus treaty.

Surplus Treaty accounting incorporating the above example is framed in the

following manner under the accounting year system.

Any
Insurance Co may present the following terms under surplus treaty:
Portfolio Marine as mentioned above
Treaty inception 01/01/2020
Reinsurance share 5 lines surplus treaty
Proportional cover 5,00,000 and 1,00,000 = 1 line
Commission 30%+ 0.5% if loss ratio < 42.5%
up to 7.5% if loss ratio < 28.5%
Difference: 0.5% 1.0% loss ratio

308
 Provisional commission: 32.5%
Profit commission Management expenses 3%
Profit commission 20%
Rendering of accounts Closing of books at 31 December
Deadlines: rendering of accounts 60 days,
Accounting currency INR
Payment currency INR
Unearned premium reserve 40%
Loss reserves Are entered at 100%
Let us understand the concept of surplus treaty with the help of a
comprehensive example:

Pristine insurance company entered into two surplus treaty contracts with
reinsurers.

 First surplus treaty - 10 lines; maximum liability Rs. 20,00,000.

 Second surplus treaty - 20 lines; maximum liability Rs. 40,00,000.

Risk Gross Sum Insured (Rs.) Retention Applicable (Rs.)

1 4,00,000 2,00,000
2 14,00,000 3,00,000
3 28,00,000 4,00,000
4 70,00,000 2,00,000

Calculate the cessions to first surplus treaty.

Calculate the cessions to second surplus treaty.
Risk Gross Sum Retention Cession to Cession to Balance
Insured 1st Surplus 2nd Surplus
Treaty Treaty
1 4,00,000 2,00,000 2,00,000 - -
2 14,00,000 3,00,000 11,00,000 - -
3 28,00,000 4,00,000 24,00,000 - -
4 70,00,000 2,00,000 20,00,000 40,00,000 8,00,000

In case of risk 4:

 1st Surplus treaty 10 line; maximum risk transferred Rs.20,00,000.

 2nd Surplus treaty 20 line, maximum risk transferred Rs.40,00,000.
 Balance of Rs. 8,00,000 has to be arranged through facultative reinsurance.

Reinsurance Premium: Premium is determined as per local practice, terms of

contract, class of business etc. In some, market premium means gross premium
and expenses, and fees taxes are accounted for separately while in other cases

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(marine & aviation business) it is accounted for on a net basis. Consequently,
commission amount becomes relatively less in the second case.

4.2 Excess of Loss Treaty

Excess of loss treaty is also referred to as non-proportional reinsurance
arrangements. These treaties are characterized by a distribution of liability
between the primary insurer (or referred to as the cedant) and the reinsurer on
the basis of losses rather than sums insured. Unlike proportional treaties which
focus on sharing the size of risk, the focus of excess of loss treaties is on the
size of the loss.
Under an excess of loss treaty, the reinsurer only receives a part of the original
premium. Reinsurance premium is worked out on the basis of exposure and past
loss experience.

PQR Ltd has a capacity of retention of loss upto Rs.10,00,000 and purchases a
layer of reinsurance of Rs.40,00,000 in excess of its retention of Rs.10,00,000.
If a loss of Rs.30,00,000 were to occur, PQR Ltd would retain Rs.10,00,000 of
the loss and would recover Rs.20,00,000 from its reinsurer. Furthermore, PQR
also retains any loss exceeding Rs.50,00,000 unless it has purchased a further
excess layer of reinsurance.

There are three general classes of excess of loss treaties:

1. Per Risk Excess
2. Per Occurrence Excess
3. Aggregate Excess

1. Per Risk Excess Treaty

Risk excess treaties are generally entered into to reinsure loss in respect of
property claims. The retention and limit are decided separately for each risk
insured by the primary insurer.

Example: PQR Ltd has issued a policy to insure commercial property risks for its
clients with policy limits of up to Rs.10 lakhs. PQR Ltd then buys per risk
reinsurance of Rs.5 lakhs with retention of Rs.5 lakhs. In case there is a loss of
Rs.6 lakhs on the policy, PQR Ltd can recover Rs.1 lakh from the reinsurer. In
this way, PQR Ltd can safeguard itself from individual risk by entering into per
risk treaty reinsurance.

2. Per occurrence excess

These treaties are designed to protect the reinsured against catastrophic events
that involve more than one policy. These treaties gives the primary insurer the
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indemnity against loss sustained in excess of their net retention, subject to the
reinsurance limit. Unlike per risk excess treaty, these treaties cover all the risks
involved in respect of one accident, event or occurrence. This kind of
reinsurance when applied to property coverage is called catastrophe excess and
when applied to liability coverage is called clash cover.

Example: An insurance company issues property policies with individual limits of

these policies up to Rs.5,00,000. It then buys catastrophe reinsurance of
Rs.40,000,000 (in excess of Rs.30,00,000). In this case, the insurance company
would be able to recover from reinsurers in the event of multiple policy losses
in one event (i.e. due to catastrophes such as hurricane, earthquake, flood,
etc.).

3. Aggregate excess

Such treaties provide indemnity to reinsurers on an aggregate basis. The

reinsurer pays when a single loss or series of losses arising from a single event
exceeds a certain figure. Thus if all the claims which occur during a given year
exceed a certain percentage of the ceding company's premium, the reinsurer
will pay all amounts exceeding this figure.

Aggregate excess treaties also referred to as excess of loss ratio or stop loss
treaties

Excess
of Loss Treaty for Rs.9,50,000 (excess Rs.50,000)

Year Premium Claims to be accounted for

2016 8,00,000 1 claim of Rs.60,000 paid.
Rs. 50,000 retention; Rs.10,000 loss to treaty
2017 9,00,000 1 of 2016 of which Rs. 30,000 paid and Rs. 90,000
outstanding. Total 1,20,000
Rs. 50,000 retention; Rs. 70,000 to treaty
1 of 2017 Rs. 70,000 paid
Rs. 50,000 retention; Rs.20,000 to treaty
2018 10,00,000 1 of 2016 estimated Rs. 2,40,000
Rs. 50,000 rentention; Rs. 1,90,000 to treaty
3of2017estimated Rs.80,000,Rs.1,25,000, Rs.1,80,000
Rs. 50,000 retention for each claim; Rs.30,000,
Rs.75,000, Rs.1,30,000 to treaty
2019 12,00,000 1 of 2016 estimated loss Rs.1,00,000
Rs. 50,000 retention; Rs.50,000 to treaty
2 of 2017 estimated loss Rs.2,90,000 & Rs.1,25,000
Rs. 50,000 retention for each claim; Rs.2,40,000 &
Rs.75,000 to treaty
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 1 of 2018 estimated loss Rs.1,80,000
Rs. 50,000 retention; Rs.1,30,000 to treaty
2020 15,00,000 1 of 2017 estimated loss Rs.1,70,000
Rs. 50,000 retention; Rs.1,20,000 to treaty
2 of 2018 estimated loss Rs.3,10,000 & Rs.1,80,000
Retention Rs. 50,000 for each claim; Rs.2,60,000 &
Rs.1,30,000 to treaty
1 of 2019 estimated loss Rs.1,90,000
Rs. 50,000 retention; Rs.1,40,000 to treaty

Prestige Ltd enters a 4 line first surplus treaty and 5 line second surplus treaty
in respect of their commercial property business. The company’s retention is
Rs.4,00,00,000 on any risk. The sum insured is given as follows:

Risks Sum Insured

1 4,00,000
2 14,00,000
3 40,00,000
4 70,00,000
Required:
Calculate the cessions to first surplus treaty.
Calculate the cessions to second surplus treaty.

4.3 Rating for excess of loss covers

The concept of “Burning Cost” is often used in the calculation of the rate for
excess of loss covers (either per risk or per policy). This is arrived at by taking a
fixed period and computing the ratio of claims paid and outstanding for the
share of the excess of loss to the gross net premium income of the company for
the period. The burning cost ratio (or percentage) is used for determining
premium rates for excess of loss reinsurance.

Sometimes, an average is taken of these ratios (or percentages) and loading is

added to cover the reinsurance expenses and profit. Sometimes, reinsurance
accounts based on the above percentage may not consider certain aspects such
as:

 Claims still outstanding

 IBNR Claims (incurred but not reported)
 Increasing court awards and
 Inflationary effect

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Therefore, while computing the burning cost, all these aspects should be
considered with due adjustments to the accounting results.

5. Discuss the reinsurance regulations in India.

[Learning Outcome e]

The placement of reinsurance business (both life and non-life) from the Indian
market is governed by IRDAI (Reinsurance) Regulations, 2008 framed by the
IRDAI. The objective of the regulation is to maximize the retention of premiums
within the country.

Major guidance given in this regulation includes the following:

1. The Re-insurance Programme of every Indian Insurer shall be guided by the

following objectives to:
o Maximize retention within the country
o Develop adequate technical capability and financial capacity
o Secure the best possible Re-insurance coverage
o Simplify the administration of business.

2. Retention policy
Every Indian Insurer shall
o maintain the maximum possible retention in commensuration with its
financial strength, quality of risks and volume of business;
o formulate a suitable insurance segment-wise retention policy; bearing in
mind the above stated objectives, duly approved by its Board;
o ensure that the Re-insurance arrangement is not fronting.

3. Every Indian Re-insurer shall maintain a minimum retention of 50% of its

Indian business. The Authority may require an Indian Insurer to justify its
retention policy and may give such directions, as considered necessary, to
fulfil the objectives.

4. Re-insurance Arrangements

o Every Indian Insurer shall commence its annual Re-insurance Programme

from the beginning of every financial year.

o They shall submit to the Authority, its Board approved Re-insurance

Programme along with its retention policy for the forthcoming financial
year, 45 days before the commencement of the financial year.

o They shall file with the Authority, its Board approved Final Re-insurance
Programme within 30 days of the commencement of the financial year.

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 o Any new or revision of Re-insurance arrangement should be submitted
within 15 days of approval of the Board.

The factors that are to be considered while formulating the Re-insurance

Programme and the retention policy are business mix, overall risk appetite,
type and extent of Re-insurance protection required and level of risk
concentration and retention levels.

Catastrophic Risk Protection

Every Indian Insurer shall ensure that its Re-insurance arrangements in respect
of catastrophe accumulations are adequate; have the catastrophe modelling
report and the basis along with return period estimates, on which the quantum
of catastrophe protection is purchased for each of the perils for the forthcoming
financial year duly approved by its Board.

Cross Border Re-insurer (CBR):

o The CBR is an insurance or Re-insurance entity in its home country, duly
authorized by its home country regulator to transact re-insurance
business during the immediate past 3 continuous years.

o The CBR has a credit rating of at least BBB from Standard & Poor or
equivalent rating from an international rating agency during the
immediate past 3 continuous years, has minimum solvency margin or
capital adequacy, the past claims settlement experience of the CBR is
found to be satisfactory.

Procedures for Re-insurance placements:

o Cedants shall seek terms at least from all Indian Re-insurers, who have
been transacting Re-insurance business (other than emanating from
obligatory cession) during the immediate past 3 continuous years and at
least from 4 FRBs.

o No cedant shall seek terms from IIOs having credit rating below A- from
Standard & Poor’s or equivalent rating from any other International
Rating Agency, or

o CBRs having credit rating below A- from Standard & Poor’s or equivalent
rating from any other International Rating Agency.

o No cedant shall seek terms from any Indian Insurer, not registered with
the Authority to transact reinsurance business.

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Credit ratings by Standard & Poor:

AAA EXTREMELY STRONG financial security characteristics

AA VERY STRONG financial security characteristics
A STRONG financial security characteristics, somewhat more
likely to be affected by adverse business conditions
BBB GOOD financial security characteristics, more likely to be
affected by adverse business conditions
BB MARGINAL financial security characteristics, adverse business
conditions could lead to insufficient ability to meet financial
commitments
B WEAK financial security characteristics
CCC VERY WEAK financial security characteristics, dependent
upon favourable business conditions to meet financial
commitments
CC EXTREMELY WEAK financial security characteristics, not likely
to meet some of its financial commitments
R Under REGULATORY SUPERVISION
NR NOT RATED

Plus (+) or minus (-) signs following the ratings from ‘AA’ to ‘CCC’ show relative
standing within the major rating categories.

Credit ratings by A M Best:

Secure:
A++ Very strong. Superior on balance. Not vulnerable to adverse
A+ changes in underwriting and economic conditions.
A Strong. Excellent on balance. Not vulnerable to adverse changes
A- in underwriting and economic conditions.
B++ Very good in balance.
B+
Vulnerable:
B Fair on balances. Have ability to meet ongoing obligations to
B- policyholders but vulnerable to adverse changes in underwriting
and economic conditions.
C++ Marginal on balances. Have ability to meet ongoing obligations
C+ to policyholders but vulnerable to adverse changes in
underwriting and economic conditions.
C Weak on balances. Have ability to meet ongoing obligations to
C- policyholders but very vulnerable to adverse changes in
underwriting and economic conditions.
D Poor on balance. May have no ability to meet ongoing
obligations to policyholders and extremely vulnerable to adverse
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 changes in underwriting and economic conditions.
E Placed by Regulator under a significant form of supervision
F Placed under an order of liquidation
S Rating suspended

Domestic Insurance Pools:

The proposal for an Insurance Pool, could be initiated by any Indian Insurer by
submitting a proposal to the Authority. The Authority, after examining various
factors including its objectives, basis, capacity for participation, limits of
liability, terms and conditions, may permit formation of domestic Insurance
Pool.

Alternative Risk Transfer (ART):

An Indian Insurer, intending to adopt ART solutions, shall submit such proposals
to the Authority. The Authority, after necessary examination and on being
satisfied with the type of ART solution may allow the ART proposal on a case to
case basis.

Inward Re-insurance Business:

Every Indian Insurer shall file with the Authority, its inward re-insurance
underwriting policy, stating the insurance segments, geographical scope,
underwriting limits, and performance objectives duly approved by its Board
along with the Re-insurance Programme.

For further details about these regulations, students may also refer to IRDAI
(Reinsurance Regulations), 2018 issued by the IRDAI in Nov, 2018.

Summary

 Reinsurance is insurance for insurance companies.

 The purpose of reinsurance is to provide greater financial capacity to the
primary insurer to assume more risks.
 Reinsurance brokers act as an intermediary between the primary insurer and
reinsurers.
 Reinsurance arrangements are broadly divided into: Facultative reinsurance
and Treaty Reinsurance.
 When the business is not covered by the insurer’s reinsurance treaty, or the
amount of insurance needed exceeds the net treaty capacity of the primary
insurer, the primary insurer can transfer that excess to a facultative
reinsurer.
 Reinsurance accounting is a process of identifying, analyzing and reporting
such financial data and results for the various groups of people interested in
reinsurance transactions for their various decisions.

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 There are 3 major reinsurance accounting systems: Accounting Year System,
Occurrence Year System and Underwriting Year System.
 Reinsurance Commission is paid by the re-insurer to the ceding (direct)
insurer. Reinsurance commission may be fixed either on a: fixed scale or
sliding scale.
 Profit commission is an additional commission percentage payable to a
ceding insurer on profitable treaties in accordance with an agreed formula.
 Under the surplus treaty, the ceding insurer (direct insurer) decides the
limit of liability which he wants to retain on any one risk or class of risk.
Surplus treaty insurance is usually arranged in terms of number of lines of
retention.
 Excess of Loss treaties are characterized by a distribution of liability
between the primary insurer (referred to as the cedant) and the reinsurer on
the basis of losses rather than sums insured. There are three general classes
of excess of loss treaties: Per Risk Excess, Per Occurrence Excess and
Aggregate Excess.
 The placement of reinsurance business (both life and non-life) from the
Indian market is governed by IRDAI (Reinsurance) Regulations, 2008 framed
by the IRDAI.

Answers to Test Yourself

Answer to TY 1
The correct option is A. Excess of loss describes a treaty condition stating that
the insurer’s loss must exceed a certain specified limit for the reinsurer to get
involved.

Answer to TY 2
Division of sum insured, insurance premium and losses under a quota share
treaty

Orion Ins.Co.(Rs.) Artis Reins. Co(Rs.) Total (Rs.)

20% 80%
Policy 111
Sum Insured 80,000 320,000 400,000
Premium 320 1,280 1,600
Loss 20,000 80,000 100,000
Policy 112
Sum Insured 120,000 4,80,000 6,00,000
Premium 600 2,400 3,000
Loss 32,000 128,000 160,000
Policy 113
Sum Insured 160,000 6,40,000 8,00,000
Premium 680 2,720 3,400
Loss 36,000 144,000 180,000
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Answer to TY 3
Division of sum insured, insurance premium and losses under a surplus share
treaty

Orion Ins.Co.(Rs.) Artis Reins. Co(Rs.) Total

(Rs.)
Policy 111
Sum Insured 400,000 (100%) 400,000
Premium 1,600 1,600
Loss 100,000 100,000
Policy 112
Sum Insured 4,00,000 (66.67%) 2,00,000 (33.33%) 6,00,000
Premium 2,000 1,000 3,000
Loss 106,666 53,334 160,000
Policy 113
Sum Insured 4,00,000 (50%) 4,00,000 (50%) 8,00,000
Premium 1,700 1,700 3,400
Loss 90,000 90,000 180,000

Answer to TY 4
Profit commission account

Rs Rs
Commission @ 40% 26,40,000 Premium 66,00,000
premium 66 lakhs
Claims paid 24,00,000 Portfolio
entry
Portfolio withdrawal - Premium 22,00,000
- Premium 23,10,000 - Loss 40,00,000
- Loss 40,00,000
Management expense @ 3,30,000
5% on 66 lakhs
Profit 11,20,000
Total 1,28,00,000 1,28,00,000

Profit Commission @ 25% on the profit of Rs.11,20,000 = Rs.2,80,000.

Answer to TY 5
Calculate Profit Commission

Rs.
15% PC up to 10% on Premium
10% on Premium 35,37,000 3,53,700
@15% on above - A 53,055
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 75% of Balance
Profit 20,25,000
Less : 10% Premium 3,53,700
Balance 16,71,300
@75% on Balance - B 12,53,475
Commission (A+B) 13,06,530
Answer to TY 6

Risk Gross Sum Retention Cession to Cession to Balance

Insured 1st Surplus 2nd Surplus
Treaty Treaty
1 4,00,000 4,00,000 - - -
2 14,00,000 4,00,000 10,00,000 - -
3 40,00,000 4,00,000 16,00,000 20,00,000 -
4 70,00,000 4,00,000 16,00,000 20,00,000 30,00,000

In case of Risk 4, balance of Rs.30,00,000 has to be arranged through facultative

reinsurance.

Self Examination Questions

Question 1

A reinsurance contract under which the ceding company has the option to cede
and the reinsurer has the option to accept risk of a specific business line is
called ______________
A Facultative reinsurance
B Treaty reinsurance
C Proportional reinsurance
D Optional reinsurance

Question 2

Which of the following are the commissions involved in a reinsurance

transaction?

(i) Ceding commission

(ii) Brokerage commission
(iii) Settlement commission
(iv) Profit commission

A (i), (ii) and (iv)

B (i), (ii) and (iii)
C (i) and (ii)
D Only (i)
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Question 3

The amount of liability the ceding company (primary insurer) keeps for its
account on a risk is known as:

A Retention
B Cession
C Retrocession
D None of the above

Question 4
The amount of retention of a Direct Insurer is also referred to as:

A Cession
B Retrocession
C Line
D None of the above

Question 5
Reinsurers also may reinsure some of the loss exposures they assume under
reinsurance contracts. Such a transaction is known as

A Cession
B Reinsurance portfolio
C Retrocession
D Pool arrangements

Question 6

A reinsurance contract under which the reinsured company agrees to cede and
the reinsured agrees to assume a particular class or classes of Insurance
business automatically is referred to as:

A Inward reinsurance
B Retrocession
C Treaty
D None of the above

Answers to Self Examination Questions

Answer to SEQ 1

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The correct option is A. A reinsurance contract under which the ceding company
has the option to cede and the reinsurer has the option to accept a risk of a
specific business line is called Facultative Reinsurance.

Answer to SEQ 2
The correct option is A.

Answer to SEQ 3
The correct option is A. The amount of liability the ceding company (primary
insurer) keeps for its account on a risk is known as Retention.

Answer to SEQ 4
The correct option is C. The amount of retention of a Direct Insurer is also
referred to as Line.

Answer to SEQ 5
The correct option is C.

Reinsurers also may reinsure some of the loss exposures they assume under
reinsurance contracts. Such a transaction is known as Retrocession.

Answer to SEQ 6
The correct option is C. A reinsurance contract under which the reinsured
company agrees to cede and the reinsured agrees to assume a particular class or
classes of Insurance business automatically is referred to as Treaty.

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 CHAPTER 4
ACCOUNTING METHODS AND PROCESS OF SPECIAL
ACCOUNTING TRANSACTIONS

UNIT-14
IRDAI (INVESTMENT) REGULATIONS
BASED ON IRDAI (INVESTMENT) REGULATIONS, 2016
Chapter Introduction

In this chapter we will discuss the regulatory aspects applicable to general

insurance business based on IRDAI (Investment) Regulations, 2016 with
reference to earlier regulations for this purpose.

The said regulations provide necessary directives norms, requirements for

investments, manners of investment, exposure / prudential norms of
investments, reporting Requirements, Investment Policy etc.

a) Know about the Investment Regulations for Insurance Business in India

b) Understand the Manner of Investments by General Insurance Companies
c) Learn about the returns to be submitted by Insurer
d) Know about the Provision on Investment Management
e) Learn about Approved Investments, Policyholders’ and Shareholders’ Fund
f) Know about Dealing in Financial Derivatives

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1. Know about the Investment Regulations for Insurance Business in
India
[Learning Outcome a]

1.1 Investment Regulations for Insurance Business in India

Every insurer carrying on insurance or reinsurance business in India shall invest

and at all times keep invested his total assets as per provisions of Sec 27 or Sec
27A of the Insurance Act, 1938 as amended by the Insurance Laws (Amendment)
Act 2015 and in the same manner as set out in specific regulations framed by
the IRDAI. Importantly this unit only deals with regulatory aspects, while
investment accounting methods and process are discussed in the following unit
XVI. Though unit XVI is basically based on AS 13, which is not relevant for
insurance business, the accounting procedures are almost same for both
insurance business and non-insurance business. For general accounting of
investment, the students must have clear and complete understanding of
accounting methods for investment as discussed in unit XVI.

In exercise of the powers conferred by sections 27, 27A, 27B, 27C, 27D and 114A
of the Insurance Act, 1938, as amended by the Insurance Laws (Amendment) Act
2015 the Authority (IRDAI) in consultation with Insurance Advisory Committee,
makes these regulations on Investments of insurance companies. The
Regulations originally framed by the IRDAI is called the IRDAI (Investment)
Regulations 2000, which have been amended several times. The last amendment
was made into IRDAI (Investment) (Fifth Amendment) Regulations, 2013.
Presently, the IRDAI (Investment) regulations, 2016 was published on 1st Aug,
2016.

Here we will discuss only those regulatory aspects applicable to general

insurance business based on IRDAI (Investment) Regulations, 2016 with
reference to earlier regulations for this purpose. The said regulations provide
necessary directives norms, requirements for investments, manners of
investment, exposure/ prudential norms of investments, reporting
Requirements, Investment Policy etc.

1.2 Regulatory directives for investments by insurance companies

The following are the important regulatory directives/ norms for investments by
insurance companies:

1. Definition of Investment Assets

As per regulation “Investment Assets mean all investments made out of:

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i) In case of a General Insurer

a) Shareholders’ Funds representing solvency margin and policyholders’

funds at their carrying value as shown in its balance sheet drawn as per
the IRDAI (Preparation of Financial Statements and Auditors’ report of
Insurance Companies) Regulations.

2. Investments to be based on Credit Ratings

All investments in assets or instruments, which are capable of being rated as

per market practice, shall be made on the basis of credit rating of such assets
or instruments. No investments shall be made in instruments, if such
instruments are capable of being rated, but not rated.

3. Credit Rating Agencies

The rating should be carried out by a credit rating Agency registered under SEBI
(Credit Rating Agencies) Regulations1999. For example CRISIL (India) and ICRA
are well known rating agencies.

Following is the list of various ratings for long term instruments

Rating Explanations
AAA Highest Safety: Lowest Credit Risk
AA High Safety: Very Low Credit Risk
A Adequate Safety: Low Credit Risk
BBB Moderate Safety: Moderate Credit Risk
BB Moderate Risk of default relating to timely servicing of
financial obligations
B High Risk of default relating to timely servicing of financial
obligations
C Very High Risk of default relating to timely servicing of
financial obligation
D Default / expected to be in default soon

Rating Scale for short-term instruments: A1, A2, A3, A4 and D

4. Approved Investments

Corporate bonds or debentures rated not less than AA or its equivalent and PI or
equivalent ratings for short term bonds, debentures, certificate of deposits and
commercial paper, by a credit rating agency, registered under SEBI (Credit
Rating Agencies) Reg,1999 would be considered as ‘Approved Investments’.

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5. Rating of a Debt Instrument

The rating of a debt instrument issued by All India Financial Instruments

recognized as such by RBI shall be of ‘AA’ or equivalent rating. In case
investments of this grade are not available to meet the requirements of the
investing insurance company and the Investment Committee of the investing
insurance company is fully satisfied about the same, then for the reasons to be
recorded in the Investment Committee’s minutes, the Investment Committee
may approve investments in instruments carrying current rating of not less than
‘A+’ or equivalent as rated by a credit rating agency registered under SBI
(Credit Rating Agencies) Regulations 1999 and would be considered as
“Approved Instruments”

6. Automatic Reclassification as Other Investments

Approved investments which are downgraded below the minimum rating

prescribed should be automatically re-classified under ‘Other Investments’
category for purpose of pattern of investment.

7. Investment in Listed Equity Shares

Investments in equity shares listed on a recognized stock exchange should be

made in actively traded and liquid instruments viz equity shares other than
those defined as thinly traded as per SEBI Regulations and guidelines governing
mutual funds issued by SEBI from time to time.

8. Investment in Debt Instrument

a) Not less than 75% of investment in debt instruments (including Central

Govt. Securities, State Govt. Securities or Other Approved Securities) in
the case of life insurer and not less than 65% of investment in debt
instruments (including Central Govt. Securities, State Govt. Securities or
Other Approved Securities) in the case of general insurer – shall be in the
Sovereign debt, AAA or equivalent rating for long term and P1 (= A1) or
equivalent for short term instruments.

b) Not more than 5% of funds under Reg. 3(a) and Reg.3(c) in debt
instruments (including Central Govt. Securities, State Govt. Securities or
Other Approved Securities) in the case of life insurer and not more than
8% of investment in debt instruments (including Central Govt. Securities,
State Govt. Securities or other Approved Securities) in the case of
general insurer – shall have a rating of A or below or equivalent rating
for long term.

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 Note; Funds under Reg. 3(a) include all funds of Life insurance business
and one year Renewable pure Group Term Assurance Business and non-
unit reserves of all categories of Unit Linked life insurance business.
Funds under Reg. 3(c) include the unit reserves portion of all categories
of Unit linked funds.

9. Appropriate risk analysis and management

It is emphasized that rating should not replace appropriate risk analysis and
management on the part of the insurer. The insurer should conduct risk analysis
commensurate with complexity of the products and the materiality of their
holding or could also refrain from such investments.

Which among the following rating will have the lowest credit risk?

A B
B BB
C BBB
D AA

2. Understand the Manner of Investments by General Insurance

Companies
[Learning Outcome b]

Manner of Investments by General Insurance Companies

1) Investment assets mean all investments made out of shareholders’ funds

representing solvency margin and policyholders’ funds at their carrying
value as shown in its balance sheet drawn as per the IRDAI (Preparation of
Financial Statements and Auditors’ Report of Insurance Companies)
Regulations 2002.

2) As per Regulation 8 of the IRDAI (Investment) Regulations, 2016 every

insurer carrying on general insurance business shall invest and keep invested
his investment assets in the following manner

No Type of Investment Percentage of

investment assets
(i) Central Government Securities Not less than 20%
(ii) Central Govt. Securities, State Govt. securities Not less than 30%
or other approved securities {incl. (i) above}

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(iii) Approved investments as specified in Regulation Not exceeding 70%
3(a),(b) and Other Investments as specified in
Section 27A(2) and Schedule II to these
Regulations, (all taken together) subject to
Exposure / Prudential Norms as specified in
Regulation 9;
(iv) Other Investments as specified in Section
27A(2), subject to Exposure / Prudential Norms Not more than 15%
as specified in Regulations 9;

(v) Housing and Loans to State Govt. for Housing

and Fire Fighting equipment, by way of
subscription or purchase of:
A. Investment in Housing Total Investment in
1. Bonds / debentures of HUDCO, National housing and
Housing Bank infrastructure (i.e.)
2. Bonds/debentures of Housing Finance investment in
Companies either duly accredited by categories (i), (ii),
National Housing Banks for house building (iii) & (iv) above
activities or duly guaranteed by Government taken together shall
or carrying current rating of not less than not be less than 15%
‘AA’ by a credit rating agency registered of the Investment
under SEBI (Credit Rating Agencies) Assets
Reg,1999
3. Asset Backed Securities with underlying
housing loans, satisfying the norms specified
in the guidelines issued under these
regulations from time to time.

B. Investment in Infrastructure
(Subscription or purchase of Bonds /Debentures,
Equity and Asset Backed Securities with
underlying infrastructure assets would qualify
for the purpose of this requirement.
‘Infrastructure facility’ shall have the meaning
as given in regulation 2(h) as amended from
time to time.

Note : Investments made under category (i) and

(ii) above may be considered as investment in
housing or infrastructure, as the case may be,
provided the respective Government issues such
a security specifically to meet the needs of any
of the sectors specified as ‘Infrastructure
facility’
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1. Investment Regulations in Reinsurance Business

Every insurer carrying on reinsurance business shall invest and at all times keep
invested his investment assets in the same manner as set out in Regulation 8
above as applicable to a general insurance company.

2. Exposure / Prudential Norms for general insurance business

Regulation 9 of IRDAI (Investment) Regulations, 2016

Without prejudice to anything contained in Sections 10(2AA), 27, 27A, 27B and
27C of the Insurance Act, 1938 as amended by the Insurance Laws (Amendment)
Act 2015, every insurer shall limit his investments based on the following
exposure norms:

1. Exposure Norms for investment assets of General Insurance business, Re-

insurance Business, Health Insurance Business.

For both Approved Investments as per regulation 3(a), Schedule I and Schedule
II of these Regulations, and Other Investments as permitted under Sec. 27A(2)
shall be as under.

A) The maximum exposure limit for a single ‘investee’ company (equity, debt
and other investments taken together) from all investment assets under
point (A.1.a, A.1.b, A.1.c all taken together), (A.2),(A.3) and (A.4)
mentioned above, shall not exceed the lower of the following;

i) An amount of 10% of the investment assets as under Regulation 2 (i)(1),

Regulation 2(i)(2) excluding fair value change of investment assets under
regulation 4(a), 4(b) and Regulation 2(i)

ii) An aggregate of amount calculated under point (a) and (b) of the
prescribed table.

As per the IRDAI (Investment) Regulations 2016 every insurer carrying on general
insurance business shall invest in Central Government Securities ________.
A Not less than 10%
B Not less than 20%
C Not less than 30%
D Not more than 20%

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3. Learn about returns to be submitted by Insurer
[Learning Outcome c]

As per Reg. 9 of IRDAI (Investment) Regulations, 2016, every insurer shall submit
to the Authority the following returns (in physical/electronic mode) for every
quarter within 30 days of end of the quarter duly verified/ certified in the
manner as indicated there against.

Form Statement Verified/Certified by

Form 1 Investment and Income on Investment Principal Officer/Chief of
Investment/Chief of (Finance)
Form 2 Downgraded Investments, Details of Principal Officer/Chief of
(Part A, B, C) Rated Instruments Investment/Chief of (Finance)
Form 3B Investment Assets (General Insurers) Principal Officer/Chief of
(Part A, B) Investment/Chief of (Finance)
Form 4 Exposure/Prudential and other Principal Officer, Chief of
(Part A) Investment Norms – Compliance (Investments), Chief of
Certificate (Finance) Chief Risk Officer
Form 4 Internal/Concurrent Auditor's Certificate Internal/Concurrent Auditor
(Part B) on Investment Risk Management Systems appointed under this
-Implementation Status regulation
Form 4A Investment Subject to Exposure Norms – Principal Officer/Chief of
(Part A, B, Investee Company, Group, Promoter Investment/Chief of (Finance)
C,D) Group, Industry Sector
Form 5 Investment Reconciliation Principal Officer/Chief of
Investment/Chief of (Finance)
Form 6 Certificate under Sec 27A (5) Chairman, Director 1,
Director 2, Principal Officer
Form 7 Non-Performing Assets Principal Officer/Chief of
Investment/Chief of (Finance)

Note: All returns for the quarter ending March shall be filed within the period
stipulated above based on provisional figures and later re-submitted with
Audited figures within 15 days of adoption of accounts by the Board of
Directors.

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As per Regulation 9 of IRDAI (Investment) Regulations 2016, every insurer shall
submit a statement of Investment & Income on Investment in _______.
A Form 1
B Form 2
C Form 3
D Form 4

4. Know about the Provisions on Investment Management

[Learning Outcome d]

Provisions on Investment Management

A. Constitution of Investment Committee
The Investment Committee shall consist of a minimum of
 two non-executive directors,
 the Chief Executive Officer,
 Chief of Finance,
 Chief Risk Officer,
 Chief of Investment division,
 the Appointed Actuary.

Chief of Finance, Chief of Investment and the Chief Risk Officer, shall fulfil
the minimum qualification requirements specified in the
regulations/guidelines issued by the Authority.

B. Investment Policy
1. Every Insurer shall draw up, an Investment Policy (IP) and place the
same before its Board of Directors for its approval.
2. Every insurer shall have a model code of conduct to prevent
insider/personal trading of Officers involved in various levels of
Investment Operations in compliance with SEBI (Prohibition of Insider
Trading) Regulation, 1992 as amended from time to time and place
the same before its Board of Directors for its approval.
3. While framing the Investment Policy, the Board shall ensure
compliance with the following:
(i) Issues relating to liquidity, prudential norms, exposure limits,
stop loss limits including securities trading, management of all
investment risks, management of assets liabilities mismatch,
Scope of Internal or Concurrent audit of Investments, criteria
form empanelment and review of investment brokers,
330
 investment statistics and all other internal controls of
investment operations, the provisions of the Insurance Act, 1938
and IRDAI (Investment) Regulations, Guidelines and Circulars
made there under.
(ii) Ensuring adequate return on policyholders and shareholders'
funds consistent with the protection, safety and liquidity of such
fund(s).

4. The investment policy, as approved by the Board shall be

implemented by the investment committee. The Board shall review
on a quarterly basis the following minimum:

i. gross level of premium income projected vs actual along with

reasons for negative growth if any
ii. steps to correct the business achieved as planned in case of
under achievement of gross written premium
iii. underwriting results planned vs achieved along with reasons for
negative deviations
iv. claims outgo projected versus actual - major reasons for
increase/decrease in loss ratio and corrective steps planned for
future
v. expenses including acquisition cost planned vs actuals- in case of
excess over permitted limits, reasons for such excess along with
plan to comply limits
vi. overall incremental investments projected vs actual - reason for
deviation from the planned accretion and steps planned to
correct the trend if the same is negative.

5. The Board shall review the investment policy and its implementation on a half-
yearly basis or at such short intervals, keeping in mind protection of
policyholders' interest and pattern of investment.

6. In order to ensure proper internal control of investment functions and

operations the insurer shall segregate the functions and operations of front
office, mid office and back office.

As per Regulation 13 A of IRDAI (Investment) Regulations 2016, every insurer

shall constitute an Investment Committee. Suggest the minimum number of
non-executive directors required in the committee.
A One
B Two
C Three
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D Four

As per Regulation 13 A of IRDAI (Investment) Regulations 2016, the investment

policy of non-life insurers approved shall be implemented by the __________.
A Shareholders
B Board of Directors
C Investment Committee
D IRDAI

5. Learn about Approved Investments, Policyholders’ and

Shareholders’ Fund
[Learning Outcome e]

List of Approved Investments

Regulation 3 (a) throws light on this.
Approved Investments
Insurer shall invest any part of its Controlled Fund in any of the following
approved investments.
1. Debentures secured by a first charge on any immoveable property plant or
equipment of any company which has paid interest in full
2. Debentures secured by a first charge on any immovable property, plant or
equipment of any company where either the book value or the market value,
whichever is less, of such property, plant or equipment is more than three
times the value of such debentures
3. First debentures secured by a floating charge on all its assets of any
company which has paid dividends on its equity shares
4. Preference shares of any company which has paid dividends on its equity
shares for at least two consecutive years immediately preceding
5. Equity shares of any listed company on which not less than ten percent
dividends have been paid for at least two consecutive years immediately
preceding
6. Immovable property situated in India, provided that the property is free of
all encumbrances;
7. Loans on policies of life insurance within their surrender values issued by
him or by an insurer whose business he has acquired and in respect of which
business he has assumed liability;
8. Fixed Deposits with banks included for the time being in the Second
Schedule to the Reserve Bank of India Act, 1934 (2 of 1934)
9. Such other investments as may be notified by the Authority.
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The following investments shall be deemed as Approved Investments
1. All rated debentures (including bonds) and other rated & secured debt
instruments as notified
2. Bonds or debentures issued by companies, rated not less than AA or its
equivalent and A1 or equivalent ratings for short term bonds, debentures,
certificate of deposits and commercial papers by a credit rating agency,
registered under SEBI (Credit Rating Agencies) Regulations 1999
3. Collateralized Borrowing & Lending Obligations (CBLO) created by the
Clearing Corporation of India Ltd and recognized by the Reserve Bank of India
and exposure to Gilt, G Sec and liquid mutual fund forming part of Approved
Investments as per Mutual Fund Guidelines issued under these regulations and
money market instrument / investment.
5. Asset Backed Securities with underlying Housing loans or having
infrastructure assets as underlying as defined under ‘infrastructure facility’ in
Regulation 2 (h) as amended from time to time.
6. Commercial papers issued by All India Financial Institutions recognized as
such by Reserve Bank of India having a credit rating of A1 by a credit rating
agency registered under SEBI (Credit Rating Agencies) Regulations 1999
7. Money Market instruments as defined in Regulation 2(j) of this Regulation,
subject to provisions of approved investments.
No investment shall be made in any entity not formed under laws relating to
companies in India and in any private limited company or one person company
or a company formed under section 8 of the Companies Act, 2013 or erstwhile
Section 25 of the Companies Act, 1956.

Policyholders' Funds:
Policyholders funds shall be the sum of
 Estimated liability for Outstanding Claims including Incurred but not
Reported (IBNR) & Incurred but not Enough Reported (IBNER)
 Unearned premium Reserve (UPR)
 Catastrophe Reserve
 Premium Deficiency Reserve
 Other liabilities net off Other Assets

Other Liabilities comprise of

 Premium received in advance
 Unallocated premium
 Balance due to other Insurance Companies
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  Due to others members of Third Party Pool (IMTPIP)
 Sundry creditors (due to Policyholders).

Other Assets comprise of

 Outstanding premium
 Due from other Insurance companies including Re-insurers
 Balance with terrorism pool (if applicable)
 Balance with Motor Third Party Pool if any (if applicable)

Shareholders' Funds
Shareholders' funds comprise of
 Share Capital
 All Reserves and Surplus
 except Revaluation Reserve and fair value change account as at the
Balance Sheet date, represented by investments of funds held in
business beyond solvency margin.
D) Applicability of Pattern of Investment
Where an Insurer, hold the entire investment assets, as per Regulation
2 (i) for and behalf of the Policyholders, the pattern of investment shall
apply to the entire investment assets (both shareholder and policyholders
funds taken together) and the investment assets can be maintained in a
single custody account.

E) Miscellaneous
The mandatory minimum investment in Housing and Infrastructure as per
Regulation 8, will not apply for Health Insurers.

6. Know about dealing in Financial Derivatives

[Learning Outcome f]

Dealing in Financial Derivatives

As per Reg 15, every insurer carrying on the business of life insurance or general
insurance may deal in financial derivatives only to the extent permitted and in
accordance with the guidelines issued by the Authority in this regard from time
to time.

334
 Policyholders funds shall compise
i) Estimated liability for Outstanding Claims including Incurred but not
Reported (IBNR) & Incurred but not Enough Reported (IBNER)
ii) Unearned premium Reserve (UPR)
iii) Catastrophe Reserve
iv) Premium Deficiency Reserve
v) Other liabilities net off Other Assets

A i, ii
B i, iii
C ii, iii,iv,v
D All 5

Summary
 Every insurer carrying on insurance or reinsurance business in India shall
invest and at all times keep invested his total assets as per provisions of Sec
27 or Sec 27A of the Insurance Act, 1938 as amended by the Insurance Laws
(Amendment) Act 2015 and in the same manner as set out in specific
regulations framed by the IRDAI.

 Investment Assets in case of a General Insurer includes shareholders’ funds

representing solvency margin and policyholders’ funds at their carrying
value as shown in its balance sheet drawn as per the IRDAI (Preparation of
Financial Statements and Auditors’ report of Insurance Companies)
Regulations 2002, but excluding items under Misc. Expenditure.

 General Insurers can make investments on such assets that can be being
rated as per market practice. Investments can be made on the basis of
credit rating of such assets or instruments. No investments shall be made in
instruments, if such instruments are capable of being rated, but not rated.

 The rating should be carried out by a credit rating Agency registered under
SEBI (Credit Rating Agencies) Regulations1999.

 For investment in corporate bonds or debentures rating with not less than
AA or its equivalent and PI or equivalent ratings for short term bonds,
debentures, certificate of deposits and commercial paper, by a credit rating
agency, registered under SEBI (Credit Rating Agencies) Reg,1999 would be
considered as ‘Approved Investments’.

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 Investments by General Insurance companies can be made in only such debt
instruments for which the rating is issued by All India Financial Instruments
recognized as such by RBI and is of ‘AA’ or equivalent rating.

 For General Insurance companies investment assets mean all investments

made out of shareholders’ funds representing solvency margin and
policyholders’ funds at their carrying value as shown in its balance sheet
drawn as per the IRDAI (Preparation of Financial Statements and Auditors’
Report of Insurance Companies) Regulations 2002.

 Regulation13 (A) provides for Constitution of Investment Committee and its

Role, which states that every insurer shall constitute an Investment
Committee which shall consist of a minimum of two non-executive directors,
the CEO, Chief of Finance, Chief of Investment Division and the Appointed
Actuary.

 As per Regulation on investment policy, every insurer shall draw up an

Investment Policy (fund wise IP in case of Unit Linked Insurance Business)
and place the same before its Board of Directors for its approval and its
annual review.

 As per Schedule II of the IRDAI (Investment) all investments specified in

section 27B of the Act will be considered as Approved Investments for
general insurance business except:
i. Securities of or guaranteed as to the principle and interest by the
Government of the UK in another country as stated in Section 27B (1)(b).
ii. Immovable property situated in another country as mentioned in
27A(1)(n)
iii. First mortgage on immovable property situated in another country as
stated in 27A(1)(i)

 As per Regulation on investment policy, every insurer shall have a model

code of conduct to prevent insider trading / personal trading of officers
involved in various levels of investment operations in compliance with SEBI
(Prohibition of Insider Trading) Regulations 1992 as amended from time to
time and place the same before its Board of Directors for approval.

 As per Regulation 15 on Financial Derivatives every insurer carrying on the

business of life insurance or general insurance may deal in financial
derivatives only to the extent permitted and in accordance with the
guidelines issued by the Authority in this regard from time to time

336
Answers to Test Yourself

Answer to TY 1
The correct option is D. The highest credit rating will have a lowest credit risk.

Answer to TY 2
The correct option is B. As per the IRDAI (Investment) Regulations 2016 every
insurer carrying on general insurance business shall invest in Central
Government Securities not less than 20%.

Answer to TY 3
The correct option is A. As per Regulation 9 of IRDAI (Investment) Regulations
2016, every insurer shall submit a statement of Investment & Income on
Investment in Form 1.

Answer to TY 4
The correct option is B. The minimum number of non-executive directors
required in the committee should be two.

Answer to TY 5
The correct option is C. As per Regulation 13 A of IRDAI (Investment)
Regulations 2016, the investment policy of both life and non-life insurers
approved shall be implemented by the Investment Committte.

Answer to TY 6
The correct option is D.

Self-examination Questions

Question 1
Which of the following forms need to be submitted quarterly by the insurer
company to the Authority?

(i) Statement of Investment & Income on Investment

(ii) Statement of Downgraded investments, details of Rated Investments
(iii) Statement of Non-performing assets
A Only (i)
B Only (ii)
C Only (iii)
D (i), (ii) and (iii)

337
Question 2
As per Regulation 9 of IRDAI (Investment) Regulations 2016, every insurer shall
submit a statement of Investment & Income on Investment on a ________ basis.
A Monthly
B Quarterly
C Half yearly
D Yearly

Question 3
As per Regulation 13 A of IRDAI (Investment) Regulations 2016, every insurer
shall constitute an Investment Committee. Which among the following are
eligible for membership of this committee?
(i) Chief of investment division
(ii) Chief of finance
(iii) Directors of company
A Only (i)
B Only (ii)
C Only (iii)
D (i), (ii) and (iii)

Question 4
As per the IRDAI (Investment) Regulations 2016 every insurer carrying on general
insurance business shall invest in Central Government Securities, State
Government Securities or other approved securities ________.
A Not less than 10%
B Not less than 20%
C Not less than 30%
D Not more than 20%

Question 5
As per Regulation 13 A of IRDAI (Investment) Regulations 2016, every Insurer
shall draw up, annually an investment policy and place the same before the
________.
A Shareholders
B Board of Directors
C Investment Committee
D IRDAI

338
Answers to Self-examination Questions

Answer to SEQ 1
The correct option is D. All of the statements need to be submitted on a
quarterly basis.

Answer to SEQ 2
The correct option is B. As per Regulation 9 of IRDAI (Investment) Regulations
2016, every insurer shall submit a statement of Investment & Income on
Investment on a quarterly basis.

Answer to SEQ 3
The correct option is D. All of the above are eligible for membership of
Investment committee.

Answer to SEQ 4
The correct option is C. As per the IRDAI (Investment) Regulations 2016 every
insurer carrying on general insurance business shall invest in Central
Government Securities, State Government Securities or other approved
securities not less than 30%.

Answer to SEQ 5
The correct option is B. As per Regulation 13 A of IRDAI (Investment)
Regulations 2016, every Insurer shall draw up, annually an investment policy
and place the same before the Board of Directors

339
 CHAPTER 4
ACCOUNTING METHODS AND PROCESS OF SPECIAL
ACCOUNTING TRANSACTIONS

UNIT-15
INVESTMENT ACCOUNTING
Chapter Introduction

Accounting for investments in insurance business is governed by two Regulations –

one is IRDA (Investment) Regulations, 2016 and the other is IRDA (Preparation of
Financial Statements and Auditor’s Report of Insurance Companies) Regulations,
2002. Investment Accounting in other companies is governed by Accounting
Standard (AS)-13. Though AS13 is not applicable to insurance business, for better
understanding of investment accounting, the students must have knowledge in
respect of general accounting treatment of investment governed by AS 13, in
addition to thorough knowledge of the regulatory aspects for investment process
and accounting principles applicable to insurance companies.

The Regulatory requirements for investment functions and accounting thereof are
discussed separately in unit 14. This unit deals with general investment
accounting with reference to the requirements of AS 13.

a) Briefly explain classification of investments.

b) Explain how accounting of investments is done according to AS 13
Guidelines.
c) Show the preparation of investment account.

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1. Briefly explain classification of investments.
[Learning Outcome a]

As per AS 13, investments are assets are held by an enterprise for earning income
by way of dividends, interest and rentals, for capital appreciation, or for other
benefits to the investing enterprise.

1.1 Classification of Investments and Valuation thereof

As per AS-13, investments may be either current Investments or long-term

Investments.

1. Current investments

Current investment is an investment which by its nature is readily realisable and

intended to be held for not more than one year from the date when such
investment is made.

These investments shall be carried in the financial statements at the lower of

cost and fair value. Market Value or Net Realisable Value (NRV) provides the
base for fair value.

Fair value is the amount for which an asset could be exchanged between a
knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s
length transaction. Under appropriate circumstances, market value or net
realisable value provides an evidence of fair value.

Market value is the amount obtainable from the sale of investments in an open
market, net of expenses.

2. Long-term Investments
These are investments other than current investments. Long-term Investments
are held for more than one year from the date of their acquisition.
These are always valued at cost. However, if there is a decline of permanent
nature in the value of long-term investments, their carrying amount is to be
reduced to the declined value.
The carrying amount of long-term investments is always determined on an
individual basis, with reference to their market value, underlying assets of the
investee, and expected cash-flows from investments.

341
Any reduction in the carrying amount of investment is charged or debited to
Profit and Loss Account. Similarly, reversal of such reductions is credited to Profit
and Loss Account.

Investment valuation vis-à-vis determination of fair market value largely depends

on restrictions on distribution of income or disposable of investments.

Classification of investments:

Short term (Current) investments Long term investments

Readily realizable and intended to Held for more than 1 year from the
be held for more than 1 year date of acquisition
Carried in the financial statements Always valued at cost
at lower of ‘Cost’ or ‘Fair value’

2. Explain how accounting of investments is done according to AS 13

Guidelines.
[Learning Outcome b]

Investments are either current investments or long-term investments. Long-

term investments may also include investment in property.

AS 13 provides the following guidelines in regard to investment accounting:

1. An enterprise shall disclose current investments and long-term investments

distinctly in the financial statements.

2. Further classification of current and long-term investments should be as per

norms specified in the statute or regulations as applicable to the enterprise.
In the absence of statutory or regulatory requirements, the investments
shall be further classified as:

a) Investments in Govt. or Trust Securities

b) Shares, Debentures and Bonds
c) Investment Property
d) Others-Specifying nature

3. Cost of an investment shall include acquisition charges such as brokerage,

fees and duties.

Ishan Industries sought the advice of an Investment Advisor for investment of its
surplus funds worth Rs. 25,00,000. He advised investing in the shares of
342
Supreme Ltd and charged fees worth Rs. 8,000. Accordingly, Ishan Industries
invested in the 20,000 shares at the rate of Rs. 120 each and paid brokerage 2%.

The cost of acquisition will be calculated as follows:

Rs.
Prime Cost of shares (20,000 shares x Rs. 120) 24,00,000
Add: 2% brokerage (2% of Rs. 24,00,000) 48,000
Total Cost of shares 24,48,000
Add: Investment Advisor’s fees 8,000
Total cost of acquisition / cost of investment 24,56,000
If an investment is acquired by the issue of shares or other securities, the
acquisition costs shall be fair value of the securities. Again, acquisition cost
varies with the mode of acquisition of investment, for example, investment can
be acquired either through IPO or private placements, or through exchange.

When the investment or the shares are acquired through IPO (fresh issue of share
by the company), the acquisition cost will be the fair value of the securities,
which is equivalent to issue price as indicated or specified by the authority or
issuer.

Market forces do not have any impact on the fair value of the securities acquired
by the IPO. However, when the shares are acquired in the secondary market, the
fair value of securities is decided by the exchange rate.

A separate investment account is made for each scrip purchased to determine the
profit and loss on that particular scrip.

4. Investment in properties shall be accounted for as Long-term Investment.

5. Current Investments shall be carried in the financial statements at cost.

However, provision for diminution shall be made to recognise decline, if not
temporary.

Investment in properties shall be accounted for as _______________.

A Current investment
B Short-term investment
C Long-term investment
D Either current investment or long-term investment

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Which of the following statements are correct with regard to guidelines issued
by AS 13 ?

A An enterprise shall disclose current investments and long-term investments

jointly in the financial statements
B Cost of an investment does not include acquisition charges such as
brokerage, fees and duties
C Any reduction in the carrying amount of investments or any reversal thereof
should be charged or credited to Profit and Loss Account
D Long-term Investments shall be carried in the financial statements at cost

3. Show the preparation of investment account.

[Learning Outcome c]
Investment Accounting is done through maintaining a separate Investment
Account for each scrip purchased for holding and sale as trading.

The scrips purchased are divided into two classes:

1. Fixed- Income Bearing Securities (Scrips) and
2. Variable Income Bearing Securities (Scrips)

1. Fixed- Income Bearing Securities

Such securities are Govt. securities, bonds, foreign govt. securities, debentures
etc. In this type of scrip, the interest accrued from the date of the last payment
to the date of the transaction is calculated.

2. Variable income bearing securities

These investments are also known as marketable investments. They include

investment in equity shares of a company.

3.1 Investment Account

The investment account shows three components –Nominal Value, Capital or

Cost and Income on investment which are shown in three columns, Nominal
Column, Capital / Cost Column and Interest / Income Column in the Investment
Account.

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Nominal for recording the nominal value of investments
purchased, sold, bonus etc.
Cost/Capital for recording the costs of acquisition or purchase of
investments and sale proceeds of the investments sold
and the profit or loss on sale of investments.
Income / Interest for recording the interest paid at the time of purchase
(Ex-interest / Cum-interest), Interest or Income received
or receivable on investments.

Format of investment account

Investment Account for the period from _ _ _ _ _ _ _ to _ _ _ _ _ _ _

Security _ _ _ _ _ _ _ _ _ _ _ Interest due date/s _ _ _ _ _ _ _ _ _

Face value Rs. _ _ _ _ _ _ _ _

Dr Cr
Interest
Nominal
Cost / / Nominal Cost / Interest /
/
Capital / Income / Face Capital / Income /
Date Particulars Face Date Particulars
Principal / value Principal Revenue
value
Rs. Revenue Rs. Rs. Rs.
Rs.
Rs.
To Balance … … … By Bank … …
b/d sale /
interest
A/c
To Bank … … By Interest …
purchases accrued on
A/c investment
A/c
To Profit … … … By Balance … … …
and loss c/d
A/c
Total … … … Total … … …

3.2 Other aspects, terms and procedures followed in the preparation of

investment account are discussed below in brief:

1. Opening balance
The investments in hand at the beginning of the year are to be shown as opening
balance on the debit side with Nominal value in the Nominal column and cost in
the cost column. Accrued interest, if any, up to the last closing date is to be
brought down in the Income Column.

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The accrued interest arises only when the closing date does not coincide with the
date of payment of interest and such accrued interest is calculated on the closing
balance of the investment of the last period.

2. Cum-interest Purchase

Here, the price paid for acquisition includes the accrued interest on the
securities purchased for the period commencing from the last date of payment of
interest to the date of the transaction. So the investor is required to find out the
cost of investment and accrued interest due thereupon.

The transaction is to be recorded on the debit side with nominal value in the
Nominal column, accrued interest in the Income column and the cost in the Cost
column.

Journal entries

1. Investment A/c Dr (Quoted price – accrued interest)

Interest on investments A/c Dr (Accrued interest)
To Bank A/c (Quoted price)
(Being purchase cum-interest)

2. Bank A/c Dr
To Interest on investments
(Being first interest received
after purchase)

3. Ex-interest Purchase

In case of transaction on “Ex-interest basis” the amount of interest accrued till

the date of transaction has to be paid in addition to the price of the security. In
the Investment Account, the amount of accrued interest from the date of the last
payment to the date of sale is credited in the Income Column.

Brokerage and expenses are to be added to the price to ascertain the cost. The
nominal value is to be debited in the Nominal value column and the cost is to be
debited in the Cost column. Simultaneously, for the interest from the date of
transaction to the next date of payment of interest less tax (if any), a contra
entry is to be passed (to capitalise the interest forgone) by debiting the cost
column and crediting the Income column.

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Journal entries

1. Investment A/c Dr (Quoted price)

Interest on Investment A/c Dr (Accrued interest)
To Bank A/c (Quoted price + Accrued
(Being purchase ex-interest) interest)

2. Bank A/c Dr
To Interest on Investment
(Being
A/c first interest received
on due date after purchase)

4. Cum-interest sale

Brokerage and expenses are to be first deducted from the price, then the
accrued interest from the last date of payment to the date of transaction less tax
(if any) will have to be deducted to ascertain the cost (i.e., capital income). The
nominal value and the cost are to be credited to the Nominal value column and
Cost column respectively, while the accrued interest less tax (if any) is to be
credited to the Income column.

Journal entry

1. Bank A/c Dr (Quoted price)

To Investment A/c (Quoted price – accrued
interest)
To Interest (Accrued interest)
(Being sale of investment)

5. Ex-interest sale

Brokerage and expenses are to be deducted from the price to find out the cost or
capital income. The Nominal value and the capital income are to be credited to
the Nominal value column and cost column respectively.

The interest on investment from the date of transaction to the next date of
payment of interest less tax (if any) is to be treated as the capital income of the
seller and hence, a contra entry is to be passed simultaneously, debiting the
Income column and crediting the cost column.

Disposal of Investments: in case the transaction is on ex-interest basis, the

entire sale proceeds are credited in the capital column and the amount of
accrued interest to the date of sale will be taken to the credit side in the income
column.

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Journal entries

1. Bank A/c Dr (Quoted price + Accrued

interest)
To Investment A/c (Quoted price)
To Interest on Investment (Accrued interest)
A/c
(Being sale of investments ex-
interest)

Profit on sale of investments

Investment A/c Dr
To profit on sale of (Ex-interest price (net) – Cost
investments price)
(Being profit on sale of
investments)

Loss on sale of investments

Loss on sale of investment A/c Dr (Cost price – Ex-interest price
(net))
To Investment A/c
(Being loss on sale of
investments)

6. Interest received

Whenever any interest is received less tax (if any), it has to be credited to the
Income Column.

While calculating the amount of interest, it must be seen that interest in respect
of ex- interest purchase before this interest-date but after the previous interest-
date shall not be received, while interest on ex- interest sale before this interest-
date but after the previous interest-date shall be received.

7. Accrued interest on the closing date

When the date of interest does not coincide with the closing date, the question of
accrued interest arises.

Suppose the last date of interest was 31st October while the closing date is 31st
December. Interest on the closing balance of investment for November and
December less tax (if any) is the accrued interest on the closing date. This has to
be credited to the Income column on the closing date and brought down to the
next period in the debit side of the Income column.
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8. Closing of Investment Transactions

a) After recording the various transactions as mentioned above, the closing

balance of the investment is to be valued.

b) The value of the closing balance is to be credited to the investment ledger

with nominal value and cost in the respective columns and these are to be
brought down at the beginning of the next period.

c) The Nominal value columns on both the sides will not agree; the difference
in the total of income columns (always credit balance) represents revenue
income to be transferred to the general Interest A/c or to the Profit and
Loss A/c.

d) Difference between the totals of the Cost columns represents profit or loss
on sale of investment (Dr Balance is loss and Cr balance is profit) to be
transferred to Profit and Loss A/c.

e) In the above discussion, we have mentioned that the closing balance of the
investment is to be valued.

The valuation may be done on any of the following principles:

 At specific cost where the closing balance represents a specific
purchased investments.
 At specific cost on the basis of FIFO i.e., investments purchased first are
sold first.
 On average cost.
Ex-interest price and cum-interest price

While closing the investment account, what does the difference in the cost
column represent?
349
A Revenue income
B Profit or loss on sale of investment
C Balance of the Investment A/c
D None of the above

3.3 Investment in shares and Certain Transactions

1. Bonus shares received

Sometimes an investor in shares of a company receives bonus shares from the

company on the basis of his holding. Since bonus shares cost nothing to the
investor, the nominal value of such shares will have to be debited to the
Nominal value column and nothing will be debited to the Cost column.

The effect of the bonus shares received will be the reduction in the value of the
closing balance of investment.

If a company has 10,000 equity shares each of Rs. 125 (i.e. Rs. 12,50,000) and it
receives bonus shares of 2,000, the closing balance of the investment would be
12,000 equity shares worth Rs. 12,50,000 only.

2. ‘Right shares’ purchased

Sometimes the investor (investing in shares) enjoys the right of purchasing some
new shares of the company through letters of right. He has an option to exercise
or not to exercise the right.

If he exercises the right, i.e. if he purchases some or all of the shares offered,
the total nominal value of the shares purchased will be debited to the Nominal
value column at the time of allotment while the cost is debited to the Cost
column as and when paid by instalment.

3. Surrender and acquisition of ‘Right’ to/from third parties

350
Sometimes the investor (in shares of a company), on receiving the letters of right,
sells some or all of the rights to a third party, who can, on authority of such
letters of right, purchase the shares offered by the company. Such transfer is a
capital income on the part of the investor and hence it has to be credited to the
cost column of his investment ledger. If, however, the investor purchases similar
rights from third parties, the price paid has to be capitalised by debiting the cost
column of the Investment ledger.

Investment in Equity Shares

On 1 April 2019, M/s. X Ltd purchased 10,000 equity shares of face- value of
Rs.100 each in ABC Ltd @ Rs.110 each from a broker who charged 2% brokerage.
72 paise per Rs.100 as cost of share transfer stamps was incurred. On 31
December 2019, Bonus was declared in the ratio of 2:1. On 31 March 2020, M/s.
X Ltd sold the bonus shares @ Rs. 90 per share to a broker, who charged 2%
brokerage.
In The Books of M/S. X Ltd

Investment in Equity Shares in ABC Ltd A/c

Dr Cr
Date Particula No. of Nominal Cost Date Particula No. of Nominal Cost
rs shares Rs. Rs. rs shares Rs. Rs.
01.04.2019 To Bank 10,000 10,00,000 11,29,920 31.3.2020 By Bank 5,000 5,00,000 4,41,000
31.12.2019 To Bonus 5,000 5,00,000 31.3.2020 By Bal 10,000 10,00,000 7,53,280
Shares c/d
31.3.2020 To P&L 64,360
A/c
15,000 15,00,000 11,94,280 15,000 15,00,000 11,94,280

Workings

W1Cost of Acquisition of Shares

Nominal Value 110.00 11,00,000
Brokerage 2% 2.20 22,000
Stamp Duty ( 0.72% of Rs. 110) 0.792 7,920
Cost of 10,000 equity shares 11,29,920

Note: Brokerage and stamp duty should be calculated on the nominal value / face
value of the investment.
W2 Sale Proceeds of Bonus Shares

Rs.
Unit Price 90.00
Less: Brokerage @2% (deducted on sale) 1.80
88.20
Total Sales Price ( 5,000 bonus shares x Rs. 88.20) 4,41,000

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W3 Calculation of Profit on Sale of Bonus Shares

Rs.
Sales Proceeds 4,41,000
Less: Cost of Sales(11,29,920/ 15,000 x 5,000) 3,76,640
Profit on Sale 64,360

W3 Valuation of Closing Stock i.e. 10,000 Equity Shares on 31.03.2020

= Rs. 11,29,920/15,000 shares x 10,000 shares = Rs. 7,53,280

Purchase and Sale of Debentures

On 1.4.2019, 9% 1,500 Debentures of Rs 100 each in P and Y Ltd were held as

investment by XYZ Ltd at the cost of Rs 1,60,000. Interest is payable on 30th
Sep and 31st March. On 1.8.2019, Debentures of Rs 60,000 were purchased for Rs
52,000 Ex-Interest and Rs 30,000 at Rs 30,600 Ex-Interest on 1.1.2020. On
1.3.2020, Debentures for Rs 20,000 were sold for Rs 20,300 ex-interest.

Show the Investment Account in the books of XYZ Ltd assuming that Accounts
are closed on 31st March 2020 every year.

Solution
Investment in Debentures of Rs100 each in P and Y Ltd A/c

Dr Cr
Date Particulars Nominal Capital Interest Date Particulars Nominal Capital Interest
1.4.2019 To Balance 1,50,000 1,60,000
30.9.2019 By Bank 6,750
1.8.2019 To Interest 900 1.8.2019 By Interest 900
(C) (C)
1.8.2019 To Bank 60,000 52,000
1.1.2020 To Interest 675 1.1.2020 By Interest 675
(C) (C)
1.1.2020 To Bank 30,000 30,600 1.3.2020 By Bank Sale 20,000 20,300
1.3.2020 To Capital 150 1.3.2020 By Interest 150
(C)
31.3.2020 By Bank 9,450
Interest-
6mths
31.3.2020 To Profit 150 31.3.2020 By Balance 2,20,000 2,23,875
on Sale of c/d
Deb (Profit
and Loss)
To Profit 17,625
and Loss
2,40,000 2,44,325 17,775 2,40,000 2,44,325 17,775

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Workings

W1 1-8-2019 Ex-Interest Purchase for Rs. 60,000

Additional Cost being 9% interest on Rs.60,000 for 2 months (1.8.19 to 30.9.19)
= 60,000* (9/100) * (2/12) = 900 debited to Capital column and credited to
Interest Column by Contra Entry for Rs. 900.

W2 30.9.19 Half-yearly Interest

9% on Rs. 1,50,000 * (9/100)* (6/12) = Rs. 6,750
No Interest on Ex-Interest purchase of Rs. 6,000 on 1.8.19 will be received

W3 1-1-20; Ex-Interest Purchase for Rs. 30,000 (nominal)

Additional Cost being interest on Rs 30,000 for two months (1.1.20 to 31.3.20) =
30,000 * (9/100) * (2/12) = 675 debited to Capital column and credited to
Interest Column by Contra Entry for Rs 675

W4 1.3.20; Sale of Rs.20,000 - Debentures for Rs. 20,300 Ex-interest

Additional proceeds for interest for 1month = 20,000*(9/100)*(1/12)= Rs 150

W5 31.3.20; Half-yearly Interest: 9% on Rs 2,10,000 (1,50,000 +60,000)=

2,10,000*(9/100)*(6/12) = Rs 9,450

No Interest on Ex-Interest purchase of Rs 20,000 on 31.3.20 will be received.

Interest on Rs 20,000 Debentures sold on 1.3.20 included in Interest on Rs
2,10,000

W6 Valuation of closing Stock

Cost of Rs 2,20,000 Debentures (1,50,000+60,000+30,000-20,000) is Rs 2,23,875
(balance figure).

Investment in Equity Shares

On 1.4.20, XYZ Ltd were holding 10,000 equity shares of Rs 100 each in M/s ABC
Ltd with acquisition cost of Rs 12,50,000. On 15.8.20 M/s ABC Ltd made a Bonus
issue of 1 fully paid share for every 2 held on 15.8.20. In addition, on the same
day, it declared a Right Issue of 3 for every 5 held on that date at a premium of
Rs 30; Rs70 to be paid on application and the balance in one call after a month.
Rights were exercised for 2,000 shares. The balance shares were sold on 25-8-20
@ Rs 20 per share. The shares were not eligible for dividend for the year ended
31st March 2020. M/s ABC Ltd declared dividend on 15.01.2021 @20% for the
year ended 31st March 2020.
Prepare the Investment Account in the books of XYZ Ltd

353
Solution
In the books of XYZ Ltd
Investment Account –Equity Shares of M/s ABC Ltd

Dr Cr
Date Particulars Nominal Capital Income Date Particulars Nominal Capital Income
01.04.2020 To Balance 10,00,000 12,50,000 25.08.2020 By Bank –Sale 80,000
b/d of Rights
(4000 @20)
15.08.2020 To Bonus 5,00,000 15.01.2021 By Bank – 2,00,000
Share Dividend 20%
on
Rs10,00,000
15.08.2020 To Bank 2,00,000 1,40,000 31.03.2021 By Balance 14,00,000 14,30,000
Right issue c/d
Appl Money
@70-
2,000shares
15.09.2020 To Bank 1,20,000
Right issue
- Call
Money @60
15.09.2020 To P&L A/c 2,00,000
Investment
income

17,00,000 15,10,000 2,00,000 17,00,000 15,10,000 2,00,000

Workings

Total Rights: 10,000 x 3/5 6,000 shares

Rights Exercised 2,000 shares
Right Sold 4,000 shares

Summary
 Investments may be classified as either current Investments or long-term
Investments in accordance with AS 13.
 Valuation
 Current investments: lower of cost or fair value / NRV
 Long-term investments: at cost
 Any dividend received out of pre-acquisition profit is credited to Investment
A/c in the “cost column” only. However, dividend received out of post-
acquisition profit is credited to the “income column”.
 On disposal of investment, the difference between the carrying amount and
the net disposal proceeds should be charged or credited to the profit and
loss A/c.
 When rights shares offered are subscribed for, the cost of right shares is
added to the carrying amount of the original holding.

354
 Where an investment is acquired by way of issue of bonus shares, no amount
is entered in the capital column of investment account since the investor
does not have to pay anything.

Answers to Test Yourself

Answer to TY 1
The correct option is C. Investment in properties shall be accounted for as Long-
term Investment.

Answer to TY 2
The correct option is C. Option A is incorrect because an enterprise shall
disclose current investments and long-term investments separately in the
financial statements. Option B is incorrect because cost of an investment shall
include acquisition charges such as brokerage, fees and duties. Option D is
incorrect because Current Investments shall be carried in the financial
statements at cost.

Answer to TY 3
The correct option is B. Difference between the totals of the Cost columns
represents profit or loss on sale of investment (Dr Balance is loss and Cr balance
is profit) to be transferred to Profit and Loss A/C.

Self-Examination Questions

Question 1
When dividends declared on equity are declared from pre-acquisition profits,
such dividends shall be ___________.
A Debited to Profit and Loss A/c
B Debited to Investment A/c
C Credited to Profit and Loss A/c
D Credited to Investment A/c

Question 2
Profit on disposal of investment is:
A Credited to Investment A/c
B Credited to Revaluation Reserve
C Credited to Investment Fluctuation Fund
D Credited to Profit and Loss A/c

Question 3
Dividend received from pre-acquisition profit will _______ the average cost of
shares, and dividend received from post-acquisition profit will _______ the
income.
A Increase, reduce
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B Reduce, increase
C Reduce, reduce
D Increase, increase

Question 4
Mr. Shah purchased 500 equity shares of Rs. 100 each in Parekh Ltd for Rs.
62,500, inclusive of brokerage and stamp duty. At the end of 6 years, the
company decided to capitalise its profits and to issue to the shareholders of
equity shares, one equity bonus share for every share held by them. Prior to
capitalisation, the shares of Parekh Ltd. were quoted at Rs. 180 per share. After
the capitalisation, the shares were quoted at Rs. 92.50 per share. Mr. Shah sold
the bonus shares and received Rs. 90 per share.

What will be the cost of the closing investment (on average cost basis)?
A Rs. 46,250
B Rs. 50,000
C Rs. 31,250
D Rs. 45,000

Question 5
On 1.4.2020, Ms. Kavita Puri purchased 1,000 equity shares of Rs. 100 each in
Tibco Ltd @ Rs. 120 each from a Broker, who charged 2% brokerage. She
incurred 50 paise per Rs. 100 as cost of share transfer stamps.

On 31.1.2021, Bonus was declared in the ratio of 1 : 2. Before and after the
record date of bonus shares, the shares were quoted at Rs. 175 per share and
Rs. 90 per share respectively. On 31.3.2021, Ms. Kavita Puri sold bonus shares to
a Broker, who charged 2% brokerage. Ms. Kavita Puri held the shares as Current
assets, and the closing value of investments shall be calculated at Cost or
Market value whichever is lower.

What will be the amount transferred to the Profit and Loss A/c?
A Rs. 3,100
B Rs. 11,100
C Rs. 4,000
D Rs. 900

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is D. When dividends declared on equity are declared from
pre-acquisition profits, such dividends shall be credited to the investment
account, in the capital column.

Answer to SEQ 2
356
The correct option is D. Profit on disposal of investment is credited to Profit and
Loss A/c.

Answer to SEQ 3
The correct option is B. Dividend received from pre-acquisition profit will
reduce the average cost of shares, and dividend received from post-acquisition
profit will increase the income.

Answer to SEQ 4
The correct option is C.
Investment A/c
Dr Cr
Particulars Nominal Cost Particulars Nominal Cost
To Bank 50,000 62,500 By Bank @ 90 50,000 45,000
To Bonus shares 50,000 By Balance c/d 50,000 31,250
To Profit and 13,750
Loss A/c
1,00,000 76,250 1,00,000 76,250

The total cost of 1,000 equity shares (including 500 bonus shares) is Rs. 62,500
Total cost of closing investment: 500 equity shares = Rs. 31,250
Market price of closing investment: 500 equity shares x 92.50 = Rs. 46,250
Cost being lower than the market price, shares are carried forward at cost.

Answer to SEQ 5
The correct option is A.

Date Particulars Nominal Cost Date Particulars Nominal Cost

1 Apr 20 To Bank 1,00,000 1,23,000 31 Mar 21 By Bank - 50,000 44,100

sales
31 Jan 21 To Bonus 50,000 31 Mar 21 By Balance 1,00,000 82,000
shares c/d
31 Mar 21 To Profit 3,100
and Loss A/c
1,50,000 1,26,100 1,50,000 1,26,100

Workings
W1 Cost of equity shares purchased on 1 April 2020
Rs.
1,000 shares x Rs. 120 1,20,000
Add: 2% of Rs. 1,20,000 2,400
Add: 0.5% of Rs. 1,20,000 600
Cost of shares 1,23,000

357
W2 Sale proceeds of equity shares sold on 31 March 2021
Rs.
500 shares x Rs. 90 45,000
Less: 2% of Rs. 45,000 900
44,100

W3 Profit on sale of bonus shares on 31 March 2021

Rs.
Sale proceeds 44,100
Less: Average cost (1,23,000 x 50,000/1,50,000) 41,000
3,100

W4 Valuation of equity shares on 31 March 2021

Rs.
Cost (1,23,000 x 1,00,000/1,50,000 82,000
Market value (1,000 shares x Rs. 90) 90,000
Closing balance (lower of cost and market value) 82,000

358
 CHAPTER 5
ANNUAL REPORTS, AUDIT AND INTERNATIONAL
FINANCIAL REPORTING STANDARDS

UNIT-16
ANNUAL REPORTS
(BASED ON THE COMPANIES ACT 2013)
Chapter Introduction

An annual report is a comprehensive report on a company’s activities throughout

the financial year. Annual report is intended to give shareholders and other
interested people information about the company’s activities and financial
performance. This report is presented before the shareholders by the Board of
Directors along with the annual accounts of the organisation in the Annual
General Meeting (AGM). The companies Act provides for the contents and
disclosures required to be furnished in the annual report and the procedure of
presenting at the meeting of the shareholders and filing of these documents with
the Registrar of Companies.

Hence in this chapter we will study about the contents and disclosures that have
to be included in an annual report and procedures for preparing and placing the
annual reports at the AGM in respect of the company in general.

a) Learn about Annual Report and the Companies Act 2013

b) Learn about disclosures made in Directors’ Report of an Insurance
Company

359
1. Learn about Annual Report and the Companies Act 2013
[Learning Outcome a]

Introduction
Annual report i.e. board’s report is the most important tool or means for the
board of directors for their reporting to the shareholders and other stakeholders
of the company’s annual performance. The Companies Act provides for the
contents and disclosures required to be furnished in these annual reports. It also
provides the procedure of presenting at the meeting of the shareholders and filing
of these documents with Registrar of Companies. The provisions of Sec.134 of the
Companies Act 2013 govern the contents and disclosures of annual report of a
company.

1.1 Annual Report and the Companies Act 2013

We will first discuss the gist of specific statutory requirements for annual reports
of companies and then special requirements of Annual reports of Govt.
companies.

a) Sec. 92 (3) - An extract of the annual return in such form as may be prescribed
shall form part of the Board’s report.

b) Sec. 134. (1) - The financial statement, including consolidated financial

statement, if any, shall be approved by the Board of Directors.

It is to be signed at least by
 the chairperson of the company or by two directors out of which one
shall be managing director and the Chief Executive Officer, if he is a
director in the company,
 the Chief Financial Officer and
 the company secretary of the company.

(i) The auditors’ report shall be attached to every financial statement.

(ii) A report by its Board of Directors shall be attached to statements laid
before a company in general meeting

c) Sec. 135 (2) - Board's report shall disclose the composition of the Corporate
Social Responsibility Committee, which shall be constituted as per 135 (1) of
the Act 2013.

d) Sec. 177(8) - Board’s report shall disclose the composition of an Audit

Committee
Where the Board had not accepted any recommendation of the Audit
Committee, the same shall be disclosed in such report along with the reasons
therefor.
360
e) Sec. 204 (1) - Every listed company and a company belonging to other class
of companies shall annex with its Board’s report, a secretarial audit report,
given by a company secretary in practice, in such form as may be prescribed.

1.2 Annual Reports on Government Companies

Sec. 394. (1) - Where the Central Government is a member of a Government

company, the Central Government shall cause an annual report.

i) The comments given by the Comptroller and Auditor-General of India and

the audit report shall be placed in the Annual general meeting
ii) A copy of the audit report and comments upon or supplement to the audit
report made by the Comptroller and Auditor-General of India shall be laid
before both Houses of Parliament.

2.1 Contents of Annual Report- a general insurance company

The annual report of a general insurance company generally contains the

following.

1. Directors’ report
2. Management Report
3. Statutory auditors’ Report
4. Comments of CAG (in case of public sector undertakings)
5. Financial Statements with schedules
6. Receipts & Payments (Cash flow)
7. Segment Reporting
8. Shareholder’s Funds and Policy holder’s Fund details
9. Significant Accounting Policies, Notes and Disclosures forming part of financial
statements

Annual reports of companies can be accessed on the website of respective

company and can be referred to know about the contents of the annual report in
detail.

Who among the following can sign the financial statements as per the Companies
Act, 2013?
(i) Chairperson, authorised by the board
(ii) Company Secretary
(iii) Managing Director

A. (i) and (ii)

361
B. (i) and (iii)
C. (ii) and (iii)
D. (i), (ii) and (iii)

Which of the following form part of the Annual report of a general insurance
company?
i) Financial statements
ii) Board Report
iii) Auditors report

A. (i) and (ii)

B. (i) and (iii)
C. (ii) and (iii)
D. (i), (ii) and (iii)

2. Learn about disclosures in Directors’ Report of an Insurance

Company
[Learning Outcome b]

4.1 Disclosures in Directors’ Report of an Insurance Company

Director Report of an insurance Company is required to furnish the following

information in accordance with provisions of the Companies Act and this report
forms part of the annual report of the company.

1. Classwise performance summary, containing the extarct of the results of the

company
2. An overview of the company’s operations of the performance of both India
and abroad; of various departments
3. The composition of board of directors
4. Composition of various committees, terms of reference and attendance. Some
of them are -
 Audit committee
 Investment committee
 Risk management committee
 Policyholders protection committee
 Nomination & remuneration committee
 Corporate social responsibility committee
 Stackholders relationship committee
 Information technology committee
5. Shareholders information, share price trends, shareholding pattern etc.

362
For better understanding about the Director’s report in detail, the annual report
of any company may be referred on the website.

As per the Companies Act, a Directors report should disclose comparative

information with regards to which of the following?

(i) Gross Direct Premium and percentage of growth over previous year
(ii) Reinsurance Premium Ceded
(iii) Reinsurance Accepted

A. (i) and (ii)

B. (i) and (iii)
C. (ii) and (iii)
D. (i), (ii) and (iii)

Summary

 It is a legal obligation for the Board of Directors of every company to prepare

and present annual accounts to the shareholders along with its Annual report
i.e. Board’s Report.

 The Companies Act provides for the contents and disclosures required to be
furnished in the annual reports. It also provides the procedure of presenting
at the meeting of the shareholders and filing of these documents with
Registrar of Companies.

 Section 92 (3) of the Companies Act 2013 provides that an extract of the
annual return in such form as may be prescribed shall form part of the Board’s
report.

 Section 134. (1) of the Act provides that the financial statement, including
consolidated financial statement, if any, shall be approved by the Board of
Directors before they are signed on behalf of the Board at least by the
chairperson of the company.

 Section 135 (2) of the Act provides that the Board's report under sub-section
(3) of section 134 shall disclose the composition of the Corporate Social
Responsibility Committee, which shall be constituted as per 135 (1) of the Act
2013.

 Section 177(8) of the Act provides that the Board’s report under sub-section
(3) of section 134 shall disclose the composition of an Audit Committee and
363
 where the Board had not accepted any recommendation of the Audit
Committee, the same shall be disclosed in such report along with the reasons
therefor.

 Section 204 (1) Of the Act provides that every listed company and a company
belonging to other class of companies as may be prescribed shall annex with
its Board’s report made in terms of sub-section (3) of section 134, a secretarial
audit report, given by a company secretary in practice, in such form as may
be prescribed.

 Sec. 394. (1) Of the Act provides that where the Central Government is a
member of a Government company; the Central Government shall cause an
annual report on the working and affairs of that company to be prepared
within three months of its annual general meeting before which the comments
given by the Comptroller and Auditor-General of India and the audit report is
placed under the proviso to sub-section (6) of section 143.

Answers to Test Yourself

Answer to TY 1
The correct option is A. The chairperson authorised by Board and the Company
Secretary can sign the financial statements as per the Companies Act 2013.

Answer to TY 2
The correct option is D. All of the above form part of the annual report

Answer to TY 3
The correct option is D. All of the above form part of the comparative information
in a Directors report

Self-examination Questions

Question 1
Sec. 92 (3) of the Companies Act 2013 provides that an extract of the annual
return in prescribed format shall form part of the _________.
A. Board Report
B. Auditor Report
C. Compliance report
D. Statutory Report

Question 2
Who among the following can sign the financial statements as per the Companies
Act, 2013?
(i) Chairperson, authorised by the board
(ii) Company Secretary
364
(iii) CEO, who is not a director

A. (i) and (ii)

B. (i) and (iii)
C. (ii) and (iii)
D. (i), (ii) and (iii)

Question 3
Which of the following is/are a part of the Director's Report of a general insurance
company?
(i) Audited Financial Statements
(ii) Foreign operation details
(iii) CSR activities

A. (i) and (ii)

B. (i) and (iii)
C. (ii) and (iii)
D. (i), (ii) and (iii)

Question 4
Which of the following shall not be a part of the annual report of a company?
(i) Auditor's Report
(ii) Director's report
(iii) CAG Report

A. Only (i)
B. Only (ii)
C. Only (iii)
D. (i) and (ii)

Question 5

Which section in the Companies Act 2013 would govern the contents and
disclosures of annual report of a company?

A. Section 134
B. Section 140
C. Section 208
D. Section 217

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Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is A. Sec. 92 (3) of the Companies Act 2013 provides that an
extract of the annual return in prescribed format shall form part of the Board
Report

Answer to SEQ 2
The correct option is A. The chairperson authorised by Board and the Company
Secretary can sign the financial statements as per the Companies Act 2013.

Answer to SEQ 3
The correct option is D. All of the above form part of the Director's Report of a
general insurance company

Answer to SEQ 4
The correct option is C. Except the CAG report, all of the others options form
part of the Annual Report.

Answer to SEQ 5
The correct option is A. Section 134 in the Companies Act 2013 would governs the
contents and disclosures of annual report of a company

366
 CHAPTER 5
ANNUAL REPORTS, AUDIT AND INTERNATIONAL
FINANCIAL REPORTING STANDARDS

UNIT-17
STATUTORY AUDIT IN GENERAL INSURANCE BUSINESS
Chapter Introduction

Insurance Business is subject to various audits such as Statutory Audit, Internal

Audit, Concurrent Audit, Operational Audit, Underwriting Audit, Investment
Audit etc.

Each of these audits has a role and objectives in:

 improving the quality of insurance accounting and

 exercising financial control over the fund management and financial
management

In PSU organisations, another important audit called CAG audit is also carried
out in addition to the above audits.

Therefore, the accountant must know the requirements of various audits to

ensure:
 quality of accounts
 complete accounts without audit objections, audit qualifications and
 compliance with statutory and regulatory requirements in financial
accounting as well as in preparation and presentation of financial
statements keeping in view the interests of all users of financial statements.

This unit discusses the various aspects of statutory audit which will enable you
to carry out your function as an accountant even more effectively. This unit
discusses the content of audit reports (main report and long form audit report).

Internal Audit is discussed in Unit 18. Again, International Financial Reporting

Standard (IFRS) 4 relating to accounting and auditing requirement has also been
discussed in brief in unit 19 in order to highlight the requirements of audit and
the quality of accounts.

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 a) Explain the management’s responsibilities towards financial
statements.
b) Explain the auditor’s responsibilities towards financial
statements.
c) Explain the specific areas where auditors are required to
express opinions.
d) Explain briefly the work of branch auditors.
e) Provide detailed audit programmes in the areas of:
i. Premium income
ii. Claim expenses
iii. Management expenses
iv. Investments
f) Understand the contents of audit reports.

Independent auditors’ report:

Branch audit: Normally, for large insurance companies, there shall be more
auditors. While the branch auditors comment on the accounts of branches, the
audit of next higher layers (called as Regional office auditors) shall consolidate
the reports of branch auditors and express their opinion on the accounts of the
regional office.

These regions all over the country is consolidated by the auditors of corporate
office along with the accounts of various departments of the company like
Investments, reinsurance etc., in addition to the accounts of its foreign
operations.

To rely on the reports of branch offices and regional offices, the respective
auditors shall issue a letter under SA-600 – Using the work of another auditor.

They confirm their audit coverage as exampled below.

“ … We understand that this letter has been requested by you in terms of SA

600 on using the work of Another Auditor.

We confirm receipt of instructions from the company requesting us to perform

the work on the financial statements of Region ………………….. of the company
for the financial year ….. so that the same are considered for consolidation.

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In connection with the work that we will perform on the financial statements
of the Regional Office, we understand that we need to draw your attention to
those matters arising from our work on the financial statements which we
believe you need to be aware of in your audit of the financial statements of
the company.

We acknowledge that:
1. The financial statements of the Regional Office will be included in the
financial statements of the Company.
2. You intend to use our work for the audit of the financial statements of
the Company and our report on the financial statements of the
Company will be relied upon and referred to by you.
3. There were no limitations on the scope of our audit that limits our
ability to provide you with any information that you or the Company has
requested.
4. That you shall be relying upon the reports issued by us in connection
with theaudit of the Regional Office allotted to us and unless the
matters are specifically reported in the manner required to be reported
under the Standards on Auditing issued by ICAI including those relating
irregular transactions/Frauds or any other such matters, you may not be
able to consider those matters while dealing with such reports, hence it
is presumed that all the such matters that came to our notice, which
required either your or the higher management attention have been
duly addressed in our report on the financial statements of respective
Regional Offices…”

Scope of audit:

The scope of audit is defined through various provisions under –

 The Insurance Act, 1938 as amended by the Insurance Laws
(Amendment) Act, 2015
 The IRDAI Act, 1999
 The IRDA (Prepartion of Financial statements and Auditor’s report of
Insurance companies) Regulations, 2002
 Orders and directions issued by IRDA Act and Companies Act
 Accounting standards specified under Sec. 133 of the Companies Act,
2013 read with rule 7 of the companies (Accounts) Rules, 2014.

Contents of independent audit report:

1. Qualified opinion:
An auditor presents a qualified opinion to highlight matters affecting the
financial statements. The overall impact on the deviation of information /
inadequate information to form an opinion to arrive at the overall impact
and its consequential effects on the state of affairs of the company may or

369
 may not be ascertainable by him. Also, the financial impact, if any, in
consequence of the above, may or may not be ascertainable.

2. Disclaimer of opinion:
When the auditor is not in agreement with the management on the
accounting policies or the methods used or the inadequacy of disclosures,
he forms a disclaimer of opinion.

3. Basis of qualified opinion:

The basis of qualified opinion expresses the exact areas where he feesl tha
accounts may be affected due to his qualifications.

4. Emphasis of matter:
This is the area where the auditor wants to draw the attention of the users
of the report, without qualifying the report and without modifying his
opinion.

5. Key audit matters:

These are matters that were of most significance in their audit. For all key
audit matters presented, the auditors shall convey the audit procedures
carried out by them.

6. Information other than financial statements:

For all other information contained in the annual report, other than the
financial statements and audit reports, the auditors make the directors
responsible. In case of a material misstatement, the auditors have to
communicate the matter to those charged with governance and determine
the actions under applicable laws and regulations.

7. Responsibilites of management:
The board is responsible for the matters under Sec. 134(5) of the
Companies Act, 2013, with respect to preparation of financial statements,
financial performance, receipts & payments and financial reporting process.

Management is responsible for the preparation and presentation of financial

statements that give a true and fair view of the state of affairs, the results
of operations and the cash flow in according with the various provisions and
regulations.

8. Auditor’s responsibilities:
The auditors have to identify and assess the risks of material
misstatements, to assess the adequacy of internal financial controls,
appropriateness of accounting policies and accounting estimates and
appropriateness of management’s use of going concern basis of accounting.

370
9. Other matters:
This includes the reliance of the reports of other auditors (SA600) including
the audit reports of foreign offices, Actuarial valuation on IBNR, IBNER and
the assumptions carried by the actuary on the valuations.

10. Report on other legal and regulatory requirements:

These requirements are specified under Sec. 143(3) of the Compnies Act,
2013, like getting adequate information and explanations necessary for the
purpose of audit, proper maintenance of books of accounts, use of reports
of component auditors, reports in agreement with the books of account,
non-disqualification of any directors etc.

All audit reports are signed by the designated partner of the chartered
accountnat firm carrying out the audit. The partners have to mention the Firm’s
name and registration number along with his name and Membership number.

It is mandatory to mention the UDIN of the firm in these reports.

Students are advised to refer the independent audit reports of various insurance
companies to enhance their knowledge in this area.

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1. Explain the management’s responsibilities towards financial
statements.
[Learning Outcome a]

Management is responsible for preparation and presentation of financial

statements that give a true and fair view of the state of affairs, results of
operation, and cash flows of the company in accordance with the required
provisions of the Companies Act 2013, the Insurance Act, 1938 as amended by
the Insurance Laws (Amendment) Act 2015, the IRDAI (Preparation of
Financial Statements and Audit Report) Regulations 2002, and the applicable
Accounting Standards passed by the Institute of Chartered Accountants of India.

The term “true and fair” is not defined in the Companies Act, but if the
accounts of an entity are prepared in accordance with the facts, correct
principles and applicable / accepted standards, the accounts are said to be true
and fair.

In simple terms, we can say that truth means something factually correct and
fair means just, equitable and not misleading. So, the auditor needs to ensure
that the financial statements are not only factually correct but are also just and
equitably presented so as to be open and understandable, and in accordance
with accounting principles and standards.

Grand Insurers has had its accounts audited by its auditor. The motor car has
been depreciated over a period of 10 years.

Mathematically, the auditor has made the calculations correctly but the useful
life of the motor car has not been estimated correctly. The useful life of the
motor car cannot be more than 5 years. Therefore, the financial statements are
true but are not fair - though arithmetically accurate; they mislead users about
the position of the motor cars.

The financial statements prepared by the management must adhere to the

provisions of:
(i) The Companies Act, 2013
(ii) The Insurance Laws (Amendment) Act 2015
(iii) The IRDAI (preparation of financial statements and audit report) regulations
2002
(iv) The applicable accounting standards passed by the ICAI

A (i), (iii) and (iv)

B (i), (ii) and (iii)
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C (ii), (iii) and (iv)
D (i) to (iv)

2. Explain the auditor’s responsibilities towards financial statements.

[Learning Outcome b]

2.1 Basic responsibility

An auditor’s responsibility is to express his opinion on the financial statements

based on audit examinations including vouching, verification, and examination
of the financial statements in accordance with various Auditing Assurance
Standards or Standard of Auditing issued by the Institute of Chartered
Accountants of India and keeping in view the requirements of the above-
mentioned statutes and regulations. The auditor performs tests to obtain
evidence of individual debits and credits that make up an account in order to
reach a conclusion about the account. The tests can be made through tracing
and vouching of transactions.

Vouching and tracing

2.2 Statutory Auditor’s responsibility

The Statutory Auditors report to the members of the company in the specified
manner. He has to express his opinion on the financial statements based on
audit examinations including vouching, verification and examination of financial
statements in accordance with various Auditing Assurance Standards issued by
the ICAI.

Statutory Audit is performed in accordance with the provisions of:

 The Companies Act, 2013,
 The IRDAI (Preparation of Financial Statements and Audit Report)
Regulations 2002,
 The Accounting Standards and Auditing Assurance Standards passed by the
Institute of Chartered Accountants of India and
 The Insurance Laws (Amendment) Act 2015.

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2.3 Powers and duties of auditors in accordance with The Companies
Act, 2013

Sec.143 of the Companies Act, 2013 provides the powers and duties of
auditors.

Under the provisions of Sec.143 of the Companies Act, 2013 every auditor
shall:
1. inquire into the areas and aspects as specified by sub-section (IA) (for
example on the loans and advances made by the company).

2. report to the members of the company on:

 the accounts examined by him and on every balance sheet and profit and
loss account and
 on every other document to be part of or annexed to the balance sheet
or profit and loss account.

3. ensure that his report provides information and particulars as per regulatory
norms (for example whether the financial statements are true and fair)

Which of the following options contains inappropriate audit procedures?

A Vouching
B Verification
C Preparation of financial statements
D Examination of the financial statements in accordance with various auditing
assurance standards

2.4 Regulatory requirements (Schedule C of IRDAI regulations) for audit

reports of insurance companies

This has been explained in detail now.

3. Explain the specific areas where auditors are required to express

opinions.
[Learning Outcome c]

The regulatory requirements for audit report in accordance with schedule C of

the Regulation called IRDAI (Preparation of Financial Statements and Auditor’s
Report of Insurance Companies) Regulations 2002 are detailed below.

3.1 Specific Areas where auditors are required to express opinions

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The auditors are required to express their opinions on the financial statements
including Balance Sheet, Revenue Accounts, Profit and Loss Account and the
Receipts and Payments Account of the insurance company for the year ended, in
which are incorporated a) Returns and Records of Regional or Zonal Offices, b)
Divisional Offices c) Branch Offices, d) Foreign Branches as the case may be,
audited by the other auditors appointed by the competent authority.

An auditors’ responsibility is to express an opinion on the financial statements

based on their audit.

The auditors shall express their opinion specifically on the following aspects as
required by the IRDAI in the specified regulations and as required by the
provisions of the Sec.143 of the Companies Act, 2013.

1. Obtaining sufficient information and explanation

Whether they have obtained all the information and explanation, which, to the
best of their knowledge and belief, was necessary for the purposes of their
audit and found them satisfactory

2. Maintenance of proper books of account

Whether the insurer has maintained proper books of account so far as appears
from an examination of those books.

Proper books of account shall be deemed to be not maintained:

a) if books of accounts which are necessary to give a true and fair view of the
state of the affairs of the company are not maintained and
b) If books of account are not maintained on accrual basis and according to the
double entry system of accounting.

3. Agreement of financial statements with books of accounts and returns

The balance sheet, revenue accounts, profit and loss account and receipts and
payments account are in agreement with the books of accounts and returns.

4. Receipt of proper returns

Whether proper returns, audited or un-audited, from branches and other offices
have been received and whether they were adequate for the purpose of audit

5. True and fair view

 Whether the revenue account , profit and loss account, balance sheet and
receipts and payments account give a true and fair view of the insurer’s
affairs as at the end of the period;

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6. Preparation of financial statements in accordance with regulations
Whether the financial statements are prepared in accordance with the
requirements of the Insurance Laws (Amendment) Act 2015 the Insurance
Regulatory and Development Act, 1999 and, the Companies Act, 2013 to the
extent applicable and in the manner so required

7. Valuation of investments in accordance with regulations

Whether investments have been valued in accordance with the provisions of the
Act and the specified Regulations

8. Appropriateness and correctness of accounting policies

Whether the accounting policies selected by the insurer are appropriate and in
compliance with the applicable accounting standards and with the accounting
principles, as prescribed in the Regulations or any order or direction issued by
the IRDAI in this behalf

The IRDAI regulations require insurance companies to adhere to the following

accounting policies:
 all accounting standards issued by the ICAI
 all accounting policies mentioned under AS-1 issued by the ICAI

An extract of the significant accounting policy of a company on salvage is as

below.

Salvage and claims recoveries

Recoveries of claims and sale proceeds on disposal of salvage are accounted on
realization and credited to claims.

It is important to note that knowledge of the client’s accounting policies and

the laws and regulations applicable to the entity is vital to the auditor because
the use of inappropriate accounting policies leads to manipulations of the
financial statements. Without an adequate understanding of the laws and
accounting policies, the auditor is unable to judge whether or not the financial
statements give a true and fair view of the position of the entity.

9. Certification of review of management report

The auditors shall further certify that they have reviewed the management
report and there is no apparent mistake or material inconsistencies with the
financial statements; and that the insurer has complied with the terms and
conditions of the registration stipulated by the authority.

Example: The matters contained in the management reports of insurance

companies relate to whether the entity has complied with matters contained in
Part IV of Schedule B of The Insurance Regulatory and Development Authority
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(Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002.

It is a common notion that auditors are responsible for providing an opinion

relating to whether the financial statements are true and fair. However, we
also need to remember that the auditor needs to also take responsibility for
matters contained in the management reports.

10. Certification of verification of cash balances and securities

The auditors specifically certify that they have verified the cash balances and
the securities relating to the insurer’s loans and investments.

11. Verification of investment transactions

Generally, the following aspect is specified in their report after verification of
assets and liabilities and vouching of revenue and expenditure of the insurance
company:
 no part of the assets of the policyholders’ funds has been directly or
indirectly applied in contravention of the provisions of the Insurance Laws
(Amendment) Act 2015 relating to the application and investments of the
policyholders’ funds.

12. Compliance and application of accounting policies with regulations

In their opinion, the accounting policies selected by the company are
appropriate and are in compliance with the applicable accounting standards and
with the accounting principles, as prescribed in the IRDAI Regulations.

Regulatory requirements (Schedule C of IRDAI regulations) for audit reports

of insurance companies

377
The auditor shall express an opinion on:
(i) True and fair view of the financial position of the entity
(ii) The compliance of the terms and conditions of registration by the insurer
(iii) Selection of appropriate accounting policies by the insurer
(iv) The verification of cash balances
(v) Preparation of financial statements in accordance with regulations
(vi) Valuation of investments in accordance with regulations
(vii)The review of the management report

A (i),(ii),(iv) and (v)

B (i), (iii), (v) and (vi)
C (ii),(iv),(vi) and (vii)
D (iii), (v),(vi) and (vii)

4. Explain the work of branch auditors.

5. Provide detailed audit programmes in the areas of:
i. Premium income
ii. Claim expenses
iii. Management expenses
iv. Investments
[Learning Outcomes d and e]

4.1 Statutory Audit in Branch Office or Divisional Office

Branch auditor

According to the provisions of Sec. 143 of the Companies Act, 2013 where a
company has a branch office, the accounts of that office shall be audited by:
 the company’s auditor appointed under Section 139; or
 a person qualified for appointment as auditor of the company under Section
141
Furthermore, where the branch office is situated in a country outside India, the
branch auditor could also be an accountant duly qualified to act as an auditor of
the accounts of the branch office in accordance with the laws of that country.

4.2 Major matters to be examined and commented upon by Branch

Auditor

The following are the important aspects which the branch auditor must consider
when devising an audit programme for the statutory audit of Branch/ Divisional
Office:
378
a) Verification of recognition of premium income, collection and accounting
thereof keeping in view the corporate policy and regulatory norms. The
auditor needs to confirm that premium income is accounted for on “ Net
Premium Earned” basis and not on “Gross Premium Collected” basis.
b) Verification of commission expenses incurred and accounting thereof
keeping in view the corporate policy and regulatory norms: For example, the
auditor confirms the adherence to TDS norms (with the provisions of Income
tax Act 1961) in respect of commission expenses incurred.
c) Verification of Claims Paid, Claims Outstanding and Claims Incurred, IBNR
(Intimated, but not reported) Claims and IBNER (Intimated, but not
sufficiently reported) claims.

Example: In respect of IBNRs, the auditor needs to check the records for the
subsequent period in order to confirm that adequate provisions have been
created for such claims.

d) Verification of settled claims with reference to settled claims files.

e) Verification of claims outstanding with reference to outstanding claims

register, survey report and management note on status of the outstanding
claims and also age-wise analysis of claims.

f) Verification of Management Expenses and accounting thereof. The auditor

must ensure that expenses of management should fall within the limits
prescribed under the Act.

g) Appropriate treatment of capital expenditure and revenue expenditure. The

auditor needs to ensure that capital receipts and capital expenditure appear
in the Balance Sheet while revenue receipts and revenue expenditure
appear in the Profit and Loss A/c.

h) Budgetary Control: The establishment of budgets relating the

responsibilities of executives to the requirements of a policy, and the
continuous comparison of actual with budgeted results, either to secure by
individual action the objective of that policy, or to provide a basis for its
revision.

The auditors can pay extra attention to audit of cost centres and revenue
centres where unfavourable variances are noticed.

i) Reconciliation of inter-office balances and availability of balance

confirmations for their necessary comments on certain balances on the
financial statements.

379
j) Availability or verification of the historical / weighted average cost of listed
and unlisted equity/equity related instruments / preference shares, the
value of which was impaired on or before the accounting period and the
consequent impact of impairment losses recognized in profit and loss /
revenue account.

k) Availability or verification / reconciliation of reinsurers’ balances and

balance confirmations and its consequent impact on the financial
statements.

l) The accounting of Tax Liability in Foreign Countries is proper and in

accordance with the Accounting Standard

m) Adequacy of Internal Audit and Control System and corporate governance.

n) Procedure followed for amortization of expenses on account of pension,

gratuity and leave encashment under voluntary retirement schemes if any,
and whether in accordance with Accounting Standard 15 (AS15).

o) Whether there is any change in Accounting policy; If yes, the impact of such
policy on the financial results exhibited by the Financial Statements during
the year and the financial impact.

p) Written representation from the management with respect to any fraud

attempted / detected during the year under audit.

q) Examination of written representation obtained from the management.

r) Examination of the confirmation certificate of all bank balances (both

operative as well as dormant).

s) Balance confirmation certificate with respect to receivables.

t) Verification of loans and advances given to employees and recovery thereof

in the year under audit.

u) Audit Of Investments – acquisition, sale, valuation and returns as pre

regulatory norms, requirements and statutory provisions.

v) Valuation methods adopted for real estate investment. Real estate property
is valued at historical cost less accumulated depreciation and impairment
loss.

w) Physical verification report of fixed assets if any conducted by the

management during the period under audit.

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x) Verification of amounts payable in respect of provident fund, income tax,
investor education and protection dues, employees state insurance, wealth
tax, sales tax, service tax, custom duty, excise duty and any other material
statutory dues outstanding for more than 6 months from the date on which
they become payable.

y) Verification of details of related party transactions, if any, entered into

during the year.

4.3 Detailed audit programme on important areas of insurance

business which are required to be conducted by the Branch or DO
auditor

1. Examination of premium income

Purpose of Audit procedure (in respect of premium income booked

procedure by the operating office (OO))
Adhere to Whether premium has been recognized by OO as income
matching over the contract period of risk or the period of risks,
principles as whichever is appropriate.
well as
proper cut- Whether a ‘reserve for unexpired risks’ has been created as
off of the amount representing that part of the premium written
revenue. which is attributable to, and to be allocated to the
succeeding accounting periods

Whether unearned premium has been shown separately as

Current Liabilities;

premium received in advance shall not be included in the

unearned premium.
Classification Whether premium received in advance, which represents
under premium income not relating to the current accounting
appropriate period, has been disclosed separately in the financial
headings in statements under the head ‘Current Liabilities’.
the FS
Appropriate Whether necessary changes based on actuarial/ technical
valuation evaluation has been made to the liability for contracts
and exceeding 4 years.
accounting
of liability Whether Premium Deficiency has been recognized when the
sum of expected claim costs, related expenses and
maintenance costs exceeds related unearned premiums.

381
2. Examination of claim expenses

Purpose of Audit procedure

procedure
Classification a) To confirm that:
and i) the components of the ultimate cost of claims to an
accounting insurer comprise:
under  the claims under policies and
appropriate  specific claims settlement costs
headings in ii) claims under policies comprise:
the FS  the claims made for losses incurred, and
 those estimated or anticipated under the policies
following a loss occurrence

Completeness b) Whether the liability for outstanding claims in respect

of liability of both direct business and inward reinsurance business
account has been brought to account
c) Whether all the claims have been recorded in the books
of accounts and not kept outside the books for any
reason whatsoever
d) Whether reserves have been made for IBNR and IBNER
e) Whether the TPA claims provisions have been made as
per the statements received from the TPA
Accuracy of f) Whether the accounting estimate includes claims cost
expenses adjusted for estimated salvage value if there is
sufficient degree of certainty of its realization
g) Whether estimate of claims made in respect of
contracts exceeding 4 years have been recognised on an
actuarial basis.

3. Examination of Management Expenses

Purpose of Audit procedure

procedure
Accuracy of a) To confirm that the competent authority has approved
expenses all management expenses
Classification b) To confirm that:
and  the items of management expenses in excess of 1% of
accounting net premium or Rs. 5,00,000 (or any other amount as per
under corporate policy ) whichever is higher have been shown
appropriate separately
headings in  any expense of revenue nature has not been incorrectly
the FS recorded as capital expenditure
 all expenses incurred, but not paid have been duly
accounted for under the relevant head and shown
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 separately as current liabilities

4. Investments audit

Purpose of Audit procedure

procedure
To verify To verify the certificates or other documents evidencing the
existence of ownership of securities.
ownership
Appropriaten To confirm that:
ess of  the method of accounting (e.g. cost or market value) is
method of appropriate, having regard to the requirements of the
accounting company
 the method of accounting is consistently applied
 the financial statements disclose the method of
accounting followed
Valuation of  To confirm that various investments are valued and
investments disclosed in the books as per the significant accounting
policies of the company

Management Report for Statutory Auditor

Management Report for the year …….

Regional Office: ………………. Code ……….

1. We confirm that all the dues payable to the Statutory Authorities have been
duly paid.

2. We certify that the values of all the assets have been reviewed on the date
of preparation of Trial Balance and that in our belief the assets set forth in
the Trial Balance are shown in the aggregate at amounts not exceeding
their realizable or market value under the several headings- "Loans",
"Investments", "Agents balances", "Outstanding Premiums", "Interest,
Dividends and Rents outstanding", "Interest, Dividends and Rents accruing
but not due", "Amounts due from other persons or Bodies carrying on
insurance business", "Sundry Debtors", "Bills Receivable", "Cash" and the
several items specified under "Other Accounts".

3. We certify that none of the directors is disqualified as on 31st March, ….

from being appointed as a director in terms of Section 164 (2) of the
Companies Act.

383
4. It is hereby confirmed:
That in the preparation of financial statements, the applicable Accounting
Standards, principles and policies have been followed along with proper
explanations relating to material departures, if any;

That the management has adopted accounting policies and applied them
consistently and made judgments and estimates that are reasonable and
prudent so as to give a true and fair view of the state of affairs of the
Regional Office at the end of the financial year and of the operating profit
or loss of the Regional Office for the year.

That the management has taken proper and sufficient care for the
maintenance of adequate accounting records in accordance with the
applicable provisions of the Insurance Act, 1938 and Companies Act, 2013,
for safeguarding the assets of the company and for preventing and
detecting fraud and other irregularities;

That the management has prepared the financial statements on a going

concern basis.

That the management has ensured that an internal audit system

commensurate with the size and nature of the business exists and is
operating effectively.

The ageing of claims indicating the trends in average claim settlement time
during the preceding 5 years as below.
Age band No. of Claims Amount (in ₹
Lakhs)

30 days

30 days – 6 months

6 months – 1 year

1 year – 5 years

More than 5 years

Grand Total

Signature & Name of RO IN-CHARGE

PLACE:
DATE:

384
Real Insurers carries out non-life insurance business. The company is an Indian
company having branches in Sri Lanka and Bangladesh. J.K. Shah can be
appointed as the auditor for the Bangladesh branch if:

(i) He is the company’s auditor appointed under section 224 of the Companies
Act
(ii) He is qualified for appointment as auditor of the company under section 226
(iii) He is qualified for appointment as auditor of the company in accordance
with the laws of Bangladesh
(iv) He is qualified for appointment as auditor of the company in accordance
with international laws
A (i) or (ii) or (iii)
B (i) or (ii)
C (i) or (iii)
D (i) or (ii) or (iii) or (iv)

6. Understand the contents of audit reports.

[Learning Outcome f]

Audit Reports

For an Insurance company, usually Audit reports are prepared and submitted by
Statutory Auditors as under:
1. By the Branch/Divisional office statutory auditors to Central Statutory
auditors at Head Office, keeping in view statutory, regulatory and auditing
standards. Audit Reports are of basically two types:
 Main Reports and
 Long-form Audit Reports (LFAR).
2. By Central Statutory auditors at Head Office of the company to Board of
Directors of the company.

6.1 Branch/Divisional Office auditors’ report:

Branch/Divisional Office Audit report usually contains the following
points:

h) Main Report

Main reports are prepared in certain specified formats with expression of the
auditor’s opinion on true and fair view of operating results as shown by income
statement and true and fair view of the profits and losses.

Example: Main Audit Report of a Regional Office

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To the Central Statutory Auditors of ….. Company Limited

Report on the Audit of the Standalone Financial Statements Opinion

We have audited the Financial Statement of … (“the Company”) ………….

REGIONAL OFFICE ………. which comprise the Trial balance, schedules and
necessary information of RO Unit (code) and its Divisions (codes) as at 31st
March ….

In our opinion and to the best of our information and according to the
explanations given to us, the aforesaid financial statements and the Trial
Balance dealt with by this Report read together with the schedules give the
information required by the Act in the manner so required and give a true and
fair view in conformity with the accounting principles generally accepted in
India as applicable to Insurance Companies, of the state of affairs of the
Regional Office/Divisional Office as at 31st March ….and the operations of the
Regional Office for the year ended on that date.

Basis for Opinion:

We conducted our audit in accordance with the Standards on Auditing (SAs)

specified under section 143(10) of the Companies Act, 2013. Our responsibilities
under those Standards are further described in the Auditor’s Responsibilities for
the Audit of the Financial Statements section of our report. We are independent
of the Company in accordance with the Code of Ethics issued by the Institute of
Chartered Accountants of India together with the ethical requirements that are
relevant to our audit of the financial statements under the provisions of the
Companies Act, 2013 and the Rules there under, and we have fulfilled our other
ethical responsibilities in accordance with these requirements and the Code of
Ethics. We believe that the audit evidence we have obtained is sufficient and
appropriate to provide a basis for our opinion.

Management’s Responsibility for the Standalone Financial Statements

The Company’s Board of Directors is responsible for the matters stated in

section 134(5) of the Companies Act, 2013 (“the Act”),The Insurance Act , 1938
and the Accounting Principles as prescribed in the Insurance Regulatory and
Development Authority (Preparation of Financial Statements and Auditors’
Report of Insurance Companies) Regulations, 2002 and order or direction issued
by the Insurance Regulatory and Development Authority ( “the Act, Rules and
Regulations”)with respect to the preparation of these financial statements that
give a true and fair view of the financial position, financial performance of the
Company in accordance with the accounting principles generally accepted in
India, including the accounting Standards specified under section 133 of the
Act. This responsibility also includes maintenance of adequate accounting
386
records in accordance with the provisions of the Act for safeguarding of the
assets of the Company and for preventing and detecting frauds and other
irregularities; selection and application of appropriate implementation and
maintenance of accounting policies; making judgments and estimates that are
reasonable and prudent; and design, implementation and maintenance of
adequate internal financial controls, that were operating effectively for
ensuring the accuracy and completeness of the accounting records, relevant to
the preparation and presentation of the financial statement that give a true and
fair view and are free from material misstatement, whether due to fraud or
error.

In preparing the financial statements, management is responsible for assessing

the Company’s ability to continue as a going concern, disclosing, as applicable,
matters related to going concern and using the going concern basis of
accounting unless management either intends to liquidate the Company or to
cease operations, or has no realistic alternative but to do so. The Board of
Directors is also responsible for overseeing the Company’s financial reporting
process.

Auditor’s Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement, whether due to
fraud or error, and to issue an auditor’s report that includes our opinion.
Reasonable assurance is a high level of assurance, but is not a guarantee that an
audit conducted in accordance with SAs will always detect a material
misstatement when it exists. Misstatements can arise from fraud or error and
are considered material if, individually or in the aggregate, they could
reasonably be expected to influence the economic decisions of users taken on
the basis of these financial statements.

Other Matters:
We did not audit the financial statements/ information of ………………. divisional
offices included in the financial statements of the Regional Office whose
financial statements/financial information reflect total assets of Rs. ………………..
(Total of Assets side of all Divisions) as at 31st March ….. and the total revenue
of Rs. ………………. (Total Gross Premium of all Divisions) for the year ended on
that date, as considered in the financial statements/information of these
divisional offices have been audited by the other auditors whose reports have
been furnished to us, and our opinion in so far as it relates to the amounts and
disclosures included in respect of divisional offices, is based solely on the report
of such divisional office auditors.

Our opinion is not modified in respect of these matters.

Report on Other Legal and Regulatory Requirements

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As required by Section 143(3) of the Act and Insurance Regulatory and
Development Authority of India (Preparation of Financial Statements and
Auditors’ Report of Insurance Companies) Regulations, 2002 and orders or
direction issued by the Insurance Regulatory Authority of India, we report that:
i) We have sought and obtained all the information and explanations which to
the best of our knowledge and belief were necessary for the purposes of our
audit.
ii) In our opinion, proper books of account as required by law have been kept
by the Company so far as it appears from our examination of those books
and proper returns adequate for the purposes of our audit have been
received from the divisional office not visited by us.
iii) The reports on the accounts of the divisional offices of the Company audited
under Section 143(8) of the Act by divisional office auditors have been sent
to us and have been properly dealt with by us in preparing this report.
iv) The Financial Statements dealt with by this Report are in agreement with
the books of account and with the returns received from the divisional
offices not visited by us.
v) In our opinion, the aforesaid financial statements comply with the
Accounting Standards specified under Section 133 of the Act, read with Rule
7 of the Companies (Accounts) Rules, 2014 to the extent applicable and with
the Accounting principles as prescribed in the Insurance Regulatory and
Development Authority of India (Preparation of financial Statements and
Auditors’ Report of Insurance Companies) Regulations, 2002 and orders or
directions issued by the Insurance Regulatory and Development Authority of
India.
vi) On the basis of the written representations received from the directors as
on 31st March, 2021 taken on record by the Board of Directors, none of the
directors is disqualified as on 31st March, 2021 from being appointed as a
director in terms of Section 164 (2) of the Act.
vii) With respect to the adequacy of the internal financial controls over financial
reporting of the Company and the operating effectiveness of such controls,
refer to our separate Report as annexed herewith.
viii) Proper provisioning has been made for all liabilities including claims at
the closing date.
ix) We have reviewed the Management Report attached with the Financial
Statements and there are no apparent mistakes or material inconsistencies
between the Management Report and the Financial Statements.
x) Disclosures forming part of Financial Statements have been duly verified by
us.
xi) With respect to the other matters to be included in the Auditor’s Report in
accordance with Rule 11 of the Companies (Audit and Auditors) Rules, 2014,
in our opinion and to the best of our information and according to the
explanations given to us:

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The Company has disclosed the impact of pending litigations on its financial
position in its financial disclosure forming part of Financial Statement under
contingent liabilities and provisions for claims.

The regional office and Divisional offices have made provision as required under
the applicable law or accounting standards for material foreseeable losses.
The Regional office/ Divisional offices do not have any long-term contracts
including derivative contracts for which there were any material foreseeable
losses.

There has been no delay in transferring amounts, required to be transferred, to

the Investor Education and Protection Fund by the Company.

As required under section 143 (5) of Companies Act, 2013, we enclose herewith,
as per annexure, the directions including sub-direction issued by Comptroller &
Auditors General of India, action taken thereon and the financial impact on the
accounts and financial statement of the company.

For XYZ & Co

Chartered Accountants
(Firm’s Registration No.)
Signature
(Name of the Member Signing the Audit Report)

(Designation)
(Membership No. …….)
UDIN No. …………
Place:
Date:

ii) Long-form Report by Branch Auditors;

Long-form reports (LFAR) provide information on process lapses including

underwriting, claims, accounts, internal control, investments etc.

Long-form Report by Branch Auditors generally provides information or auditors’

observations on the following aspects:

 Observation on non-compliance of accounts closing circulars

 Cases of cheques dishonoured where the relevant risks covered have not
been cancelled from inception
 Cases where there have been violations of Sec.64VB of the Insurance Act,
1938
 Status of large Outstanding claims, cause-wise, age-wise
 Comments on adequacy of claims provisions
 Observations on Bank Reconciliations, aging of open items.
389
 Listing stale cheques not transferred to stale cheques account.
 Inter office balances not reconciled.
 Comments on adequacy of Internal Audit and adequate internal control
system.
 Comments on action taken on the qualifications given in the previous
statutory audit report
 Comments on GST recovery and deposits and availing input credit
 Comments on disposal of salvage system-whether salvage register has been
updated; whether there is an effective control system of collecting,
accounting and disposal of salvage within reasonable time
 Confirming co-insurance balances from / to other companies are reconciled
 Updation of fixed assets register and assets verification
The contents of LFAR are finalized by statutory auditors in discussion with the
management, explaining the reasons.

6.2 Central Statutory auditors report :

Central Statutory auditors report usually contains the following points (of a
Government listed company)

Central auditors review the all audit reports submitted by the branch auditors /
Divisional auditors / Foreign offices and consolidate all the points at Head
office. Any adverse comment(s) or important aspects reported in
branch/divisional office /foreign branches reports to central auditors is
incorporated in their report.

Given below is the specimen of central statutory auditors report usually

prepared and submitted by them to the Board of Directors:

To the Members of ….. Company Limited

Report on the Audit of the Standalone Financial Statements
1. Qualified Opinion
We have audited the standalone financial statements of …. Company Limited
(“the Company”), which comprise the Balance sheet as at March 31, …., the
Revenue Accounts of Fire, Marine and Miscellaneous Insurance Business
(collectively known as ‘Revenue Accounts’), Profit and Loss Account and the
Receipts and Payments Accounts for the year then ended, and notes to the
standalone financial statements, including a summary of significant accounting
policies and other explanatory information, in which are incorporated returns for
the year ended on that date from …. offices audited by the other firms of
Auditors appointed by the Comptroller and Auditor General of India under section

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139 of the Companies Act,2013 and from … Foreign Branches audited by local
auditors appointed by the Company;
In our opinion and to the best of our information and according to the
explanations given to us, except for the effects of the matter described in the
Basis for Qualified Opinion section of our report, the aforesaid standalone
financial statements give the information required in accordance with the
Insurance Act, 1938 as amended by the Insurance Laws (Amendment) Act, 2015
(‘the Insurance Act’), the Insurance Regulatory and Development Authority Act,
1999 (‘the IRDA Act’), the Insurance Regulatory and Development Authority
(Preparation of Financial Statements and Auditor’s Report of Insurance
Companies) Regulations, 2002 (‘the IRDA Financial Statements Regulations’),
orders/ directions issued by the Insurance Regulatory and Development
Authority of India (‘the IRDAI’), the Companies Act (‘the Act’) including the
accounting Standards specified under section 133 of the Companies Act, 2013
read with rule 7 of the Companies (Accounts) Rules, 2014 (‘the Accounting
Standards’), to the extent applicable in the manner so required and give a true
and fair view in conformity with the accounting principles generally accepted in
India, of the state of affairs of the Company as at March 31, 2020, the Revenue
Accounts, Profit and Loss Account and the Receipts and Payments Accounts for
the year ended on that date.
Basis for Qualified Opinion
(here, the auditors list out the adverse comments on specific areas)
Overall impact of the above para … and the consequential effects on Revenue
Accounts, Profit and Loss Account and Balance Sheet as on March 31, …. are not
ascertainable and cannot be commented upon.
We conducted our audit in accordance with the Standards on Auditing (SAs)
specified under section 143(10) of the Companies Act, 2013. Our responsibilities
under those Standards are further described in the Auditor’s Responsibilities for
the Audit of the Standalone Financial Statements section of our report. We are
independent of the Company in accordance with the Code of Ethics issued by
the Institute of Chartered Accountants of India together with the ethical
requirements that are relevant to our audit of the standalone financial
statements under the provisions of the Companies Act, 2013 and the Rules there
under, and we have fulfilled our other ethical responsibilities in accordance
with these requirements and the Code of Ethics. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for
our qualified opinion.
2. Emphasis of Matter
Without qualifying our report in respect of the following
(here, the auditors draw the attention of the members which they wish to look
into)

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Our opinion is not modified in respect of the above matters.
3. Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of
most significance in our audit of the standalone financial statements of the
current period. These matters were addressed in the context of our audit of the
standalone financial statements as a whole, and in forming our opinion thereon,
and we do not provide a separate opinion on these matters. We have
determined the matters described below to be the key audit matters to be
communicated in our report.
(Here, the key audit matters and the auditor’s response are specified)
4. Information other than the standalone financial statements and
Auditor’s report thereon
The Company’s Board of Directors is responsible for the other information. The
other information comprises the information included in the Annual report, but
does not include the standalone financial statements and our auditor’s report
thereon. The Annual report is expected to be made available to us after the
date of this auditor’s report. Our opinion on the standalone financial statements
does not cover the other information and we do not express any form of
assurance conclusion thereon.
In connection with our audit of the standalone financial statements, our
responsibility is to read the other information and, in doing so, consider
whether the other information is materially inconsistent with the standalone
financial statements or our knowledge obtained in the audit or otherwise
appears to be materially misstated. When we read the other information
included in the above reports, if we conclude that there is material
misstatement therein, we are required to communicate the matter to those
charged with governance and determine the actions under the applicable laws
and regulations.
5. Responsibilities of Management and Those Charged with Governance
for the Standalone Financial Statements
The Company’s Board of Directors is responsible for the matters stated in
section 134(5) of the Companies Act, 2013 (“the Act”) with respect to the
preparation of these standalone financial statements that give a true and fair
view of the financial position, financial performance and receipts and payments
of the Company, in accordance with the accounting principles generally
accepted in India, including the accounting Standards specified under section
133 of the Act, the requirements of the Insurance Act, the IRDAI Financial
Statements Regulations and the orders /directions and circulars issued by the
IRDAI in this regard, to the extent applicable and in the manner so required.
This responsibility also includes maintenance of adequate accounting records in
accordance with the provisions of the Act for safeguarding of the assets of the
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Company and for preventing and detecting frauds and other irregularities;
selection and application of appropriate accounting policies; making judgments
and estimates that are reasonable and prudent; and design, implementation and
maintenance of adequate internal financial controls, that were operating
effectively for ensuring the accuracy and completeness of the accounting
records, relevant to the preparation and presentation of the standalone
financial statements that give a true and fair view and are free from material
misstatement, whether due to fraud or error.
In preparing the standalone financial statements, management is
responsible for assessing the Company’s ability to continue as a going concern,
disclosing, as applicable, matters related to going concern and using the going
concern basis of accounting unless management either intends to liquidate the
Company or to cease operations, or has no realistic alternative but to do so.
The Board of Directors are also responsible for overseeing the Company’s
financial reporting process.
6. Auditor’s Responsibilities for the Audit of the Standalone Financial
Statements
Our objectives are to obtain reasonable assurance about whether the
standalone financial statements as a whole are free from material
misstatement, whether due to fraud or error, and to issue an auditor’s report
that includes our opinion. Reasonable assurance is a high level of assurance but
is not a guarantee that an audit conducted in accordance with Standard on
Auditing will always detect a material misstatement when it exists.
Misstatements can arise from fraud or error and are considered material if,
individually or in the aggregate, they could reasonably be expected to influence
the economic decisions of users taken on the basis of these standalone financial
statements.
As part of an audit in accordance with Standard on Auditing, we exercise
professional judgment and maintain professional skepticism throughout the
audit. We also identify and assess the risks of material misstatement of the
Standalone financial statements, whether due to fraud or error, design and
perform audit procedures responsive to those risks, and obtain audit evidence
that is sufficient and appropriate to provide a basis for our opinion. The risk of
not detecting a material misstatement resulting from fraud is higher than for
one resulting from error, as fraud may involve collusion, forgery, intentional
omissions, misrepresentations, or the override of internal control.
We obtain an understanding of internal control relevant to the audit in order to
design audit procedures that are appropriate in the circumstances. Under
section 143(3)(i) of the Companies Act, 2013, we are also responsible for
expressing our opinion on whether the company has adequate internal financial
controls system in place and the operating effectiveness of such controls.

393
We evaluate the appropriateness of accounting policies used and the
reasonableness of accounting estimates and related disclosures made by
management.
We conclude on the appropriateness of management’s use of the going concern
basis of accounting and, based on the audit evidence obtained, whether a
material uncertainty exists related to events or conditions that may cast
significant doubt on the Company’s ability to continue as a going concern.
If we conclude that a material uncertainty exists, we are required to draw
attention in our auditor’s report to the related disclosures in the financial
statements or, if such disclosures are inadequate, to modify our opinion. Our
conclusions are based on the audit evidence obtained up to the date of our
auditor’s report. However, future events or conditions may cause the Company
to cease to continue as a going concern.
We evaluate the overall presentation, structure and content of the financial
statements, including the disclosures, and whether the financial statements
represent the underlying transactions and events in a manner that achieves fair
presentation.
Materiality is the magnitude of misstatements in the financial statements that,
individually or in aggregate, makes it probable that the economic decisions of a
reasonably knowledgeable user of the financial statements may be influenced.
We consider quantitative materiality and qualitative factors in (i) planning the
scope of our audit work and in evaluating the results of our work; and (ii) to
evaluate the effect of any identified misstatements in the financial statements.
We communicate with those charged with governance regarding, among other
matters, the planned scope and timing of the audit and significant audit
findings, including any significant deficiencies in internal control that we
identify during our audit.
We also provide those charged with governance with a statement that we have
complied with relevant ethical requirements regarding independence, and to
communicate with them all relationships and other matters that may reasonably
be thought to bear on our independence, and where applicable, related
safeguards.
From the matters communicated with those charged with governance, we
determine those matters that were of most significance in the audit of the
financial statements of the current period and are therefore the key audit
matters. We describe these matters in our auditor’s report unless law or
regulation precludes public disclosure about the matter or when, in extremely
rare circumstances, we determine that a matter should not be communicated in
our report because the adverse consequences of doing so would reasonably be
expected to outweigh the public interest benefits of such communication.
7. Other Matters

394
We did not audit the financial statements of … offices and …. Foreign Branches
included in the standalone financial statements of the Company for the year
ended on that date, as considered in the standalone financial statements. The
financial statements / information of these offices have been audited by the
other firm of auditors whose reports have been furnished to us, and our opinion
in so far as it relates to the amounts and disclosures included in respect of these
offices, is based solely on the report of such component auditors.
The actuarial valuation of liability in respect of Claims Incurred but Not
Reported (IBNR) and those Incurred but Not Enough Reported (IBNER) as at
March 31, …., is as certified by the Company’s Appointed Actuary and our
opinion in so far as it relates to the amounts and disclosures related to such
liability, is based solely on such report. The Appointed Actuary has also certified
that the assumptions considered by him for such valuations are in accordance
with guidelines and norms prescribed by the Insurance Regulatory and
Development Authority of India (IRDAI) and the Actuarial Society of India in
concurrence with the IRDAI. We have relied upon on the Appointed Actuary’s
certificate in this regard for forming our opinion on the financial statements of
the Company.
Our opinion is not modified in respect of this matter.
8. Report on Other Legal and Regulatory Requirements
As required by Section 143 (3) of the Companies Act 2013 and Insurance
Regulatory and Development Authority (Preparation of financial Statements and
Auditors’ Report of Insurance Companies) Regulations, 2002 and orders or
direction issued by the Insurance Regulatory and Development Authority, we
report that:
We have sought and except for the matters described in the Basis for Qualified
Opinion
We have obtained all the information and explanations which to the best of our
knowledge and belief were necessary for the purposes of our audit except for
the possible effects of the matter described in the Basis for Qualified Opinion
paragraph above, in our opinion, proper books of accounts have been
maintained by the Company, so far as it appears from our examination of those
books and proper returns both audited and unaudited from Regional offices,
Divisional Offices, branches and other offices, not visited by us, have been
received.
The reports of the auditors’ of other offices audited under section143(8) of the
Act by the component auditors have been sent to us and have been properly
dealt with by us in preparing this report in the manner considered necessary by
us.
The Balance Sheet, the Revenue Account, Profit and Loss Account, and the
Receipt and Payment Account dealt with by this Report are in agreement with

395
the books of account and with the returns received from offices not visited by
us
except for the possible effects of the matter described in the Basis for
Qualified Opinion paragraph above, in our opinion, the aforesaid
standalone financial statements have been prepared in accordance with
the requirements of the Insurance Act, 1938 (4 of 1938), the Insurance
Regulatory and Development Act, 1999 (41 of 1999) and the Companies
Act, 2013 to the extent applicable and in the manner so required.
except for the possible effects of the matter described in the Basis for
Qualified Opinion paragraph, in our opinion, the aforesaid Standalone
Financial Statements comply with the Accounting Standards specified
under Section 133 of the Act, read with Rule 7 of the Companies
(Accounts) Rules, 2014.
On the basis of the written representations received from the directors as on
March 31, … taken on record by the Board of Directors, none of the directors is
disqualified as on March 31, … from being appointed as a director in terms of
Section 164 (2) of the Act.
The accounting policies adopted by the company are appropriate and in
compliance with the applicable Accounting Standards specified under
Section 133 of the Act, read with Rule 7 of the Companies (Accounts) Rules,
2014 and with the Accounting Principles as prescribed in the Insurance
Regulatory and Development Authority (Preparation of financial Statements and
Auditors’ Report of Insurance Companies) Regulations, 2002 and orders or
direction issued by the Insurance Regulatory and Development Authority, except
for the possible effects of the matter described in the Basis for Qualified
Opinion paragraph above.
The actuarial valuation of liability in respect of claims Incurred but Not
Reported (IBNR) and those Incurred but Not Enough Reported (IBNER) as at
March 31, …., have been duly certified by the Company’s Appointed Actuary and
relied upon by us. The Appointed Actuary has also certified that the assumptions
considered by him for such valuations are in accordance with guidelines and
norms prescribed by the Insurance Regulatory and Development Authority of
India (IRDAI) and the Actuarial Society of India in concurrence with the IRDAI.
As per the information and explanations provided to us, the investments have
been valued in accordance with the provisions of the Insurance Act, the
regulations and orders/directions issued by IRDAI in this regard.
Further on the basis of our examination of books and records of the company
and according to the information and explanation given to us and to the best of
our knowledge and belief, we certify that:
We have reviewed the management report attached with the Standalone
Financial Statements and there are no apparent mistakes or material

396
inconsistencies between the management report and the standalone financial
statements.
Based on the management representation made by the management of the
company charged with compliance, nothing has come to our attention which
causes us to believe that the company has not complied with the terms and
conditions of registration as stipulated by IRDAI.
No part of the assets of the policyholders’ funds has been directly or indirectly
applied in contravention of the provisions of the Insurance Act, 1938 (4 of 1938)
relating to the application and investments of the policyholders’ funds.
With respect to the other matters to be included in the Auditor’s Report in
accordance with Rule 11 of the Companies (Audit and Auditors) Rules, 2014, in
our opinion and to the best of our information and according to the explanations
given to us.
The Company has disclosed the impact of pending litigations on its financial
position in its standalone financial statements as per Note No. … to the
standalone financial statements.
The Company has made provision, as required under the applicable law or
accounting standards, for material foreseeable losses, if any, on long-term
contracts including derivative contracts – The liability for Insurance Contracts, is
determined by the Company’s Appointed Actuary and is covered by the
Appointed Actuary’s certificate, referred to Other Matter paragraph above, on
which we have placed reliance.
The Company did not have any long-term contracts including derivative
contracts for which there were any material foreseeable losses.
There were no amounts which were required to be transferred to the Investor
Education and Protection Fund by the Company.
With respect to the other matters to be included in the Auditors’ Report in
accordance with the requirement of section 197(16) of the Companies Act 2013,
as amended, we report that the provisions of section 197 of the Act are not
applicable to the company vide notification No. GSSR 463(E) dated 5th June
2015. Hence reporting u/s 197(16) of the Act is not required.
There is adequacy of the internal financial controls over financial reporting of
the Company and the operating effectiveness of such controls.
As required under section 143(5) of the Companies Act, 2013, based on our audit
as aforesaid, we enclose herewith, as per “Annexure B”, the directions including
additional directions issued by the Comptroller and Auditor General of India,
action taken thereon and the financial impact on the accounts and standalone
financial statements of the Company.
Place: … For … & Co

397
 Date: …. Chartered Accountants
Firm Reg. No. ….
(Name)

Partner
M. No. – ..
UDIN: …..

Information relating to process lapses including underwriting, claims, accounts,

internal control, investments etc. is provided in:

A Internal audit reports

B Long-form reports (LFAR)
C Main audit reports
D Management reports

Summary

 Management is responsible for preparation and presentation of financial

statements that give a true and fair view of the state of affairs, results of
operation, and cash flow of the company.
 An auditor’s responsibility is to express his opinion on the financial
statements based on audit examinations of the financial statements in
accordance with various Auditing Assurance Standards.
 Every auditor shall report to the members of the company on the financial
records examined by him and ensure that his report provides information
and particulars as per regulatory norms.
 Where a company has a branch office, the accounts of that office shall be
audited by the company’s auditor appointed under Section 139 or a person
qualified for appointment as auditor of the company under Section 141.
 Main audit reports are prepared in certain specified formats with expression
of the auditor’s opinion on true and fair view of operating results as shown
by income statement and true and fair view of the profits and losses.
 Long-form reports (LFAR) provide information on process lapses including
underwriting, claims, accounts, internal control, investments etc.

398
Answers to Test Yourself
Answer to TY 1
The correct option is D. Management is responsible for preparation and
presentation of financial statements that give a true and fair view of the state
of affairs, results of operations, and cash flows of the company in accordance
with the required provisions of the Companies Act 2013, and the Insurance Laws
(Amendment) Act 2015, the IRDAI (Preparation of Financial Statements and
Audit Report) Regulations 2002, and the applicable Accounting Standards issued
by the Institute of Chartered Accountants of India.
Answer to TY 2
The correct option is C. Management is responsible for preparation and
presentation of financial statements that give a true and fair view of the state
of affairs.
Answer to TY 3
The correct option is B.

Answer to TY 4
The correct option is A. According to the provisions of Sec. 143 of the
Companies Act, 2013where a company has a branch office, the accounts of
that office shall be audited by: the company’s auditor appointed under Section
139 or a person qualified for appointment as auditor of the company under
Section 141. Furthermore, where the branch office is situated in a country
outside India, the branch auditor could also be an accountant duly qualified to
act as an auditor of the accounts of the branch office in accordance with the
laws of that country.
Answer to TY 5
The correct option is B. Long-form reports (LFAR) provide information on
process lapses including underwriting, claims, accounts, internal control,
investments etc.

Self-Examination Questions

Question 1
Financial statements are said to be true when they are:
A Just
B Factually correct
C Equitable
D Not misleading.

Question 2
An auditor performing insurance audit is required to follow a set of regulatory
requirements and the relevant provisions of which of the following?
399
(i) The Insurance Laws (Amendment) Act 2015.
(ii) The provisions of the Companies Act on accounts and audit
(iii) The Accounting Standards passed by the ICAI.

A (i) and (ii)

B (i) to (iii)
C (ii) and (iii)
D (i)and (iii)

Question 3
Accounting policies of insurance companies must adhere to:
(i) All accounting standards issued by ICAI
(ii) All auditing standards issued by ICAI
(iii) All accounting policies mentioned under AS-1 issued by ICAI
(iv) All accounting standards issued by IAASB

A (i) and (ii)

B (i) and (iii)
C (i), (ii) and (iii)
D (i) to (iv)

Question 4
While auditing debt securities, in order to confirm the correctness of the
valuation, the auditor confirms that securities have been measured:

A At historical cost less accumulated depreciation and impairment loss

B At historical cost subject to amortisation
C At fair value as at the balance sheet date
D At historical cost

Question 5
Which of the following options is not appearing in Long-form reports (LFAR)?
(i) Cases of cheques dishonoured not cancelled from inception
(ii) Status of large Outstanding claims, cause-wise and year-wise
(iii) Comments on adequacy of provision made for all outstanding claims
(iv) Confirmation that required solvency margins have been maintained

A (i)
B (ii)
C (iii)
D (iv)

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Answers to Self Examination Questions

Answer to SEQ 1
The correct option is B. Financial statements are said to be true when they are
factually correct, and said to be fair when they are just, equitable and not
misleading.

Answer to SEQ 2
The correct option is A. Insurance audit is a special type of audit where the
auditor is required to follow a set of regulatory requirements and the relevant
provisions of as amended by the Insurance Laws (Amendment) Act 2015 as well
as the provisions of the Companies Act on accounts and audit. Point (iii) is
inappropriate as adherence to the Accounting Standards passed by the ICAI is
required on the part of the insurer. The auditor only confirms whether the FS
adhere to the Accounting Standards passed by the ICAI.

Answer to SEQ 3
The correct option is B. The IRDAI regulations require insurance companies to
adhere to the following accounting policies:
 all accounting standards issued by ICAI
 all accounting policies mentioned under AS-1 issued by ICAI

Answer to SEQ 4
The correct option is B. Debt securities including government securities and
redeemable preference shares have to be considered “held to maturity”
securities and need to be measured at historical cost subject to amortisation.
Option A relates to valuation of real estate investment property. Option C
relates to the measurement of equity securities and derivative instruments that
are traded in active markets. Option D relates to the measurement of unlisted
and other than actively traded equity securities and derivative instruments.

Answer to SEQ 5
The correct option is D. The matter mentioned in points (iv) is contained in the
management report.

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 CHAPTER 5
ANNUAL REPORTS, AUDIT AND INTERNATIONAL
FINANCIAL REPORTING STANDARDS

UNIT-18
INTERNAL AUDIT IN GENERAL INSURANCE BUSINESS
Chapter Introduction

In addition to being profitable, organisations today are also expected to be

responsible. They are expected to ensure that the activities they engage in are
not only profitable but also in line with the best interests of their various
shareholders.

For this to be achieved, organisations need to implement systems of internal

controls and corporate governance. Such systems will help ensure the efficiency
and effectiveness of operations and compliance with all relevant laws and also
ensure that organisations are properly governed and controlled. However,
designing and implementing appropriate and adequate internal controls is only
the first step. These controls have to be tested on an on-going basis to ensure
that they are effective and still relevant for the business operations of the
organisation.

This is where the function of internal auditing comes into effect. Internal
auditors are the internal “checkers” of an organisation. They are responsible for
determining if the organisation’s activities and management are operating in
accordance with its prescribed policies and procedures.

An employee will either be involved with carrying out this function or has his
work checked by an internal auditor. Therefore, it is important that we
understand the concept behind internal audit and all that it involves.

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 a) Explain the meaning and scope of internal audit.
b) Explain the objectives of internal audit.
c) Explain the relationship between the statutory and the internal
auditors.
d) Explain the major considerations for devising internal audit systems
in general insurance business.
e) List the common internal audit queries in general insurance business.
i. Provide detailed audit programmes to be carried out by internal
audit and inspection function in the areas of Premium income,
refund premium and commission, Claims and estimated liabilities
for outstanding claims, Commission, Coinsurance, Bank
transactions and bank reconciliation, Fixed assets, Advances and
Investment audit.

f) Explain the reporting systems for internal auditors.

g) Explain the standards on internal audits (SIA).

1. Explain the meaning and scope of internal audit.

[Learning Outcome a]

1.1 Meaning

Internal Audit is a thorough examination of the financial transactions as well as

the system of accounting.

Internal audit is aimed at reassuring the management that:

 all financial transactions are taking place according to the corporate policy,
rules and directives
 all transactions are being recorded in accordance with accounting
principles, accounting standards, and accounting policies
 the system of accounting provides adequate safeguards to check the
wastage of revenue and misappropriation of property of the organisation

Internal auditing is an independent appraisal function, established within an

organisation to examine and evaluate its activities as a service to the
organisation. The objective of internal auditing is to assist members of the
organisation in the effective discharge of their responsibilities. To this end,
internal auditing furnishes them with analyses, appraisals, recommendations,
counsel and information concerning the activities reviewed.

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Internal Auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organisation’s operations. It helps an
organisation accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management,
control and governance process.

Internal audit is a managerial control function –devising and implementing both

accounting control and administrative control. Though the aims and objectives
of internal audit are the same, the nature, scope and process of internal audit
widely vary from one organisation to other depending upon their nature, size
and geographical jurisdiction. The scope of internal audit varies from
assignment to assignment.

Though the routine process of internal audit is the same as is followed in a

statutory audit, its depth and coverage (regarding checking and examination)
are more than for statutory audit.

When statutory audit is primarily concerned with the statutory or legality of the
business transaction, internal audit is mainly concerned with the propriety and
validity of the transaction for the purpose and the maximum profitability of the
entity.

Internal audit is required to ensure that various functions mentioned below are
carried out in accordance with the various corporate policies, laid-down rules
and manuals for Underwriting, Claims settlement, Financing and Investment,
Financial Accounting andReinsurance Accounting.

1.2 Scope of internal audit

The scope of internal audit is wide and includes:

 The operational audit of various operating activities in the organisation
 The audit of management itself.

It emphasises the role of internal audit in achieving the maximum organisational

effectiveness. Internal audit, which is considered an integral part of an
organisation, finds its base in financial accounting. Internal audit also plays a
very important role in improving the quality of financial accounting of an
organisation.

Nowadays there is growing tendency in the corporate world to make internal

auditors responsible directly to the Board of Directors for the maintenance of:
 adequate accounting procedure,
 preparation of financial statements and
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 reports as regards various business activities.

The definition clearly implies that the scope of internal audit is not confined to
routine checking of the accounting records but also includes an appraisal of the
various operational functions together with providing advice and
recommendations on the activities and operations reviewed.

The Institute of Internal Auditors defines the scope of internal auditing as:
 the examination and evaluation of the adequacy and effectiveness of the
system of internal control
 the quality of performance in carrying out assigned responsibilities

Accordingly, the scope of internal audit should include, but not necessarily be
limited to:

1. Examination and evaluation of the adequacy and effectiveness of the

internal control system of an entity. In order to conduct an internal audit of
fixed assets, the internal auditor will evaluate the fixed assets management
system by looking into the documentation and physical verification
processes and determining whether or not the system itself prevents any
fraud or error.

2. Review of reliability, integrity, adequacy, timeliness of the financial and

operating information and also the mechanism employed for identifying,
measuring, classifying and reporting such information.

3. An internal auditor checks outstanding claims and age-wise analysis of

claims in order to ascertain the reliability, integrity, adequacy and
timeliness of the information regarding claims.

4. Review of the system established for ensuring compliance with the

applicable laws and regulations and also management policies. An internal
auditor needs to check whether the laws relating to maximum working
hours, minimum wages, etc. are complied with while engaging and paying
employees.

5. Review of the system for ensuring that the assets of the entity are
safeguarded from various losses like damage, fire, misappropriation etc. An
internal auditor needs to check the safety and security measures of the
assets of an insurance company in order to assure himself that the assets are
safeguarded from various losses.

6. Determination of the effectiveness, efficiency and also the economy of the

operations of the entity. According to the definition of internal audit given
by the Institute of Internal Auditors, suggestions of improvements to the
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 entity’s operations are also expected from the internal auditor. This can be
achieved by evaluating and improving the effectiveness of the following:

a) Risk management

Risk management refers to the set of activities that involve:

 identifying and assessing any and all relevant risks that the organisation
may face while conducting its daily operations; and
 then identifying and implementing a set of policies and procedures that
will help the organisation to mitigate these risks.

Sun Insurance Co. has invested in new sophisticated financial accounting

software, based on double-entry accounting system. The software has been
tailor-made for the company.

The terms of the purchase order for the software are that:
 The company will test the software during the various stages of its
development

 Payments to the supplier will be made at each stage of development e.g.

the module for recording assets and expenses will be tested after
completing the module. If the module operates according to the
requirements of the company, the company will accept the software and
make payment to the software company.

Therefore, the risk of failure of the software is reduced through a combination

of testing and contractual terms.

Risk management is important in supporting the achievement of company

objectives. Corporate collapses and failures have often been linked to excessive
risk taking or risky business models. Risk management systems and internal
controls provide an essential check and balance, particularly when combined
with corporate governance mechanisms for executives, managers and staff.

For example, risk management systems facilitate:

 safeguarding shareholders’ investment and the company’s assets.
 the effectiveness and efficiency of operations.
 ensuring the reliability of external and internal reporting.
 ensuring compliance with laws and regulations.
 ensuring the effectiveness of financial controls.
 a thorough evaluation of the risks which the company is exposed to.

To provide the directors with assurance that the controls have been properly
designed and implemented and are working effectively, it is necessary to
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conduct internal audits. Risk management also includes proper reporting of risks
and internal controls to management and obtaining assurance from internal
audit reports. The risk committee and audit committee can bring non-executive
directors into the control process to provide an independent and unbiased
opinion on the internal controls of the company.

b) Internal control process

The internal auditor’s primary duty is to examine and evaluate the adequacy
and effectiveness of the system of internal control and to assess the quality of
performance in carrying out assigned responsibilities.

While
performing an internal audit of debtors, the internal auditor needs to ensure
that the debtors on a particular date reconcile with the debtors at the
beginning of the year, taking into consideration the total amount of billing
made and the amount collected with respect to the debtors’ accounts under
consideration. If the balances reconcile, it gives him some assurance about the
effectiveness of the internal control over debtors. In order to be more confident
about the effectiveness of the internal control system, an internal auditor may
carry out an ageing analysis of the debtors’ accounts with large outstanding
amounts.

c) Corporate governance
Corporate governance consists of 4 elements, namely, the external auditor, the
audit committee, management, and the internal audit function. The internal
audit function serves as a resource for each of the other three parties
responsible for corporate governance. Accordingly, the nature and value of
corporate governance depends on the quality of the internal audit function.

The internal audit function provides an insight into the effectiveness and quality
of operations of an organisation. If the internal audit function is not performed
appropriately, it may provide misleading or insufficient information about the
functioning of the organisation, causing the objective of corporate governance
to be defeated.

Some expenses of management may be recorded under other account heads or

may exceed the budget. If the internal auditor does not bring this problem to
the attention of the audit committee, the whole purpose of corporate
governance may be defeated.

Traditionally, an internal audit was a review on behalf of management to

ensure that:
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(i) Existing internal controls are adequate and effective
(ii) Review and analysis of risk management activities is done
(iii) Financial and operating information is reliable
(iv) Review of corporate governance arrangements is done
(v) The laws and regulations and the policies of the management are complied
with
(vi) Assets of the entity are safeguarded
A (i), (ii), (iii), (v)
B (ii), (iv), (v), (vi)
C (i), (iii), (v), (vi)
D (i), (ii), (iii), (v), (vi)

2. Explain the objectives of internal audit.

[Learning Outcome b]

As mentioned above, internal audit is fundamentally concerned with

identifying, analyzing, and evaluating risks associated with management
functions to realize the objectives of an organisation. It is an integral part of
enterprise risk management.

Enterprise risks include financial risks, operational risks, technology risks,

market risks, and so on. Thus, the role of the internal auditor is to identify,
analyze and evaluate the above risks and also provide assurance to management
that all key risks are being managed effectively. He will evaluate the quality of
risk management processes, systems of internal control and corporate
governance processes across all parts of an organisation and report on these
aspects directly and independently to the most senior level of management.

Objectives of internal audit

The objectives of internal audit can be outlined on the following points:

1. Examination of financial accounting
2. Ascertain the effectiveness of accounting policies
3. Ensure observance of financial orders
4. Confirm existence of proper authority for all business decisions
5. Confirm genuineness of liabilities
6. Improve internal control system
7. Review accounting system
8. Analyse various risk factors
9. Physical verification of assets
10. Detect and prevent fraud
11. Ensure protection of interest of all stakeholders
12. Carry out special investigation
13. Reviewing various organizational activities
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Which of the following contain the primary objective of internal audit?
A Performing audit procedures to reduce the cost of statutory audit
B Providing opinion on the true and fair nature of financial statements
C Identifying fraud
D Identifying, analyzing, and evaluating risks associated with management
functions to realize the objectives of an organisation

3. Explain the relationship between statutory and internal auditors.

[Learning Outcome c]

The function of an internal auditor being an integral part of the system of

internal control, it is obligatory for a statutory auditor to examine the scope
and effectiveness of the work carried out by the internal auditor.

Under the Companies, Companies (Auditor's Report) Order, 2015 notified by MCA
on 10-4-2015 the statutory auditor is required to comment (as amended in Nov,
2004) on the internal audit system.

For the purpose, the statutory auditor should examine:

1. The organisation of the Internal Audit Department
2. Skill, qualifications, strength and efficiency of the audit staff
3. The internal audit procedures
4. The scope and extent of internal audit examination with reference to
internal audit reports
5. Points raised therein and the subsequent actions taken by management on
the internal audit queries.
6. Independence: The extent of independence exhibited by the internal auditor
in the discharge of his duties and his status in the organisation are important
factors for the statutory auditor to determine the effectiveness of internal
audit commensurate with the size and nature of the organisation.

Little LLP, an audit firm, is the ERP consultant of RSA Technologies last year.
John, an employee of Little LLP, was involved in setting up the ERP systems in
RSA Technologies. Now, Little LLP has been appointed as the internal auditors
of RSA Technologies. Little proposes to assign the internal audit task to John.

In this situation, John would be required to review the controls in the ERP which
were set up by him. This causes a threat to the auditor’s independence because
he could face a conflict of interest, i.e. if John notices some irregularities in
the controls of the ERP, he may not report the matter.

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7. Co-ordination with external auditors: In a large business, it has been
recognised that if examination functions of internal auditors and those of
statutory auditors are integrated, the statutory auditors may not find it
necessary to examine and go over the same facts and figures as have been
previously examined and reported by competent and efficient internal
auditors.

Thus, internal audit examination and checking carried out by the internal
auditors efficiently and exhaustively are of great assistance to statutory
auditors and considered one of the most important factors for devising the
statutory audit programme.

If the statutory auditor is satisfied with the adequacy and the effectiveness
of the internal audit, he often curtails his audit work by dispensing with
certain detailed checking and verification. Therefore, working in close co-
ordination with the external auditors will ensure that the functions of
internal and external audits are not duplicated and the cost of external
audit is minimized.

8. Regulatory need for internal audit function: The Companies (Auditor's

Report) Order, 2015 notified by MCA on 10-4-2015 requires that companies
which meet any of the parameters mentioned below have the internal audit
system as a part of the internal control system. The parameters are as
follows:
 listed companies or
 companies having a paid-up capital of Rs.50-lakhs or
 companies having an average annual turnover in excess of Rs. 5 crores
for a period of 3 consecutive financial years immediately preceding the
financial year concerned

This is also an aspect that the statutory auditor has to examine and
comment upon.

Which of the following options contain the parameters set by The Companies
(Auditor's Report) Order, 2015 notified by MCA on 10-4-2015 that make it
mandatory for entities to have the internal audit system as a part of the
internal control system?
(i) Listed companies
(ii) Trusts
(iii) Companies having a paid-up capital of Rs.50 lakhs
(iv) Companies having a paid-up capital of Rs.40 lakhs

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(v) Companies having an average annual turnover in excess of Rs. 5 crores for a
period of 3 consecutive financial years immediately preceding the financial
year concerned
A (i) or (ii) or (iv)
B (i) or (iii) or (v)
C (i) or (iii)
D (i) or (iv)

4. Explain the major considerations for devising internal audit

systems in general insurance business.
[Learning Outcome d]

Every insurance company must have a sound system of internal audit for the
obvious reasons mentioned above. In order to ensure effectiveness and
adequacy of the internal audit system, the insurance company generally
considers the following aspects while devising an internal audit system.

1. Internal Audit Manual

An insurance company must have an exhaustive and well-defined audit manual
prescribing policy, principles and procedure of internal audit, keeping in view
the underwriting policy, risk inspection policy, reinsurance policy, investment
policy, accounting policy etc. Internal audit can be conducted efficiently if
internal auditors have a good understanding of company policies and internal
audit procedures which relate to insurance business.

2. Professional Approach
The head of the audit and inspection department at the head office should be
preferably a professional, senior and experienced person who could report
directly to the top management on the performance, prospects and problems of
various departments and discuss on possible ways of improvement in the
internal control system. The officers in this department should have sufficient
experience and exposure in all department functions, through knowledge on
corporate rules and manuals on various aspects and also on various regulatory
norms and requirements.

3. Periodicity of Audit
The periodicity of the internal audit for every operational unit should be at
least once in a year, and preferably unannounced, or without intimation (i.e.
having a surprise element).

4. Coverage of Audit
The coverage of internal audit should be made comprehensive so that statutory
auditors get satisfied with the adequacy and effectiveness of internal audit and
that all fraud or financial irregularities are detected by internal audit
inspection.
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The inspection / audit officials should also critically analyse and study in-depth
all fraud-prone areas such as acceptance of bad or declined risks, settlement of
fraudulent claims, functions in establishment and estate department , financing
and investment activities, loans and advances to employees, inter-related
parties’ transactions, balancing of books, reconciliation of inter-branch
accounts, third party claim settlements etc.

5. Special Investigation
The internal auditor should scrutinise the suspense account, long pending cases
of uncleared cheques, High Value Claim Settlement, Off-balance sheet
transactions etc.

6. Supplementary Short Inspections

The annual internal inspection should be supplemented by surprise short
inspections at irregular intervals, particularly of large branches on certain
specific transactions like incentive payments, arrear payments on revision of
salaries, MACT claims, HRM functions, payment of non-core benefits etc.

7. Revenue Audit
Besides annual internal audit and short inspections, there should be a regular
system of revenue audit or underwriting audit including verification of practice
of risk acceptance – whether on proper risk-inspection as per laid down norms,
observance of laid-down norms in case of a break in insurance or in case of
acceptance of large and complicated risks.

8. EDP Audit
Internal audit is conducted to ensure that the EDP applications have resulted in
a consistent and reliable system for inputting of data, processing and generation
of output. For this purpose, various tests to identify erroneous processing, to
assess the quality of data, to identify inconsistent data and to compare data
with physical forms should be introduced by the internal auditor in his system of
audit. Entire domain of EDP activities (from policy formulation to
implementation) should be brought under close scrutiny of Inspection and Audit
Department.

9. Audit Compliance Cell

There must be an audit compliance cell responsible for review compliance of
audit queries raised by the internal auditor and review the implementation of
the guidelines issued by the internal auditor in view of the procedural lapses in
order to improve the performance of the unit itself and various departments
functioning in the unit.

10. Audit Committee of Board (ACB)

ACB provides direction and oversees the operations of the total audit function in
insurance. The total audit function includes the organisation, operation and
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quality control of internal audit and inspection within the organisation and
follow-up on the statutory audit of the company, C&AG and Regulator. It may
review the follow up action on the internal inspection reports, particularly of
"unsatisfactory" branches and branches classified by the IRDAI as non-
compliance branches. It should also specially focus on the follow up on inter-
branch adjustment accounts, un-reconciled long outstanding entries in inter-
branch accounts, suit claims, MACT claims etc.

The head of the Audit Department at the Head Office should preferably:
(i) Be a professional
(ii) Be an employee of the company
(iii) Be a practicing professional
(iv) Report to the CEO
(v) Report to the top management
(vi) Be a topper in the professional course

A (i), (ii), (iv)

B (i), (iii), (v), (vi)
C (i), (v)
D (i), (iii), (v)

5. List the common internal audit queries in general insurance

business.
[Learning Outcome e]

The accountant and other officers must have adequate knowledge about the
common queries (relating to financial accounting) in the internal audit report,
which lead to qualifications to the statutory audit report afterwards.

Some of the common internal audit queries in a general insurance business

are as follows:

1. Inappropriate revenue recognition

Inappropriate revenue recognition occurs due to overstatement of premium
income, booking of advance premium as current premium, recording fictitious
income by way of excess booking of premium in co-insurance arrangement etc.
Rate of premium or commission may be incorrectly accounted.

2. Incorrect expenses recognition

Incorrect expenses recognition occurs due to treating:
 revenue expenses as capital expenditure or vice-versa,
 personal expenses of officers as business expenses,
 excess payment of motor car running expenses,
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 excess payment of incentive and non-core expenses
 incorrect categorisation of expenses

3. Understatement of outstanding claims liability

Understatement of outstanding claims liability occurs either in the form of
claims ‘reported but not registered” (RBNR) or reported but not enough
registered” (RBNER) to project higher solvency and inflated profits. Non
registration of a claim, delayed registration of a claim, under or over
provisioning may impact this.

4. Overstatement of Assets
Overstatement of Assets occurs from avoiding impairment or proper
depreciation of assets.

5. Misappropriation of assets
Misappropriation of assets occurs due to fraudulent conduct in the incorrect
booking of premium or settlement of fraudulent / false claims.

6. False accounting entries

False accounting entries by way of window dressing i.e. wrong valuation of
investments or other asset.

Collections made before 31st March in respect of risks commencing on or after

1st April of the next year are accounted for as premium income in the
accounting year. This is an example of:

A Incorrect expense recognition

B Inappropriate revenue recognition
C Misappropriation of assets
D False accounting entries

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6. Provide detailed audit programmes to be carried out by internal
audit and inspection function in the areas of:
i. Premium income, refund premium and commission
ii. Claims and estimated liabilities for outstanding claims
iii. Commission
iv. Coinsurance
v. Bank transactions and bank reconciliation
vi. Fixed assets
vii. Advances
viii. Investment audit
[Learning Outcome f]

The most important areas of work carried out by internal audit relate to the
review the internal control systems. Therefore, most of the internal audit
queries pertain to system and procedural lapses. Generally, procedural or
system lapses result into financial irregularity, frauds and loss of revenue for
the company. Therefore, the internal auditors should always take serious view
of system and procedural lapses and report them. Following are the areas where
system lapses may arise and cause financial loss of revenue to the company or
insurance fraud in some cases.

 Premium Income, Refund Premium and Commission

 Claims and estimated liabilities for Outstanding Claims
 Commission
 Coinsurance
 Bank Transactions and Bank Reconciliation
 Fixed Assets
 Advances
 Investment Audit

6.1 Premium Income, Refund Premium and Commission

In auditing Premium Income, Refund of Premium and Commission expenses, the

internal auditor is to examine the following aspects:

1. All policies for risks commencing in the year are accounted for in the same
year. There should not be any instances of carry-over of premium to the
next accounting year in respect of risks commencing in the year. This will
ensure that the matching principle of recording income and the related
expenses during the same period will be ensured.

2. Collections made before 31st March in respect of risk commencing on or

after 1st April of the next year should not be accounted for as premium
income in the accounting year and such collections are to be credited to
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 “Premium Received in Advance A/c. This will be in line with the accrual
system of accounting.

3. In Marine Hull and other Engineering policies allowing collection of

premium on installment (like MCE policies), instalments received within the
accounting year are duly accounted for. The accounting aspect of
bifurcating Marine and Engineering portions in case of MCE policies has to be
followed.

4. In all Declaration Policies expiring before March, premium should be

reworked, and refund endorsements, if any, have to be passed before
closing the books of accounts.

5. All dishonoured cheques returned by banks up to 31st March are to be duly

accounted for and cancellation endorsements are to be passed by the office
immediately.

6. Co-sharing of business amongst operating offices are not allowed.

7. Excess collections to be refunded are shown in a register with complete

details.

8. Collections due for documents to be allotted are to be verified. As far as

possible, it should be ensured that no collection remains outstanding under
this head as all collections for which risk is commencing in the year have to
be accounted for in the same year and should not be carried over to the
next year. Similarly, collection for which risk is commencing on or after 1st
April should be transferred to ‘premium received in advance account’.

9. Bank Guarantee Account should show client-wise balances mentioning

clearly the bank guarantee limit, expiry date and subsequent collection
particulars.

6.2 Claims and estimated liabilities for Outstanding Claims

While checking claims paid and estimated liabilities for outstanding claims, the
internal auditor may look into the following aspects:

1. Claims Settled:
The auditor should examine whether the settlement of all claims are in
accordance with:
 the corporate manual,
 the financial order delegating financial authority; and
 power for claims settlement
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Furthermore, the auditor will examine whether the legal and technical aspects
have been duly taken into consideration by the authority approving the
settlement of claims as per the financial limits.

2. Liabilities for Outstanding claims

The auditor has to verify that:

a) Liabilities for outstanding claims are determined after review of outstanding

claims by the department. Outstanding claims must be made with reference
to:
 policy terms and conditions,
 nature and damages described in claim intimation,
 survey report,
 post-claim inspection, if any etc.

b) Outstanding claims statements are to be verified with reference to the

claims file and the latest review report.

c) In respect of coinsurance business where the company is the leader,

provision for outstanding claims has to be made only for its share. Full
particulars of the claims registered by the company should be sent to the
co-insurers for enabling them to make necessary provisions in their books of
account.

d) In the case of coinsurance business where the company is not the leader,
provision should be made for its share of claim as intimated by the leader
company. In respect of incoming coinsurance, the office should address a
letter to the lead insurer seeking information / confirmation regarding
claims outstanding at the end of the year.

e) While providing for third party outstanding claim, it is to be ensured that

interest has been provided from the date of petition as per the rates advised
by the corporate office technical department. Each year, the provision
should be revised taking into account the rate of interest for the current
year, as per the corporate circular.

f) Estimated liabilities for outstanding claims are booked on net of salvage

basis.

g) Deposits paid to courts as per the award have been debited to the claim
account directly and not to sundry advance account or sundry deposit
account or suspense account. Outstanding claim provision to the extent of
the deposit made should be reduced.

h) If the amount is placed in a fixed deposit in the company’s name and the
receipt is deposited in the court, full provision has to be made in the
outstanding claims statement.
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6.3 Commission
1. Commission control account should be verified with reference to:
 premium register, and
 commission payment register.

2. Statement of outstanding commission are prepared periodically, showing

agent-wise balances should be also examined.

3. If any agents’ account shows debit balances, the balances should be

recovered from the agent. Similarly, the corporate agency commission
account and brokerage control accounts are to be examined with reference
to the statement showing corporate agent / broker wise details.

6.4 Coinsurance
Coinsurance settlement is one of the major items of internal audit check and
verification.
1. It is to be ensured that:
 all co-insurance premium has been booked as per the mandate of the
client or his brokers
 there is no excess booking to bolster income and for window dressing in
the accounts by the operating units
 all claims booked in the Co-insurance Account are supported by claim
details and details of payment, if made by the leader.
2. Settlement of all coinsurance balances on a periodical basis should be
stressed upon to reduce the possibility of wrong booking and padding of
premium income.
3. However, if coinsurance balances are not settled by the year end, then
outstanding balances should be supported by written confirmation from the
other co-insurers concerned.
4. In the case of premium recoverable from other insurers, the policy number
and other details of the leader should be verified.
5. Subsequent adjustment / settlement particulars are to be verified.

6.5 Bank Transactions and Bank Reconciliation

1. The internal auditor is to thoroughly scrutinize reconciliations of all bank

accounts and should see that reconciliations of all bank accounts, including
inoperative bank accounts, are up to date, keeping in mind that delay in
bank reconciliations may lead to lot many irregularities such as accounting
frauds, issuance of policies without the requisite premium received in-
advance etc.
2. To verify that there is no long-pending case for “Cheques Deposited, but Not
Credited” in BRS, proper follow up with banks on a regular basis is necessary
to ensure that cheques deposited with banks are credited to our account
within the time-limit as per the RBI guidelines.
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3. To ensure timely transfer of funds as per standing instructions has to be
monitored so that pool accounts keep only the required balances.
4. To confirm that cheques dishonoured are accounted in time to avoid
carrying the risk.
5. Unidentified credits and debits have to be accounted immediately in liaison
with the bankers. Internal auditors have to check these entries.
6. All payments and receipts are to be brought under ‘Maker-checker’ concept
to avoid misuse of funds unless they join hands.
7. In case of ‘Online’ payments, auditors have to see that ‘end-to-end
encryption’ is happening to avoid manual intervention.
8. Under no circumstances should the book balance be overdrawn.

6.6 Fixed Assets

1. Ensure maintenance of fixed asset register
The Internal Auditor is to verify that the office has maintained a fixed assets
register. The register has to be updated then and there. Non-maintenance of
fixed assets register generally leads to serious audit qualification in the
Statutory Auditor’s report. Physical verification of inventory should be done at
frequent intervals with the statement of assets maintained by the accounts
department.

2. Reconciliation of fixed asset register

Fixed Asset Register must be reconciled with Accounts schedules forming part of
the financial statements.

3. Correct updates of register

The Internal Auditor shall verify that:
 the location of each asset is specifically mentioned, and should there be a
change in location, the same should be promptly recorded in the Assets
register.
 accounting entries are recorded in the respective office’s books of account
to give effect to such transfer in accounts.
 necessary details for sale / transfer of assets are entered into the assets
register.

4. Appropriate entries relating to depreciation

Depreciation on Assets has to be provided in the books of accounts on all the
assets.

On an asset, depreciation can be provided under the following conditions only.

 Assets purchased and put to use (commissioned) during the year.
 Assets purchased and ready for putting to use (ready for commissioning)
during the year (even though not put to use during the year).

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 Payment for purchase of assets made or not made during the year: this does
not have any bearing on providing depreciation on assets.
 When an asset is transferred from one office to another, the cost price,
depreciation fund and depreciation charged as per the Income Tax Act or
corporate guidelines should also be simultaneously informed to the
transferee office for tax audit purpose. This should be done along with the
book balance, depreciation fund balance and the depreciation charged in
the books.
 Depreciation on Assets has to be provided for in the books of accounts at the
rates applicable as per the Companies Act, 1956 or the Income-Tax Act,
1961, whichever is higher.

6.7 Advances
The audit procedures relating to advances are as follows:

1. All advances have been sanctioned by appropriate authority for the required
purpose.
2. The Internal Auditor is to examine that all advances paid to employees have
been settled as per the norms and procedures laid down by the company.
3. Advance register must be examined thoroughly for each advance and
settlement thereof.

6.8 Investment Audit

Investments constitute a significant portion of total assets in insurance business
as we have discussed in detail in the earlier chapters.

Investments of policyholders’ funds and shareholders’ funds are assets held by

insurance companies for earning income by way of:
 dividends
 interests
 rentals
 capital appreciation for the benefit of both policyholders and shareholders.

With substantial investment income, almost all insurance companies manage to

set off underwriting loss and survive in a de-tariff market today. So auditors are
required to verify investments very sincerely so as to ensure survival and growth
of business. The auditors shall verify both current investments and long-term
investments. As we have discussed earlier, investment accounting follows the
regulatory norms specified by IRDAI Investment Regulation (as discussed in unit
15).

Therefore, the auditor should particularly consider the following aspects in

regard to investment audit:

1. Internal control over acquisition, accretion and disposal of investment

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The auditor should verify that the acquisition and disposal of investments are
approved by the appropriate authority and are made in accordance with the
regulatory requirements.

2. Safeguarding of investments
The auditor should verify that all investments have been made in the name of
the entity only, and there exists a proper system for the safe custody of all
scripts and other documents of title to investment belonging to the company.

3. Control relating to title to investment

The auditor should verify that the title to all investments has passed on to the
organisation immediately on acquisition. If it is not transferred immediately
after acquisition, it must pass on to the insurance company within the shortest
period of time with all benefits.

4. Information control
Internal auditors shall give special emphasis on information control in respect of
acquisition, disposal, accretion and valuation. They should verify the detailed
records regarding acquisition and disposal etc. of the investment along with
proper documentation.

5. Physical verification of investments

The auditors shall verify the physical existence of all investments as per records
and register and verify valuation as per the regulatory norms with reference to
the IRDAI Regulations on Accounts and Audit.

The verification of investments may be carried out by auditors by employing the

following procedures:
 Verification of investment transaction
 Physical inspection of investment in the form of shares, debentures and
other securities, especially those which are not in ‘demat’ format.
 Examination of valuation and disclosure as per the regulatory requirement.
 Analytical review of income derived from investment with reference to the
total value and volume of the investment.

Conclusion
In this chapter, we have discussed the internal audit procedures and techniques
only for a few selected items of income, expenditure and assets with a view to
highlight the fact that financial accounting and internal audit are inter-related
and inter-woven. Without proper internal audit system and control, the
financial statements of an entity will never exhibit true and fair view of profit
or loss and the state of affairs of the entity, which is the ultimate objective of
financial statements.

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Which of the following instructions are to be strictly followed by the operating
offices in respect of co-sharing of business between two operating offices?

(i) The policy issuing office will account for 100% of premium, claims and
outstanding claims
(ii) The co-sharing office will account for 100% of premium, claims and
outstanding claims
(iii) Co-sharing is not allowed
(iv) IBD at RO/HO will monitor the sharing arrangement and pass on necessary
notional credit to the sharing offices at the year-end.

A (i)
B (ii)
C (iii)
D (iv)

7. Explain the reporting systems for internal auditors.

[Learning Outcome g]

There are no formal standards set for the reporting systems for the internal
audit function. However, best practices recommend the following reporting
system for internal auditors:

1. The Internal auditors will report to the top management with their
recommendations for necessary improvements in case of deficiencies and
actions for irregularities and fraud.
2. They should also verify that management has taken immediate action for
rectification of mistakes, wrongs and irregularities reported.
3. If the reported mistakes, wrongs and irregularities are not rectified within a
reasonable period of time, these may be reported to the CEO.
4. There must be a system of timely review of the working of concurrent audit.

Which of the following statements is incorrect?

A There are formal standards set for the reporting systems for the internal
audit function
B The Internal auditors should report to the finance manager.
C The internal auditors should verify that management has taken immediate
action for rectification of mistakes, wrongs and irregularities reported
D There must be a system of timely review of the working of concurrent audit

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8. Explain the standards on internal audits (SIA)
[Learning Outcome h]

The following standards on internal audit are in force:

1. Integration of internal audit system with other systems of internal

control and accounting control
While instituting the internal audit system in insurance companies, attempt
should be made by the head of the department to integrate it with other
systems of internal control and accounting control in respect of all operational
activities which change with changes in market conditions, technology, product
development and regulatory requirements.

Example: Online selling of insurance policies has the necessary technology in

place in order to carry out such transactions. However, the use of IT technology
can also result in leakage of revenue if internal controls are not in place.
Therefore, insurers need to have staff who are aware of the working of the
system, in addition to the internal control systems of the company. This will
enable them to understand the sufficiency of internal controls (like restricted
access to various staff working on the system) and also its integration with the
accounting systems. Internal audit staff will then be able to effectively audit
the design as well as the implementation of the internal control systems for this
kind of transactions.

2. Documentation of system of internal audit and inspection

It is necessary that the entire system of internal audit and inspection is properly
documented.

3. Standards of internal audit

Considering the ever-increasing importance of internal audit in contemporary
business, the Institute of Chartered Accountants has brought out certain
standards of internal audits (SIA).

The Standards on Internal Audit (SIAs) establish uniform evaluation criteria,

methods, processes, and practices. The Standards are pronouncements which
form the basis for conducting all internal audit activity. These pronouncements
are designed to help the internal auditor to discharge his responsibilities.

It covers various aspects such as Reporting, Sampling, Analytical procedures,

Quality Assurance, Terms of engagement, Evidence, Communication with
management, Correlation with External Authority Auditors and responsibility for
detection of frauds. These standards, codifying the best practices of internal
audit, may provide the benchmark for internal audits in any organisation. The
internal audit department in insurance companies may apply these standards to
the extent as relevant to make the internal audit system more effective and
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responsive to the needs of the insurance business to improve quality of financial
accounting.

4. IRDAI regulations
The IRDAI has also amended its regulation to provide that:
 every insurer having Assets under Management (AUM) not more than
Rs.1,000 crore shall have a Quality Internal Audit and
 insurers having AUM above Rs.1,000 crores should appoint a Chartered
Accountant Firm for concurrent Audit.

Traditionally, the head of the internal audit department (in insurance

companies) integrated the internal control systems with other systems of
internal control and accounting control in respect of all operational activities
which change with changes in market conditions, technology, product
development and regulatory requirements.

The above statement is:

A True
B False

Summary
 Internal Auditing is an independent, objective assurance and consulting
activity designed to add value and improve an organisation’s operations. It
helps an organisation accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk
management, control and governance process.
 The scope of internal audit is not confined to routine checking of the
accounting records but also includes an appraisal of the various operational
functions, and providing advice and recommendations on the activities and
operations reviewed.
 Internal audit is fundamentally concerned with identifying, analyzing and
evaluating risks associated with management functions to realize objectives
of an organisation. It is an integral part of enterprise risk management.
 Under the Companies (Auditor's Report) Order, 2015 notified by MCA on 10-
4-2015 the statutory auditor is required to comment (as amended in Nov,
2004) on the internal audit system.
 In order to ensure effectiveness and adequacy of the internal audit system,
the insurance company generally considers the following aspects while
devising an internal audit system:
 Internal audit manual
 Professional approach
 Periodicity of audit
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  Coverage of audit
 Special investigation
 Supplementary short inspections
 Revenue audit
 EDP audit
 Audit compliance cell
 Audit committee of board (ACB)
 There are no formal standards set on the reporting systems for the internal
audit function.
 While instituting the internal audit system in insurance companies, attempt
should be made by the head of the department to integrate it with other
systems of internal control and accounting control in respect of all
operational activities which change with changes in market conditions,
technology, product development and regulatory requirements.

Answers to Test Yourself

Answer to TY 1
The correct option is C. Traditionally, an internal audit was a review on behalf
of management to ensure that:
(i) existing internal controls are adequate and effective
(ii) financial and operating information is reliable
(iii) the laws and regulations and the policies of the management are complied
with
(iv) assets of the entity are safeguarded

Answer to TY 2
The correct option is D. Internal audit is fundamentally concerned with
identifying, analyzing, and evaluating risks associated with management
functions to realize objectives of an organisation. It is an integral part of
enterprise risk management. Option B is incorrect as providing an opinion on the
true and fair nature of financial statements is the primary objective of statutory
audit. Identifying and preventing fraud is the primary responsibility of
management.

Answer to TY 3
The correct option is C. The Companies (Auditor's Report) Order, 2015 notified
by MCA on 10-4-2015 requires that companies which meet any of the parameters
mentioned below have the internal audit system as a part of the internal
control system. The parameters are:
 the companies are listed companies or
 the companies have paid-up capital as specified in the order or
 companies have an average annual turnover in excess of Rs. 5 crores for a
period of three consecutive financial years immediately preceding the
financial year concerned
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Answer to TY 4
The correct option is C. The head of the Audit and Inspection Department at the
Head Office should be preferably a professional, senior and experienced person
who would report directly to the Chairman on the performance, prospects and
problems of various departments and discuss possible ways to improve the
internal control system.

Answer to TY 5
The correct option is B. Inappropriate revenue recognition occurs due to
overstatement of premium income.

Answer to TY 6
The correct option is C. Co-sharing of business is not allowed among operating
offices.

Answer to TY 7
The correct option is C. Option A is incorrect as there are no formal standards
set on the reporting systems for internal audit function. Option B is incorrect as
internal auditors should report to the top management. Option D is incorrect as
there must be a system of annual review of the working of concurrent audit.

Answer to TY 8
The correct option is B. The age-old internal audit practices and procedures
followed by entities were without having regard to the changes in the other
department.

Self Examination Questions

Question 1
The audit compliance cell is responsible for:
(i) Reviewing compliance of audit queries raised by internal audit
(ii) Providing direction and oversee the operations of the total audit function in
insurance
(iii) Reviewing the implementation of the guidelines issued by the Internal
Auditor in view of procedural lapses
(iv) Focusing on the follow up on Inter-branch adjustment accounts

A (i) and (iii)

B (i), (ii) and (iii)
C (ii), (iii) and (iv)
D (i) and (iv)

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Question 2
Fraud-prone areas in general insurance business include:
(i) High value claim settlement
(ii) Off-balance sheet transaction
(iii) Acceptance of bad or declined risks,
(iv) Loans and advances to employees
(v) Balancing of books,
(vi) Reconciliation of inter-branch accounts,
(vii) Third party claim settlement

A (i), (ii), (iii)

B (iii), (iv), (v), (vi) (vii)
C (i), (iv), (v), (vi)
D All the above

Question 3
Which of the following statements relating to advances is incorrect?

A The internal auditor examines all advances paid to employees in respect of

travelling, LTS and other advances
B Advance register should be examined thoroughly (by the internal auditor) for
each advance and settlement thereof
C All advances need to be sanctioned by the appropriate authority
D All are correct

Question 4
Proper internal audit system and control will ensure that the financial
statements of an entity will exhibit:

A A true and fair view of profit or loss and state of affairs of the entity
B A correct and accurate view of profit or loss and state of affairs of the
entity
C A correct and fair view of profit or loss and state of affairs of the entity
D A true and accurate view of profit or loss and state of affairs of the entity

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is A. The audit compliance cell is responsible for review
compliance of audit queries raised by internal auditors and reviewing the
implementation of the guidelines issued by the Internal Auditor in view of the
procedural lapses in order to improve the performance of the unit itself and
also of the various departments functioning in the unit.

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Points mentioned under (ii) and (iv) are applicable to the Audit Committee of
the Board. Therefore, the other options are incorrect.

Answer to SEQ 2
The correct option is D.

Answer to SEQ 3
The correct option is D.

Answer to SEQ 4
The correct option is A. With a proper internal audit system and control, the
financial statements of an entity will exhibit a true and fair view of profit or
loss and state of affairs of the entity.

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 CHAPTER 6
INDIRECT TAXATION

UNIT-19
GOODS & SERVICES TAX
Chapter Introduction

In this chapter we will discuss the concept of GST and some important
provisions of the Acts related to GST.

a) Formation of GST and GST council

b) GST model
c) Reverse Charge Mechanism
d) Registration of tax payers
e) Filing of returns

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1. Formation of GST and GST council
[Learning Outcome a]

To bring uniformity in indirect taxation, the Central Government has brought a

Goods & Services Tax Law in India which is a comprehensive, multi-stage,
destination-based tax that is levied on every value addition. It is an indirect tax
levied on the supply of goods and services.

Before GST, the sources of indirect tax revenue for the government were
customs duty, central excise duty, service tax, Central Sales Tax, entertainment
tax, octroi, entry tax etc.

The Goods and Service Tax Act was passed in the Parliament on 29th March 2017
and came into effect from 1st July 2017. The Goods and Services Tax is based
on two Parliamentary Acts – the IGST (Integrated Goods and Services Tax) Act
and the CGST (Central Goods and Services Tax) Act.

Advantages of GST:

1. It has replaced the erstwhile indirect taxes such as Customs duty,

Central Excise duty, Service tax, additional customs duty, surcharges,
state-level value added tax, Octroi and levies on Interstate goods
transport. Thus, there are fewer taxes now as it has replaced the
existing taxes.
2. It has simplified the tax structure with only 5 slabs.
3. It is addressing the cascading effort of various taxes by simplifying the
taxation process. Earlier, a transaction may get attracted to more than
one tax due to applicable provisions of the respective taxes.
4. GST has made the transactions more transparent due to periodical
matching of returns filed by both the supplier and the beneficiary.
5. Ultimately, tax structure is more rationalised and the law is clear, thus
people cannot escape from genuine taxation under the pretext of
ambiguity and complexity.
6. The procedure for filing returns, claiming refunds etc. are uniform for all
states, easing the compliance of tax provisions.
7. Credit of GST paid on input is available to the assessee.

History of formation of GST:

A committee was set up in 2000 to design a GST model for the country in VAT
format. The Central Government, then formed a taskforce on Fiscal
Responsibility and Budget Management in 2003 which recommended GST to
replace the existing tax regime by introducing a comprehensive tax on all goods
and services replacing Central level VAT and State level VATs. In 2005, the
Kelkar Task Force for a comprehensive tax on all goods and service replacing
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Central and State level VATs. It recommended replacing all indirect taxes
except the customs duty with value added tax on all goods and services with
complete set off in all stages of making of a product. The First Discussion Paper
on GST was released in November, 2009. This spelled out the features of the
proposed GST and has formed the basis for discussion between the Centre and
the States.

GST is a destination based consumption tax. Under destination based taxation,

tax accrues to the destination place where consumption of the goods or services
takes place. States having many manufacturing industries expressed their
concerns over the loss of revenue on account of shift from origin based taxation
to destination based taxation. Also, it was not easy to judge the loss or gain for
a state, thus the concept of compensation for states was suggested during the
first 5 year term of GST.

On rating, it was suggested for a rate that protects the desired revenue which
was in the range of 15%. The present rate slabs were fixed based on this, so that
basic consumables will have a lesser rate and the luxury ones attract a higher
rate.

A bill on GST was presented to Lok Sabha on 19.12.2014. It received assent of

the President on 8th September, 2016 and has since been enacted as
Constitution (101st Amendment) Act, 2016 w.e.f. 16.09.2016. By the 101st
amendment to the constitution, GST was effective to general insurance
companies effect from 1 July 2017, replacing the service tax regime.

Insertion of new article 246A specifies that Parliament has exclusive power to
make laws with respect to GST on inter- State supplies. Article 269A has been
inserted which provides for goods and services tax on supplies in the course of
inter-State trade or commerce which shall be levied and collected by the
Government of India and such tax shall be apportioned between the Union and
the States in the manner as may be provided by Parliament by law on the
recommendations of the Goods and Services Tax Council. Article 270 has been
amended to provide for distribution of goods and services tax collected by the
Union between the Union and the States.

GST Council:

Article 279A has been inserted to provide for the constitution and mandate of
GST Council. Any modification in GST Council shall also require the ratification
by the legislatures of one half of the States.

The GST Council was notified with effect from 12.09.2016. The Council is
comprised of the Union Finance Minister, the Minister of State (Revenue) and
the State Finance/Taxation Ministers as members. It shall make
recommendations on:
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 o the taxes to be subsumed under GST
o the goods and services that may be exempted from GST
o the laws, principles and apportionment of IGST
o the threshold limit of turnover for exemption
o the rate bands
o any other matter relating to the GST as the Council may decide.

Petroleum and petroleum products shall not be subject to the levy of GST till
notified by GST Council.

Presently, more than 160 countries have implemented GST / VAT but the
concept remain the same.

GST Compensation Cess:

The Goods and Services Tax (Compensation to States) Act, 2017 provides for
compensation to the States, especially the manufacturing states which lose
revenue due to GST being availed at end point.

Compensation will be provided to a State for a period of five years from the
date on which the State brings its SGST Act into force. A GST Compensation Cess
is levied on the supply of certain goods and services, as recommended by the
GST Council to mitigate such likely loss.

On the recommendation of the GST Council, compensation to the States for loss
of revenue arising on account of implementation of GST is provided for 5 years.

2. GST model
[Learning Outcome b]

GST model:

India has adopted dual GST model as the federal system functions based on
central and state governments. Under this, tax is levied concurrently by the
Centre as well as the States on a common base, i.e. supply of goods or services
or both.

Before, we go in detail, students should familiarize themselves on some of the

commonly used abbreviations.

Abbr. Expansion
GST Goods and Services Tax

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 CGST Central Goods and Services Tax
IGST Integrated Goods and Services Tax
GSTIN Goods and Services Tax Identification Number
GSTN Goods and Services Tax Network (used for filing returns)
B2B Business to Business (Supplies to registered persons having GSTIN or
UIN)
B2C Business to Customer (Supplies to consumers and un-registered
persons)
CIN Challan Identification Number
EWB E-way Bill
ARN Application Reference No. / Acknowledgement Reference No.
HSN Harmonised System of Nomenclature (for goods)
SAC Services Accounting Codes (for services)
ITC Input Tax Credit
POS Place of Supply (State/UT)
RCM Reverse Charge Mechanism
UIN Unique Identity Number
CBEC Central Board of Excise and Customs
SEZ Special Economic Zone
DTA Domestic Tariff Area

There are currently 3 types of GST:

Head Description Applicability Levied Statute

by
CGST Central GST Sales within the Central Central Goods &
state (intra state) Govt. Services Tax Act
SGST State GST / Sales within the State State Goods &
/ Union state (intra-state) Govt. Services Tax Act /
UTGST Territory UT Goods & Services
GST Tax Act
IGST Integrated Sales outside the Central Integrated Goods &
GST state (inter-state) Govt. Services Tax Act

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There is another tax ‘Compensation cess’ which is covered under Goods &
Services Tax (Compensation to state) Act, 2017.

For intra state supply, the following tax will be charged.

A CGST
B SGST
C IGST
D CGST & SGST

Under GST, there are 5 specified rates for services, classified as follows:

1 NIL rated
2 5%
3 12%
4 18%
5 28%

The rates are fixed for each classification of goods and services. For easy
identification of a goods or service, codes are used. HSN (Harmonized System of
Nomenclature) codes are used for the classification of goods and SAC (Services
account codes) codes are used for services.

GST Amount = Taxable value x GST rate %

Tax Invoice amount = Taxable value + GST amount

In case of Inter-state, the entire GST rate % is accounted under IGST.

In case of Intra-state, the rate % is shared between SGST and CGST. ie, if the
GST rate is 18% for an intra state transaction, the SGST rate would be 9% and
the CGST would be 9%.
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Example: If the cost is Rs. 1,000 for an intra-state sale, the taxable invoice
would be,

Taxable value 1,000

Add: CGST @ 9% 90
Add: SGST @ 9% 90
Total invoice 1,180

Example: If the taxable value is Rs. 1,000 for an inter-state sale, the taxable
invoice would be,

Taxable value 1,000

Add: IGST @ 18% 180
Total invoice 1,180

GST rates applicable for General Insurance services:

All the goods and services are classified into 21 sections and 99 chapters. The
chapters are again classified into 1,244 subheadings. Chapter No. 99 covers
‘services’. For each service, there is a separate HSC code (earlier called as
Services Accounting Code (SAC). The first 2 digits denote the ‘chapter’.

SAC Description of service Rate %

997133 Accident and health insurance services 18

997134 Motor vehicle insurance services 18

997135 Marine, aviation, other transport insurance services 18

997136 Freight insurance, Travel insurance services 18

997137 Other property insurance services 18

997139 Other non-life insurance services 18

However, the Government has exempted some of the general insurance services
from the ambit of GST.

The following are those exempted schemes:

1. Janashree Bima Yojana

2. Aam Aadmi Bima Yojana
3. Life micro-insurance product, max cover of 2 Lakhs.
4. Varishtha Pension Bima Yojana
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5. Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)
6. Pradhan Mantri Jan Dhan Yojana (PMJDY)
7. Pradhan Mantri Vaya Vandan Yojana (PMVVY)
8. Hut Insurance Scheme
9. Cattle Insurance under Swarnajaynti Gram Swarozgar Yojna (IRDP)
10. Scheme for Insurance of Tribals
11. Janata Personal Accident Policy and Gramin Accident Policy
12. Group Personal Accident Policy for Self-Employed Women
13. Agricultural Pumpset and Failed Well Insurance
14. Premia collected on export credit insurance
15. Restructured Weather Based Crop Insurance Scheme (RWCIS)
16. Jan Arogya Bima Policy
17. Pradhan Mantri Fasal Bima Yojana (PMFBY)
18. Pilot Scheme on Seed Crop Insurance
19. Central Sector Scheme on Cattle Insurance
20. Universal Health Insurance Scheme
21. Rashtriya Swasthya Bima Yojana
22. Coconut Palm Insurance Scheme
23. Pradhan Mantri Suraksha Bima Yojana
24. Niramaya Health Insurance Scheme

For Jan Arogya Bima insurance, the rate of GST chargeable would be -
A 18%
B 5%
C 0%
D Exempted

Output liability:

Let us understand the concept of Output liability of an insurance company.

Insurance companies charge GST on the following.

Major collections towards business:

1. Premium collection
2. Salvage collection
3. Other collections such as bank charges incurred
4. Coinsurance administration charges where the insurance company is the
leader

Major Non business collections:

1. Salvage not related to claims
2. Notice pay recoveries from employees on exit
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3. Penalty levied
4. Buy back of assets

On all these collections, GST is levied. The GST levied and collected are to be
remitted to the Government. This is the output liability for the insurance
company.

There will be Output Liability on account of the following Reverse Charges

o Agent Commission, Incentive, similar payment to agents. As agents are

not registered with GST, the company shall pay their liability on their
behalf.
o Legal fees paid to advocates
o Security Services provided by other than a Body Corporate
o Travel Agents
o Sponsorship services

While calculating output liability, challenges may arise in the following

areas.

1. GSTIN is not captured for Registered Party or an incorrect GSTIN is captured.

2. A GSTIN is corrected / rectified / amended after the collection is made.
3. The insured is an SEZ unit (Special Economic Zone) and only IGST is
applicable.
4. There is a change of address after collection or issuance of tax invoice.
5. The refund, cancellation, cheque dishonour accounting is done after 180
days of expiry of financial year.

Let us assume the following scenario

A sells a product for Rs. 100, charging 10% tax.

B buys it from A, adds Rs. 40 value, and sells at 10% tax.
C buys it from B, adds Rs. 30 value and sells at 10% tax to consumer D.

We now see the impact in case of GST regime, say at a tax rate of 10%.

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 Cost Value Value Tax @ Sale Input Tax
addition 10% value credit
(ITC)
claimed
A 100 - 100 10 110
B 100 20 120 12 132 -10 ITC claimed by
B
C 120 30 150 15 165 -12 ITC claimed by
C
100 50 37 165 -22 Final value
165 for D
Value = (100+20+30=)150+ Tax 37 – ITC 22 = 165
Thus, there is no cascading effect while implementing GST, ultimately the
consumer is benefited by, 190.30 – 165 = 25.30. Even the costs for B and C are
also less. Thus, there is a reduction in sale price when one can claim input tax
credit (ITC) which gets passed on to the buyer.
To understand more on the concept of GST, let us glance through another
example.

Seller A in Surat, Gujarat is selling service to Buyer B in Baroda, Gujarat.

Seller B, sells to Buyer C who is in Ahmedabad, Gujarat.
(Since all the services are intra state (within the state) SGST and CSGT are
applicable).

Let us see the impact of tax for all concerned, A, B, C, State Govt. and Central
Govt.

Person SGST SGST Claimed Revenue CGST CGST Revenue

collected paid as ITC to State collected paid to
Govt. Central
Govt.
Seller A
Service 100
SGST 9% 9 9
collected
CGST 9% 9 9
collected
Tax 118
invoice 1
SGST 9% -9 9
paid to
Govt.
CGST 9% -9 9
paid to
Govt.
Net tax 0 9 0 9
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impact

Buyer B
SGST paid 9 -9 -9
to A and
claimed as
ITC
CGST paid 9 -9 -9
to A and
claimed as
ITC
Net tax impact 0 -9 -9

Seller B
Service 200
SGST 9% 18 18
collected
CGST 9% 18 18
collected
Tax 236
invoice 2
SGST 9% -18 18
paid to
Govt.
CGST 9% -18 18
paid to
Govt.
Net tax impact 0 18 0 18

End user C
SGST paid -18
to B
CGST paid -18
to B

Net tax impact -18 -18

Net revenue to 18 18
Govt.

We infer the following from the above.

1. All transactions, both buying and selling are recorded by tax invoices. Thus,
all the revenue transactions are brought into tax net.
2. The transactions of the seller and the buyer are matched. An input credit
can be availed only when both the parties show their transactions correctly in
their books / GST returns. This ensures cross check of all revenue transactions
for the Government.
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3. In the chain of transactions, the net tax is the revenue for the Govt. Thus,
only the tax portion of the last transaction becomes the tax revenue of the
Government, ie, Rs. 18 each for both Central and State Govt. All the
intermediary tax collections are off-set by claiming input tax credit.
4. In case of incorrect information by any party, the link breaks and the other
party loses the benefit of claiming input credit. This ensures that any
manipulation of books by one person affects the other.

Thus, GST is a more transparent tax accounting mechanism, helping all honest
book keepers to get their tax benefits and traps others in case they falsify their
books. This is proven in this example that the net tax impacts for A and B are
Zero only as they maintain their books correctly. The final impact is the end
user thus paying the tax of 18%.

Students can expand the same example that all the above transactions are
among 3 different states (inter-state), the entire revenue of 18% will be
accounted as IGST and goes to the Central Govt.

Types of Supply:

Taxable Supply on which tax shall be paid under GST.

Supply Section 2(108) - a supply of goods and/or services which is
leviable to tax under the GST Act.

Zero-Rated Export or supply of goods or services to a Special Economic Zone

Supply developer or a Special Economic Zone unit.

Exempt NIL rate of tax or which may be wholly exempt from tax.
Supply It includes non-taxable supply.
The taxable person need not pay tax.
Sec. 2(47) – a supply of any goods and/or services which attract
NIL rate of tax or which may be ‘wholly exempt’ from tax under

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 Sec. 11 or under Sec.6 of IGST Act, and includes non-taxable
supply

Non- Non-taxable supply is the sale of any good or service which

Taxable attracts nil rate of tax.
Supply

Time of supply:
The time of supply is determined as below.
1. Date of issuing invoice (or the last day by which invoice should have been
issued)
2. the date of receipt of payment,
o whichever is earlier

Example: If the date of invoice is 15th Nov., 2021 and the date of receipt is 25th
Nov., then the time of supply would be 15th Nov.

Place of Supply of Services:

Determining the place of supply is very important as the three levels of Tax,
IGST, CGST and SGST are based on the ‘place of supply’. An incorrect mention
shall result in wrong classification of tax which will affect / favour the share of
central or state govt(s), as it may interchange among IGST, CGST and SGST.

Wrong classification of supply between interstate or intra-state may result in

confusion in case of a refund claim. Correct determination of place of supply
will help in identifying the incidence of tax.

For understanding Place of Supply for Services the following two concepts are
very important namely:
o location of the recipient of services
o location of the supplier of services

E-Way Bill System:

The electronic way bill system is a major leap forward in the history of inter-
state transport introduction by which there is only one ‘e-way bill’ for
movement of the goods throughout the country. This facilitates free movement
of goods without stopping them at state borders to collect state tax like Octroi
etc.

Introduced from 01.04.2018, the e-way bill system introduces single e-way bill
by calculation of distance based on PIN codes for the generation of e-way bill,
thereby avoiding preparation of multiple invoices.

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3. Reverse Charge Mechanism
[Learning Outcome c]

Reverse Charge Mechanism (RCM):

GST is to be collected by the person who is selling the goods or service. But in
some cases GST is incurred by the purchaser of goods/service and not by seller.
This is called Reverse Charge Mechanism.

There may be lakhs of agents all over the country and by incorporating GST on
agency commission, it would be voluminous to register all agents. To simplify
the process, the insurance company itself can pay the GST on commission on
behalf of their agents. This saves unnecessary registration and tedious
assessment procedure for agents.

The process of payment of GST by the purchaser itself is called as Reverse

charging.

Sec. 2(98) defines reverse charge as the liability to pay tax by the recipient of
supply of goods or services or both instead of the supplier of such goods or
services or both under section 9(3)/9(4), or under section 5(3)/5(4) of the IGST
Act.

Such instances happen when the supply of specific goods or services is notified
by government under Sec. 9(3). In such cases, the receiver of service will pay
the seller the payment without GST. The GST portion will be directly paid by
him to the Govt.

Normal charge
Service value 100 Purchaser pays to supplier
GST 18 Purchaser pays to supplier.
Supplier, in turn, pays to the Govt.

Reverse charge
Service value 100 Purchaser pays to supplier
GST 18 Purchaser pays tax directly to the Govt. on
behalf of the supplier.

The following transactions are not eligible for claiming Input credit.

o Employee related benefits such as refreshments, outdoor catering,

health services, Club membership
o Motor vehicle and other conveyance benefits
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 o Input applied on services related to exempt business e.g. PMFBY,
Ayushman Bharat Schemes etc.
o Rent a Cab, Life insurance premium or Health Insurance premium
o Works contract service when supplied for construction of immovable
property
o Goods & Services for construction, reconstruction, renovation, addition,
alteration or repair works.

Time of Supply under Reverse Charge

Reverse charge means the liability to pay tax is by the recipient of
goods/services instead of the supplier. In case of reverse charge, the time of
supply shall be the earliest of the following dates:

1. Date of payment
2. Date immediately after 60 days from the date of issue of invoice by the
supplier
o whichever is earlier

4. Registration of tax payers

[Learning Outcome d]

Registration of the taxpayers.

Registration gains importance to identify the jurisdiction where the person has
to be registered. A person who has not registered cannot collect GST. He cannot
claim any input tax credit of tax paid by him.

The Chapter VI of the GST Act, 2017 deals with this. It comprises of 9 sections.
Some of them are:

Section 22 - Persons liable for registration.

Section 23 - Persons not liable for registration.
Section 24 - Compulsory registration in certain cases.
Section 25 - Procedure for registration.

Liability to be registered State-wise:

Every supplier shall be liable to be registered in the State or Union Territory.
Thus, each supplier has to register State-wise. He cannot have a centralized
registration. He has to select the 'principle place of business’ in one state and
other locations in each state he functions shall be considered as ‘additional
place of business’.

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Sec.2 (89) defines ‘principal place of business’ as the place of business specified
as the principal place of business in the certificate of registration.

However, multiple registration within a state is permitted for separate business

verticals.

Determination of State or Union Territory:

The State or Union Territory where registration shall be done is the State or
Union Territory from where it makes a taxable supply of goods and/or services.

Territorial waters:

Sec. 2(56) defines “India” as the territory of India as referred to in article 1 of

the Constitution, its territorial waters, seabed and sub-soil underlying such
waters, continental shelf, exclusive economic zone or any other maritime zone
as referred to in the Territorial Waters, Continental Shelf, Exclusive Economic
Zone and other Maritime Zones Act, 1976, and the air space above its territory
and territorial waters.

Section 9 of IGST Act defines the local of supplier in the territorial waters as
below.
o Where the location of the supplier is in the territorial waters, the
location of such supplier.
o Where the place of supply is in the territorial waters, the place of
supply.
The location shall be deemed to be in the coastal State or Union territory where
the nearest point of the appropriate baseline is located.

Special Economic Zone (SEZ):

Special economic zone (SEZ) is a dedicated zone within India where tax and
benefits are special in nature. The objective of SEZ is to promote areas where
business is made busy due to exclusive benefits given. SEZs are located within
the country but treated as a special territory for tax purposes.

Any supply to or by a person from SEZ considered to be an interstate supply and

Integrated Goods and Service tax (IGST) will be applicable.

The SEZs are considered to be located as if they are in a foreign territory and
transactions with SEZs are classified as exports and imports.

GST status for SEZ:

Supply to SEZ Exempt

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Supply from SEZ to DTA Considered as export, hence exempt
Supply from SEZ to others Considered as Inter-state, hence IGST is
applicable

DTA – Domestic Tariff Area is the area outside the SEZ. It covers the whole of
India, including the territorial waters and continental shelf, but does not
include the areas of the SEZ. Hence, all the territory outside the SEZ is the DTA.

Threshold limits for exemption of registration:

The service providers below the specified limit of total turnover need not
register themselves with GST. Under Sec. 2(6), ‘aggregate turnover’ means the
aggregate value of all taxable supplies, exempt supplies, exports of goods
and/or services and inter-State supplies of a person having the same PAN.

State of Manipur, Mizoram, Nagaland, Tripura Rs. 40 lakhs

Other states Rs. 20 Lakhs

Taxpayers may opt for multiple registrations within a State/Union territory in

respect of multiple places of business located within the same State/Union
territory.

Mandatory registration is required for only those e-commerce operators who are
required to collect tax at source.

Major class of person required to obtain registration:

Sec. 22 of the GST Act, 2017 mentions 4 categories of persons who are required
to register.
1. Person who has crossed the aggregate turnover,
2. Person holding license under an existing law,
3. Business carried on by the taxable person registered under this Act is
transferred, whether on account of succession or otherwise, to another person
as a going concern, and
4. Transfer pursuant to sanction of a scheme or an arrangement for
amalgamation or, as the case may be, de-merger of two or more companies.

GST Registration number consists of a 15 digit identification number.

Digit Digits Description

range
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1 to 2 2 Ranging from 01 to 35 refers ‘State code’ for registration
3 to 12 10 PAN of the entity
13 1 It refers to the Entity code. It is in order in which
registrations was made by an entity which has more than one
registration within the same state.
If an entity has 2 business verticals registered within the
same state, the first registration will have 1 and the second
registration will have 2 here.
14 1 Presently, it is shown as Z; kept for future use by the dept.
15 1 A randomly assigned alphabetical or numeral Check code

Example: The GST number of The New India Assurance Co. Ltd. in Maharashtra
is 27AAACN4165C3ZP.

Maharashtra state PAN Entity Temp Random

27 AAACN4165C 3 Z P

State codes:
TIN State Abbr. TIN State Abbr.

12 Andhra Pradesh AP 14 Manipur MN

37 Arunachal Pradesh AR 17 Meghalaya ML
18 Assam AS 15 Mizoram MZ
10 Bihar BR 13 Nagaland NL
22 Chhattisgarh CG 21 Orissa OR
30 Goa GA 03 Punjab PB
24 Gujarat GJ 08 Rajasthan RJ
06 Haryana HR 11 Sikkim SK
02 Himachal Pradesh HP 33 Tamil Nadu TN
01 Jammu & Kashmir JK 36 Telangana TS
20 Jharkhand JH 16 Tripura TR
29 Karnataka KA 05 Uttarakhand UK
32 Kerala KL 09 Uttar Pradesh UP
23 Madhya Pradesh MP 19 West Bengal WB
27 Maharashtra MH 97 Other territory* OT

TIN U/T Abbr. TIN U/T Abbr.

35 Andaman & Nicobar AN 38 Ladakh LA
04 Chandigarh CH 31 Lakshadweep LD
Dadra & Nagar
26 DNHDD 34 Pondicherry PY
Haveli, Daman & Diu
27 Delhi DL
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*Section 2(81) of CGST Act defines that ‘other territory’ includes territories
other than those comprising in a State and those referred to in sub-clauses (a)
to (e) of clause (114).
Accuracy of GSTIN is very important, hence the correct number should be
entered in the system. It can be cross verified from GST portal,
services.gst.gov.in.

Once the GSTIN of the tax payer is entered, the following details are displayed.

o Legal name of the business

o Trade name
o Effective date of registration
o Constitution of business
o GSTIN/ UIN status (whether active or not)
o Tax payer type
o Administrative office (of GST dept.)
o Principal place of business (of the state)

Once registered, a taxable person can issue taxable invoices, avail input tax
credit (ITC) for his purchases, help the buyers to claim their input credits, can
do inter-state transactions with much ease.

At the same time, he is responsible to register in all states where he has

established his business, pay taxes and file returns within the time line
prescribed.

5. Filing of returns
[Learning Outcome e]

Filing of Returns:

A return is a summary statement containing the details on a specific type of

supply for a particular period. Every return is to be filed in the prescribed
format within the specified time limit.

GSTR-1:

Details of outward supplies of taxable goods / services of the tax payer. It

includes details of invoices, debit notes, credit notes and revised invoices issued
during the tax period. This is filed by the supplier.

Due date for filing the return: 11th of succeeding month

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Challenges arise in case of incorrect GSTIN / not entering GSTIN at all where the
party has GSTIN.

Wrong selection of using IGST for Intra state service also creates issues.

GST not to be collected in SEZ may be wrongly selected.

GSTR-2A:

When the Supplier files GSTR-1, it is reflected in GSTR-2A of the recipient

automatically. Thus, GSTR-2A is an auto generated return in Govt. portal. It can
be downloaded from the site services.

gst.gov.in -> Return dashboard -> select financial year and month -> Auto
drafted details (for view only) GSTR2A -> Download

Mismatch between 2 and 2A:

o Wrong GSTIN of vendor in supplier’ records
o Incorrect tax invoice no., date, GSTIN or amount
o Tax type mismatch
o Vendor has not filed his return

GSTR-3B:

GSTR 3B is a summary return. The amount of ITC available as disclosed in Table

4(a) must match with tax details disclosed in Form GSTR-2A. Input can be
availed only after matching of payment invoices. GSTR-3B is a summary of
Payments- output liability, input available and input availed. It ensures that
credit is being claimed only in respect of the tax which has been actually paid
to the supplier. It also cross checks that any record is not duplicated or missed.

Due date: 20th succeeding month

GSTR 7

GST law mandates TDS vide section-51 of the CGST/SGST Act 2017, Section 20
of the IGST Act. PSU and various other government establishments only are
required to deduct TDS under section 51 of the CGST Act. TDS is applicable for
only registered Supplier.

Tax is required to be deducted from the payment made to a supplier if the total
value of supply under a single contract in respect to taxable supply of goods and
services or both exceeds Rs.2,50,000.

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This value shall exclude the taxes leviable under GST. (CGST, SGST, IGST &
Cess).

Inter State Supplies 2% on IGST

Intra State Supplies 1% on IGST

No TDS is to be deducted where supply of goods and services are from one PSU
to another PSU. (Notification 61/2018 CGST)

Due date: 10th of succeeding month

GSTR-9:

This is applicable to supplies made through e-commerce operator. It is an

annual Return to be filed once in a year by the Registered Taxpayer.

It is an annual return to be filed once in a year by the registered taxpayers

under GST including those registered under composition levy scheme (GSTR 9A)
and those engaged in the supply of goods of suppliers on electronic commerce
platform. (GSTR 9B).

It consists of details regarding the supplies made and received during the year
under different tax heads i.e. CGST, SGST and IGST. It consolidates the
information furnished in the monthly/quarterly returns during the year.
Currently, it is optional for taxpayers having a turnover up to Rs. 2 Crores.

………….. is an auto generated GST return in Government portal.

A GSTR-1
B GSTR-2
C GSTR-2A
D GSTR-3

Late filing of GST Returns

The following points are to be noted for filing returns.

o Since filing return under GST is mandatory, return must be filed even if
there is no transaction during the period.
o Returns are to be filed with the frequency mentioned, ie, monthly or
quarterly or annually.
o The filing is to be done within the due date.
o Return for a month cannot be filed unless all earlier returns are filed.
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 o Late filing of return will have cascading effect resulting in penalty.

Interest and Late fee to be paid

o Any delay in remitting tax due attracts penal interest at 18% per annum.
o Interest is to be calculated on the amount of tax due to be paid.
o The days will be calculated from the next day of filing due date till the
actual date of payment.
o There will be a late fee of Rs.100 per day per Act. So it is Rs.100 under
CGST & Rs.100 under SGST, resulting in Rs. 200 per day. However, there
is a maximum levy of Rs. 5,000.
o There is no late fee separately prescribed under the IGST Act.
o The total late fee is Rs. 50 per day GSTR-1 and GSTR-3.
o For NIL filing also, there is a late fees of Rs. 20 per day.

Answers to Test Yourself

Answer to TY 1

The correct option is D. For intra state supply (within the state), CGST and SGST
will be collected.

Answer to TY 2
The correct option is D. The Government has exempted Jan Arogya Bima
insurance from the ambit of GST.

Answer to TY 3
The correct option is C. GSTR-2A is an auto generated return in Govt. portal. It
can be downloaded from the site gst.gov.in.

Self-examination Questions

Question 1
In the 15 digit GST number, the 10 digit falling from 3 to 12 stands for -

(i) TAN (Tan Deduction Number)

(ii) PAN (Permanent Account Number)
(iii) Policy Number

A (i)
B (ii)
C (iii)

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Question 2
The abbreviation RCM stands for -
A Reverse Charge Mechanism
B Refund Charge Mechanism
C Reverse Credit Mechanism
D Rectification Credit Mechanism

Question 3

GSTR-1 return containing the details of outward supplies of taxable goods /

services of the tax payer is to be filed by the supplier within -

A. 10th of succeeding month

B. 11th of succeeding month
C. 15th of succeeding month
D. 20th of succeeding month

Answers to Self-examination Questions

Answer to SEQ 1
The correct option is B. The 10 digit denotes PAN of the entity.

Answer to SEQ 2
The correct option is A. RCM denotes Reverse Charge Mechanism.

Answer to SEQ 3
The correct option is B. The due date of filing GSTR-1 is 11th of succeeding
month.

Important note:

As there is always a possibility of amendments of provisions in the GST Acts,

especially the due dates, formats and other explanations. These may change
from time to time. Hence, students are advised to refer the latest provisions of
the Act to update their knowledge.

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