Additions v Difference Method – An Analysis – Part 3 – Different Methods, Same Answer

In this, the third part of a short series of articles I am delivering on the differences between the Additions v Difference Method of calculating the Sum Insured / Declared Value, I set out a calculation side by side of using both methods.

Additions Method – Insured Standing Charges Difference Method – Uninsured Working Expenses
Insured: ABC Company $
Item 1 – Historical Insurable Profit (most recent Annual Report)
Turnover/Sales/Revenue/Fees   1,188,270
Plus: Closing Stock (if applicable)         6,400
Net Profit      144,995
Sub Total      144,995   1,194,670
Add  Standing Charge

 Subtract     Uninsured Working Expenses

Opening Stock (if applicable)         4,215
Accounting Services         6,320
Advertising and Promotion        15,500
Agents Fees        59,413
Bad Debts         8,217
Bank Fees         4,565
Computing         8,750
Depreciation        22,000
EFTPOS Fees         5,644
Electricity        47,531
Freight – Deliveries        11,883
Gas         3,765
General Expenses        17,000
Insurance        17,850
Motor Vehicle Expenses        16,995
Packaging Materials        10,464
Purchases      295,062
Rent        68,000
Repairs and Maintenance        16,500
Salaries/wages      356,481
Superannuation        32,083
Water         3,952
WorkCover        17,485
Sub Total      +654,777      -394,898
Insurable Gross Profit – based on Historical Profit      799,772      799,772

As can be clearly seen, you end up with exactly the same figure for the insurable Gross Profit. From here, you would factor in the growth rates for the following items exactly the same, whether you use the Difference or Additions Method.

  1.  Add an allowance for the growth in the business turnover from the end of the accounting period to the start of the insurance year.
  2. Add an allowance for the growth in the business turnover for the Period of Insurance
  3. Add an allowance for the growth in the business turnover for the Indemnity Period

What is different is the information to be shown on the policy Schedule. Obviously, the Sum Insured would be the same using both methods and the premium charged by the underwriter would likewise be the same if the calculations were done correctly.

The difference comes in the list of expenses.  Under the Difference Method you list the Uninsured Working Expenses, while with the Additions Method you list the Insured Standing Charges. In both cases you should always use the same terminology that the Insured uses in their books of accounts, to avoid any confusion at claims time.  You do not show the amount against each, just the name of the expense.

I, again, provide a list showing whether the expense item would be listed as an Insured Standing Charge (Additions Method) or Uninsured Working Expense (Difference Method). You will note that NO expense appears in both lists. Each expense is either a Uninsured Working Expense OR a Insured Standing Charge.

List of Insured Standing Charges / Uninsured Working Expenses to be shown on Policy Schedule Insured Standing Charges Uninsured Working Expenses
Accounting Services Y
Advertising and Promotion Y
Agents Fees Y
Bad Debts Y
Bank Fees Y
Computing Y
Depreciation Y
EFTPOS Fees Y
Electricity Y
Freight – Deliveries Y
Gas Y
General Expenses Y
Insurance Y
Motor Vehicle Expenses Y
Packaging Materials Y
Purchases Y
Rent Y
Repairs and Maintenance Y
Salaries/wages Y
Superannuation Y
Water Y
WorkCover Y

You will note how much shorter the list of Uninsured Working Expenses is.

I appreciate that you can part insure an expense, but the subject I am tackling is difficult enough as it is, so I will keep this topic for another day.

I bring this series on the difference between the Additions and Difference Methods to a climax in tomorrow’s article, where I show what happens when the policy has been calculated on a Difference Basis, with the Uninsured Standing Charges Expenses wrongly listed as Insured Standing Charges. Please join me again then.

 

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