Insurance Policy Method of Calculating Depreciation
According to this method, Insurance policy is taken for the amount of the asset to be replaced. The amount of the policy is such that it is sufficient to replace the asset when it is worn out. A sum equal to the amount of depreciation is paid as premium every year. The amount goes on accumulating at a certain rate of interest and is received on maturity. The amount so received is used for the purchase of new asset, replacing the old one. Under this method, it not only provides funds for the replacement but also provides security to the asset. When the policy is taken, the asset is secured against any loss. The system is applicable to costly wasting assets. The asset account remains at its original cost.
Merits (Insurance Policy Method):
- It provides adequate funds for replacement of assets.
- Better security is provided to the investors by assumption of risk by Insurance Companies.
- The Insurance Company will pay a stipulated amount with which replacement of asset can be made.
- This method is more expensive since Insurance Company keeps its own margin.
- When policy is surrendered for one reason or other, there is greater loss.
- The method is unsuitable, where additions are made to assets during the period.