Afar Part 1 (2017 Edition) - Sample Only
Afar Part 1 (2017 Edition) - Sample Only
Afar Part 1 (2017 Edition) - Sample Only
Financial Accounting &
Reporting
Part 1
2017 Edition
BASED ON
PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRSs)
ISBN 978-621-8029-03-3
_______________________________________
Published by:
BANDOLIN ENTERPRISE
(Publishing and Printing)
1F M BLDG., GOLF VIEW VILLAGE, STO. TOMAS, BAGUIO CITY
CONTACT NOS. (0917) 870 6962; (0917) 813 6037
ii
Preface
This book is designed to provide an invaluable learning material for
accounting students and CPA candidates. Practicing accountants
may also find this book a useful reference. This book discusses and
illustrates provisions of current financial reporting standards in a clear
and easy-to-read manner. Practical insights on how the standards are
applied in actual practice are provided as well.
iii
Each chapter thoroughly discusses the provisions in a related
financial reporting standard. Each financial reporting standard has an
equivalent chapter (or group of chapters) in order to facilitate
browsing through the contents of this book. This is followed by a
chapter summary, review questions and exercises. Suggested
answers and solutions to review questions and exercises are
available to colleagues in the academe to aid in classroom
discussions.
Since this book is dedicated to you, your thoughts about this book are
important to me. You may send your comments and suggestions to
[email protected].
iv
Tips on using this book
To get the most out of this book, I strongly suggest the following,
most especially to a CPA candidate:
v
Advanced Accounting – Part 1
Contents at a Glance
Chapter 1 Partnership (Part 1) 1
Chapter 2 Partnership (Part 2) 24
Chapter 3 Partnership (Part 3) 50
Chapter 4 Partnership (Part 4) 89
Chapter 5 Corporate Liquidation and Reorganization 135
References 664
vi
TABLE OF CONTENTS
CHAPTER 1
PARTNERSHIP – PART 1 ............................................................................ 1
OVERVIEW ON THE TOPIC .................................................................................. 1
INTRODUCTION ............................................................................................... 1
Characteristics of a partnership ............................................................. 2
Advantages and disadvantages of a partnership ................................... 3
ACCOUNTING FOR PARTNERSHIPS ....................................................................... 3
FORMATION ................................................................................................... 4
Valuation of contributions of partners .................................................. 4
Partners’ ledger accounts ...................................................................... 5
Capital and drawing accounts ............................................................ 6
Receivable from/ Payable to a partner .............................................. 6
Bonus on initial investments .................................................................. 9
Variations to the bonus method ...................................................... 10
CHAPTER 1: SUMMARY .................................................................................. 12
PROBLEMS ................................................................................................ 12
CHAPTER 2
PARTNERSHIP – PART 2 .......................................................................... 24
DIVISION OF PROFITS AND LOSSES ..................................................................... 24
CHAPTER 2: SUMMARY .................................................................................. 41
PROBLEMS ................................................................................................ 41
CHAPTER 3
PARTNERSHIP – PART 3 .......................................................................... 50
DISSOLUTION ............................................................................................... 50
Admission of partner ............................................................................ 51
Purchase of interest ......................................................................... 51
Revaluation of assets ................................................................... 53
Investment in the partnership ......................................................... 54
Withdrawal, retirement or death of a partner .................................... 61
Incorporation of a partnership ............................................................. 70
CHAPTER 3: SUMMARY .................................................................................. 74
PROBLEMS ................................................................................................ 75
vii
CHAPTER 4
PARTNERSHIP – PART 4 .......................................................................... 89
LIQUIDATION ................................................................................................ 89
Conversion of non‐cash assets into cash ............................................. 89
Methods of liquidation ..................................................................... 89
Settlement of claims ............................................................................ 90
Right of off‐set ..................................................................................... 90
Lump‐sum liquidation vs. Installment liquidation ................................ 90
Marshalling of assets ............................................................................ 98
Non‐cash asset used as payment for claim ........................................ 112
Safe payments schedule and Cash priority program ......................... 114
Safe payment schedule .................................................................. 114
Cash priority program .................................................................... 119
CHAPTER 4: SUMMARY ................................................................................ 123
PROBLEMS .............................................................................................. 124
CHAPTER 5
CORPORATE LIQUIDATION AND REORGANIZATION .............................. 135
CORPORATE LIQUIDATION ............................................................................. 135
Measurement basis ............................................................................ 135
Financial reports ................................................................................. 136
Statement of affairs ....................................................................... 136
Statement of realization and liquidation ....................................... 144
REORGANIZATION ....................................................................................... 163
Types of corporate reorganization ..................................................... 163
CHAPTER 5: SUMMARY ................................................................................ 164
PROBLEMS:............................................................................................. 167
CHAPTER 6
JOINT ARRANGEMENTS ....................................................................... 179
DEFINITION OF JOINT ARRANGEMENT .............................................................. 179
Contractual arrangement ................................................................... 179
Joint control ....................................................................................... 180
TYPES OF JOINT ARRANGEMENT ..................................................................... 183
Consideration for entity’s rights and obligations arising from the
arrangement ...................................................................................... 183
Assessment of rights and obligations ................................................. 184
viii
JOINT OPERATIONS ...................................................................................... 187
ACCOUNTING FOR JOINT OPERATION TRANSACTIONS .......................................... 188
No separate records are maintained ................................................. 188
Separate records are maintained ....................................................... 195
ADDITIONAL ILLUSTRATIONS: ......................................................................... 200
INTEREST IN JOINT OPERATIONS WHOSE ACTIVITY CONSTITUTES A BUSINESS ............ 211
JOINT VENTURES ......................................................................................... 214
Equity method .................................................................................... 214
Presentation in statement of financial position ................................. 215
TRANSACTIONS BETWEEN A VENTURER AND A JOINT VENTURE .............................. 215
PARTICIPANT TO A JOINT ARRANGEMENT WITH NO JOINT CONTROL ....................... 221
SEPARATE FINANCIAL STATEMENTS ................................................................. 221
CHAPTER 6: SUMMARY: ............................................................................... 222
RELEVANT PROVISIONS OF THE PFRS FOR SMES ............................................... 224
SECTION 15 INVESTMENTS IN JOINT VENTURES ................................................. 224
Jointly controlled operations ............................................................. 225
Jointly controlled assets ..................................................................... 225
Jointly controlled entities ................................................................... 226
Measurement – accounting policy election ....................................... 226
Transactions between a venturer and a joint venture ....................... 226
Investor does not have joint control .................................................. 226
PROBLEMS .............................................................................................. 228
CHAPTER 7
CONSTRUCTION CONTRACTS ............................................................... 243
DEFINITION OF CONSTRUCTION CONTRACT ....................................................... 245
APPLICATION OF THE BASIC PRINCIPLES OF PFRS 15.......................................... 245
Step 1: Identify the contract with the customer ................................ 245
Combination of contracts ............................................................... 246
Step 2: Identify the performance obligations in the contract ............ 246
Satisfaction of performance obligations ........................................ 249
Step 3: Determine the transaction price ............................................ 254
Step 4: Allocate the transaction price to the performance obligations
........................................................................................................... 257
Step 5: Recognize revenue when (or as) a performance obligation is
satisfied .............................................................................................. 257
PERFORMANCE OBLIGATIONS SATISFIED OVER TIME ............................................ 257
ix
METHODS FOR MEASURING PROGRESS ............................................................ 258
INPUT METHODS ......................................................................................... 258
Cost‐to‐cost ........................................................................................ 258
Efforts‐expended (labor hours‐based) method ................................. 261
CONTRACT COSTS ........................................................................................ 263
ADJUSTMENTS TO THE MEASURE OF PROGRESS UNDER THE INPUT METHOD ............ 268
PRESENTATION ........................................................................................... 271
ACCOUNTING FOR CONSTRUCTION CONTRACTS ................................................ 275
OUTPUT METHODS ...................................................................................... 287
CHANGES IN THE MEASURE OF PROGRESS ......................................................... 290
REASONABLE MEASURES OF PROGRESS ............................................................ 291
ONEROUS CONTRACT ................................................................................... 293
VARIABLE CONSIDERATION ............................................................................ 301
Incentive payments ............................................................................ 303
Cost escalations .................................................................................. 307
CONTRACT MODIFICATIONS ........................................................................... 308
Variations on the contract (Change orders) ....................................... 310
CHANGES IN THE TRANSACTION PRICE .............................................................. 310
Claims for reimbursements on the contract ...................................... 313
EXISTENCE OF A SIGNIFICANT FINANCING COMPONENT IN THE CONTRACT ............... 318
NON‐CASH CONSIDERATION .......................................................................... 319
UNCERTAINTY IN THE COLLECTABILITY OF CONTRACT REVENUE ............................. 319
ADDITIONAL ILLUSTRATIONS: ................................................................ 322
CHAPTER 7: SUMMARY ................................................................................ 335
PROBLEMS .............................................................................................. 336
CHAPTER 8
ACCOUNTING FOR FRANCHISE OPERATIONS – FRANCHISOR................. 358
LICENSING ................................................................................................. 359
DEFINITION OF FRANCHISE ............................................................................ 360
APPLICATION OF THE PRINCIPLES OF PFRS 15 .................................................. 361
Step 1: Identify the contract with the customer ................................ 361
Step 2: Identify the performance obligations in the contract ............ 362
General principles: ......................................................................... 362
Specific principles: (‘Licensing’ section) ......................................... 364
Step 3: Determine the transaction price ............................................ 373
Franchise fees ................................................................................ 373
x
Step 4: Allocate the transaction price to the performance obligations
........................................................................................................... 375
Step 5: Recognize revenue when (or as) a performance obligation is
satisfied .............................................................................................. 378
EXISTENCE OF A SIGNIFICANT FINANCING COMPONENT IN THE CONTRACT ............... 383
JOURNAL ENTRIES .................................................................................. 386
CONTRACT COSTS ........................................................................................ 397
UNCERTAINTY IN THE COLLECTABILITY OF CONTRACT REVENUE ............................. 402
CHAPTER 8: SUMMARY ................................................................................ 408
PROBLEMS .............................................................................................. 409
CHAPTER 9
CONSIGNMENT SALES .......................................................................... 420
CONSIGNMENT ARRANGEMENTS .................................................................... 420
PRINCIPAL VERSUS AGENT CONSIDERATIONS ..................................................... 423
CHAPTER 9: SUMMARY ................................................................................ 426
PROBLEMS:............................................................................................. 427
CHAPTER 10
INSTALLMENT SALES METHOD ............................................................. 436
INSTALLMENT SALES METHOD ........................................................................ 436
Applicability ........................................................................................ 436
Brief history ........................................................................................ 437
ACCOUNTING PROCEDURES ........................................................................... 437
PRESENT VALUE .......................................................................................... 448
REPOSSESSION ............................................................................................ 455
TRADE‐INS ................................................................................................. 462
ALLOCATION OF COST OF GOODS SOLD ............................................................ 468
COST RECOVERY METHOD ............................................................................. 472
CHAPTER 10: SUMMARY .............................................................................. 474
PROBLEMS .............................................................................................. 477
CHAPTER 11
HOME OFFICE, BRANCH AND AGENCY ACCOUNTING ............................ 492
BRANCH AND AGENCY DISTINGUISHED ............................................................ 492
ACCOUNTING FOR AN AGENCY ....................................................................... 493
ACCOUNTING FOR BRANCH OPERATIONS .......................................................... 495
xi
Reciprocal accounts (Interoffice or Intra‐company accounts) ........... 495
Individual financial statements .......................................................... 501
Combined financial statements ......................................................... 503
Reconciliation of reciprocal accounts ................................................ 508
Home office with several branches ................................................ 514
Special problems in Accounting for branch operations ..................... 523
Shipments to branch billed at a price above cost .......................... 523
ADDITIONAL ILLUSTRATIONS: ........................................................ 530
Inter‐branch transactions ................................................................... 554
Inter‐branch transfers of cash ........................................................ 554
Inter‐branch transfers of merchandise .......................................... 555
CHAPTER 11: SUMMARY .............................................................................. 557
PROBLEMS .............................................................................................. 558
CHAPTER 12
INSURANCE CONTRACTS ...................................................................... 570
INSURANCE CONTRACT ................................................................................. 571
Essential elements in the definition of an insurance contract ........... 571
Significant insurance risk ................................................................ 572
Indemnification against loss ........................................................... 573
Legal principles of insurance .............................................................. 574
Types of insurers ................................................................................ 576
Types of insurance contracts ............................................................. 577
Examples of insurance contracts ........................................................ 578
RECOGNITION AND MEASUREMENT ................................................................. 581
Liability adequacy test ........................................................................ 581
Changes in accounting policies .......................................................... 582
Specific issues in changes in accounting policies ........................... 583
INSURANCE CONTRACTS ACQUIRED IN A BUSINESS COMBINATION .......................... 584
CONTRACTS WITH DISCRETIONARY PARTICIPATION FEATURES ............................... 584
Accounting requirements ................................................................... 584
UNBUNDLING OF DEPOSIT COMPONENTS ......................................................... 585
EXISTING ACCOUNTING POLICIES FOR INSURANCE CONTRACTS .............................. 585
ACCOUNTING FOR NON‐LIFE INSURANCE CONTRACTS .......................................... 589
Peculiar accounts and line‐items – non‐life insurance ....................... 589
Initial recognition ............................................................................... 594
Revenue recognition – 24th Method .................................................. 596
xii
Insurance contracts covering Marine Cargo Risks ............................. 601
Subsequent measurement of Deferred acquisition costs (DAC) ........ 606
Gross benefits and claims and Liability adequacy test ....................... 607
ACCOUNTING FOR LIFE INSURANCE CONTRACTS AND CONTRACTS WITH DISCRETIONARY
PARTICIPATION FEATURE (DPF)...................................................................... 608
Life insurance contract liabilities ........................................................ 609
Gross benefits and claims .................................................................. 609
CHAPTER 12: SUMMARY .............................................................................. 611
PROBLEMS:............................................................................................. 613
CHAPTER 13
ACCOUNTING FOR BUILD‐OPERATE‐TRANSFER (BOT) ........................... 623
FEATURES OF BOT ARRANGEMENTS ............................................................... 624
SCOPE ....................................................................................................... 625
ACCOUNTING ISSUES .................................................................................... 626
Treatment of the operator’s rights over the infrastructure ............... 626
Recognition and measurement of arrangement consideration ......... 626
Construction or upgrade services ...................................................... 627
Consideration given by the grantor to the operator ...................... 627
Financial asset ............................................................................ 627
Intangible asset .......................................................................... 627
Partly by a financial asset and an intangible asset ..................... 628
Operation services ............................................................................. 628
Contractual obligations to restore the infrastructure to a specified level
of serviceability .................................................................................. 628
Borrowing costs incurred by the operator ......................................... 628
Items provided to the operator by the grantor ................................. 629
ACCOUNTING FOR SERVICE CONCESSION ARRANGEMENTS .................................. 629
CHAPTER 13: SUMMARY .............................................................................. 647
RELEVANT PROVISIONS OF THE PFRS FOR SMES ............................................... 648
SECTION 34 SPECIALIZED ACTIVITIES ............................................................... 648
Service concession arrangements ...................................................... 648
Two principal categories of service concession arrangements .......... 648
Accounting – financial asset model .................................................... 648
Accounting – intangible asset model ................................................. 649
Operating revenue ............................................................................. 649
PROBLEMS .............................................................................................. 649
xiii
APPENDICES
APPENDIX A ......................................................................................... 659
FINANCIAL ACCOUNTING & REPORTING ‐ PART 1A CONTENTS AT A GLANCE
APPENDIX B ......................................................................................... 660
FINANCIAL ACCOUNTING & REPORTING ‐ PART 1B CONTENTS AT A GLANCE
APPENDIX C ......................................................................................... 661
FINANCIAL ACCOUNTING & REPORTING ‐ PART 2 CONTENTS AT A GLANCE
APPENDIX D ......................................................................................... 662
FINANCIAL ACCOUNTING & REPORTING ‐ PART 3 CONTENTS AT A GLANCE
APPENDIX E ......................................................................................... 663
ADVANCED FINANCIAL ACCOUNTING & REPORTING ‐ PART 2 CONTENTS AT
A GLANCE
REFERENCES ........................................................................................ 664
xiv
Chapter 12
Insurance Contracts
Related standard: PFRS 4 Insurance Contracts
Learning Competencies
1. Define an insurance contract.
2. State the applicability and accounting requirements of PFRS 4.
3. State the peculiar accounts of an insurance company.
4. Account for non-life and life insurance contracts.
Introduction
The accounting practices for insurance contracts have been diverse
and often differed from practices in other sectors. IFRS 4 is
introduced primarily:
a. To make limited improvements to the accounting for insurance
contracts, pending the completion of the second phase of the
IASB’s project on insurance contracts.a
b. To require any entity issuing insurance contracts (an insurer) to
disclose information about those contracts.
a
Currently, the IASB and the FASB are undertaking a joint project to develop
common, high-quality guidance that will address recognition, measurement,
presentation, and disclosure requirements for insurance contracts (including
reinsurance). The joint project is intended to improve, simplify, and converge the
financial reporting requirements for insurance contracts.
Scope
An entity shall apply PFRS 4 to the following:
a. Insurance contracts (including reinsurance contracts) that it
issues and reinsurance contracts that it holds.
b. Financial instruments that it issues with a discretionary
participation feature. PFRS 7 requires disclosure about financial
instruments, including financial instruments that contain such
features.
570
b. Employers’ assets and liabilities under employee benefit plans
(PAS 19 and PFRS 2)
c. Contractual rights or obligations that are contingent on the future
use of, or right to use, a non-financial item (PAS 17, PFRS 15
and PAS 38)
d. Financial guarantee contracts unless the issuer has previously
asserted explicitly that it regards such contracts as insurance
contracts and has used accounting applicable to insurance
contracts, in which case the issuer may elect to apply either PAS
32, PFRS 7 and PFRS 9 or PFRS 4 to such financial guarantee
contracts. The issuer may make that election contract by contract,
but the election for each contract is irrevocable.
e. Contingent consideration payable or receivable in a business
combination (PFRS 3)
f. Direct insurance contracts in which the entity is the policyholder.
However, a cedant shall apply PFRS 4 to reinsurance contracts
that it holds.
Insurance contract
PFRS 4 defines an insurance contract as “a contract under which
one party (the insurer) accepts significant insurance risk from another
party (the policyholder) by agreeing to compensate the policyholder if
a specified uncertain future event (the insured event) adversely
affects the policyholder.”
571
2. Payment from the insured (premium) – generally, the insured
pays to a common fund from which losses are paid. However, not
all insurance contracts have explicit premiums (e.g., insurance
cover bundled with some credit card contracts).
3. Indemnification against loss – the insurer agrees to indemnify the
insured or other beneficiaries against loss or liability from
specified events and circumstances (called as ‘insured event’)
that may occur or be discovered during a specified period.
Insurance risk – is risk, other than financial risk, transferred from the
holder of a contract to the issuer.
The risk must be pre-existing at the time the insurance contract was
executed. A new risk created by the contract is not insurance risk.
572
Financial risk is the risk of a possible future change in one or more
of a specified interest rate, financial instrument price, commodity
price, foreign exchange rate, index of prices or rates, credit rating or
credit index or other variable, provided in the case of a non-financial
variable that the variable is not specific to a party to the contract.
If both significant insurance risk and financial risk are present, the
contract will be classified as an insurance contract.
In addition to financial risk, the following risks are also not insurance
risk:
a. Lapse or persistency risk – the risk that the counterparty will
cancel the contract earlier or later than the issuer had expected in
pricing the contract. This is not insurance risk because the
payment to the counterparty is not contingent on an uncertain
future event that adversely affects the counterparty.
b. Expense risk – the risk of unexpected increases in the
administrative costs associated with the servicing of a contract,
rather than in costs associated with insured events. This is not
insurance risk because an unexpected increase in expenses
does not adversely affect the counterparty.
PFRS 4 states that “a contract that exposes the issuer to lapse risk,
persistency risk or expense risk is not an insurance contract unless it
also exposes the issuer to insurance risk. However, if the issuer of
that contract mitigates that risk by using a second contract to transfer
part of that risk to another party, the second contract exposes that
other party to insurance risk.”
573
Legal principles of insurance
The principal objective of every insurance contract is to provide
financial protection to the insured in case of occurrence of an
uncertain future event. Neither the “insured” nor the “insurer” shall
misuse an insurance contract to unjustly enrich himself at the
expense of the other.
Example 1:
Mr. John Doe is an employee. As part of his employee benefits,
Mr. John has two health insurances acquired by his employer
from the Philippine Health Insurance Corporation (PhilHealth)
(government requisite) and from the Care Bear Insurance Co.
(employer’s discretion). Each of these insurances states clearly
the types of sicknesses insured, the accredited hospitals where
the insurances are applicable, the amounts of compensation the
574
insurances are bound to indemnify in cases of sickness, and all
other relevant information.
Example 2:
A year after his appendectomy, Mr. John decided to change
career. He opened a small bakery. Mr. John’s new business was
a success that after operating for only one year, Mr. John was
able to save enough money put up a house. Mr. John even
changed his name from “John Doe” to “John Dough.”
Mr. John insured his house for ₱2M. After a year, Mr. John’s
house was totally destroyed by fire due to the negligence his
neighbor, Ms. Jane Glow. The insurance company paid Mr. John
575
₱2M and at the same time filed a law suit against Ms. Jane for
₱2.4M, the fair value of the destroyed house.
If the insurance company wins the case and collects P2.4M from
Ms. Jane, the insurance company shall retain 2M (the amount
paid to Mr. John) plus other costs incurred on the lawsuit (e.g.,
attorney’s fees). The balance, if any, is paid to Mr. John. The
insurer can benefit out of subrogation rights only up to the amount
paid to the insured plus other direct costs incurred.
Example 3:
An earthquake caused an electrical post to collapse which
caused a short circuit that caused fire to a building. The building’s
fire insurance coverage does not explicitly extend to earthquakes.
When determining the extent of the insurer’s liability, the closest
cause to the destruction of the building, which is the fire, must be
taken into consideration.
Types of insurers
1. Government insurance – operated and regulated by the
government. (e.g., Government Service Insurance System (GSIS)
which extends life insurance to government employees and
Social Security System (SSS) which extends life insurance to
employees or employers in the private sector and other voluntary
members.
576
3. Mutual insurance – owned by the policyholders themselves, who
elect the board of directors, e.g., cooperative insurance.
Relevant terms:
1. Reinsurer – the party that has an obligation under a
reinsurance contract to compensate a cedant if an insured
event occurs.
Examples:
577
Mr. Juan for the losses incurred. This is an example of a direct
insurance contract.
Assuming that only 40% of the risk accepted from Mr. Juan is ceded
to XYZ Insurance Co., the other 60% risk retained by ABC Insurance
Co. is referred to as the retention limit (or net retention). The 40%
risk ceded to XYZ Insurance Co. is referred to as the cession.
578
c. Life insurance and prepaid funeral plans.
579
j. Travel assistance (i.e., compensation in cash or in kind to
policyholders for losses suffered while they are travelling).
m. Reinsurance contracts.
580
f. A credit-related guarantee (or letter of credit, credit derivative
default contract or credit insurance contract) that requires
payments even if the holder has not incurred a loss on the failure
of the debtor to make payments when due.
g. Contracts that require a payment based on a climatic, geological
or other physical variable that is not specific to a party to the
contract (commonly described as weather derivatives).
h. Catastrophe bonds that provide for reduced payments of
principal, interest or both, based on a climatic, geological or other
physical variable that is not specific to a party to the contract.
581
cash flows, and related items such as handling costs, arising under
the insurance contracts.
Current
Carrying amount of estimate
Deficiency of
insurance liability of
insurance
(less related deferred insurance
Less than = liability
acquisition costs and liability at
recognized in
related intangible end of
profit or loss
assets) reporting
period
582
Specific issues in changes in accounting policies
a. Current interest rates – insurers are permitted to designate
liabilities to be valued at current market interest rates with
changes in values recognized in profit or loss. This election is
irrevocable. Once a liability is designated to be valued at current
market interest rates, it shall be valued as such until the liability is
extinguished.
583
Insurance contracts acquired in a business combination
When accounting for business combinations, an insurer may
recognize an intangible asset for the difference between the fair
value and the carrying amount of insurance liabilities acquired. The
intangible asset recognized is excluded from the scope of both PAS
36 Impairment of Assets and PAS 38 Intangible Assets.
Accounting requirements
a. Contracts with DPF are continued to be accounted for using
existing accounting policies. PFRS 4 does not require a new
measurement basis.
b. The guaranteed element may or may not be recognized
separately from the DPF.
584
the DPF shall be classified either as a liability or a separate
component of equity.
585
Overview of accounting for insurance contracts:
Item Accounting treatment under
Phase 1 of PFRS 4
1. Insurance contracts Existing accounting policies
2. Investment or insurance Existing accounting policies
contracts with discretionary
participation features
3. Investment contracts without PFRS 9 (fair value or
discretionary participation amortized cost)
features
Non-life:
1. Marine insurance – provides protection against loss or damage
of boats, ships, cargo, and terminals during a certain voyage,
shipment, stage of preparation or for a fixed period of time.
586
a. Motor insurance (vehicle insurance, car insurance, or auto
insurance) – is insurance purchased for cars, trucks, public
utility vehicles, motorcycles, and other road vehicles. It
protects the policyholder against financial loss in case of
accident, theft and physical damage.
Example:
ABC Bank employs three cashiers, each of whom, are given
access to ABC’s cash. To protect against employee
embezzlement, ABC Bank obtains fidelity bonds from XYZ
587
Insurance Co. for each of the three employees. In case of
embezzlement, ABC Bank may claim compensation from XYZ. In
turn, XYZ is subrogated to the rights of ABC in claiming from the
dishonest employee.
Life:
5. Life insurance – “Life insurance is insurance on human lives and
insurance appertaining thereto or connected therewith.” (Sec. 179,
The Insurance Code of the Philippines)
588
Accounting for non-life insurance contracts
Assets:
589
3. Reinsurance assets – this represents balances due from
reinsurance companies. Reinsurance assets are reviewed for
impairment at each reporting period.
Liabilities:
590
recognized in profit or loss on the same basis as the related
acquisition costs are recognized in profit or loss.
Revenue:
Expenses:
591
12. Net benefits and claims – is gross benefits and claims minus
claims ceded to reinsurers.
LIABILITIES
Insurance contract liabilities ₱ 1,055,000
Accrued expenses and other liabilities 96,000
Income tax payable 32,000
Insurance payables 184,000
Deferred reinsurance commissions 60,000
Total liabilities 1,427,000
EQUITY
Share capital 2,000,000
Retained earnings 1,748,000
Other components of equity 100,000
Total equity 3,848,000
Total liabilities and equity ₱ 5,275,000
592
Illustrative Statement of profit or loss and other comprehensive
income of an insurance company
ABC Insurance Co.
Statement of profit or loss and other comprehensive income
As of December 31, 20x1
Notes
Gross premiums 6 ₱ 800,000
Premiums ceded to reinsurers 6 (200,000)
Net premiums 600,000
Fees and commission income 120,000
Investment income 60,000
Other revenue 180,000
Total revenue 780,000
Gross benefits and claims paid (450,000)
Claims ceded to reinsurers 100,000
Gross change in contract liabilities (80,000)
Change in contract liabilities ceded to reinsurers 20,000
Net benefits and claims (410,000)
Finance costs (15,000)
Other operating and administrative expenses (270,000)
Other expenses (285,000)
Total benefits, claims and other expenses (695,000)
Profit before tax 85,000
Income tax expense (18,000)
Profit for the year 67,000
Other comprehensive income, after tax:
Items that will not be reclassified subsequently to profit or loss:
Gains on property revaluation 8,000
Other comprehensive income for the year, net of tax 8,000
TOTAL COMPREHENSIVE INCOME FOR THE YEAR ₱ 75,000
Selected notes
Note 6: Net premiums
Gross premiums written
Direct a 900,000
Assumed b 300,000
Total gross premiums on insurance contracts 1,200,000
Change in provision for unearned premiums (400,000)
Gross premium 800,000
Premiums ceded to reinsurers c (300,000)
Change in provision for unearned premiums 100,000
Premiums ceded to reinsurers (200,000)
Net premiums 600,000
593
a
Direct premiums – premiums received or receivable directly from
brokers, agents, or insured individuals, before deducting premiums
paid or payable to reinsurers.
b
Assumed premiums – premiums received or receivable from other
insurance companies for reinsurance contracts written.
c
Premiums ceded to reinsurers – direct and assumed premiums paid
or payable to reinsurers for reinsurance contracts obtained.
Initial recognition
594
Illustration 2: Journal entries - Reinsurance contract written
ABC Insurance Co. writes a reinsurance contract for XYZ Insurance
Co. for a premium of ₱1,000. Commission expense incurred on the
reinsurance contract issued is 10%.
ABC Insurance Co. then ceded 80% of the insurance contract with
Mr. Juan to XYZ Insurance Co. Commission earned on the
reinsurance is ₱80. Per agreement, ABC Insurance Co. shall withhold
half of the premiums due to XYZ Insurance Co.
595
Revenue recognition – 24th Method
Most insurance contracts issued by nonlife insurance companies are
of short duration, normally one year. Premiums from these types of
contracts are recognized as revenue over the period of the contracts
using the “24th method,” except for contracts covering marine cargo
risks.
The “24th method” assumes that the average date of issue of all
policies written during any month is the middle of that month.
Requirements:
a. How much are the earned portions of the premium for the months
ended January 31, February 28, and March 31, 20x1,
respectively?
b. How much are the unearned portions of the premium for the
months ended January 31, February 28, and March 31, 20x1,
respectively?
c. How much is the earned portion of the premium for the year
ended December 31, 20x1?
d. How much is the unearned portion of the premium for the year
ended December 31, 20x1?
e. Provide the journal entries on January 1, 20x1 to recognize the
gross premium and the adjusting entry on December 31, 20x1 to
recognize the adjustment to the gross premium.
Solutions:
Requirement (a): Earned portions – 1st quarter
Jan. 31 Feb. 28 Mar. 31
Gross premium 12,000 12,000 12,000
Multiplied by: 1/24 2/24 2/24
Earned portions 500 1,000 1,000
596
Under the 24th method, it is assumed that the average date of issue of
all policies written during any month is the middle of that month.
Therefore, in January (date of issue) “1” is used in the numerator
equal to one-half month. In the succeeding months, the numerator is
“2” – equal to whole month.
597
The “Change in provision for unearned premiums” is recognized in
profit or loss as an adjustment to “Gross premiums” to compute for
the earned portion.
Requirements:
a. How much is the earned portion of the premium for the year
ended December 31, 20x1?
b. How much is the unearned portion of the premium for the year
ended December 31, 20x1?
Solutions:
598
Requirement (b): Unearned portion – Dec. 31, 20x1
Gross premium 12,000
Multiplied by: 5/24
Unearned portion - Dec. 31, 20x1 2,500
Solutions:
599
Illustration 4: 24th Method – Adjustments to premiums earned
During 20x1, ABC Insurance Co. wrote fire insurance policies for a
total premium of ₱5,000,000, ₱3,000,000 of which were ceded to
reinsurers. The following are the balances in the provision for
unearned premiums:
Provision for
Provision for Premiums unearned
unearned ceded to premiums -
premiums reinsurers Net
A b c=a-b
Balance, Jan. 1 2,000,000 1,000,000 1,000,000
Balance, Dec. 31 2,800,000 1,200,000 1,600,000
Solution:
600
Insurance contracts covering Marine Cargo Risks
For insurance contracts covering marine cargo risks, the premiums
for the last two (2) months of the year are deferred and recognized as
revenue in the following year.
Solution:
601
For contracts covering marine cargo risks, premiums for the last two
(2) months of the year are recognized as revenue in the following
year.
Illustration 1: Comprehensive
Premiums on insurance policies written by ABC Insurance Co. during
its first year of operations are shown below:
Types of non-life insurance
Fire Motor Car Bonds Marine Cargo
Gross Premiums (Direct and Assumed)
January 340,000 120,000 30,000 64,000
February 250,000 60,000 2,000 100,000
March 360,000 72,000 12,000 115,000
April 630,000 75,000 11,000 180,000
May 280,000 48,000 2,400 72,000
June 380,000 74,000 2,000 163,000
July 400,000 69,000 1,000 70,000
August 360,000 68,000 6,000 55,000
September 200,000 80,000 7,000 98,000
October 300,000 64,000 4,000 95,000
November 280,000 63,000 6,000 140,000
December 360,000 45,000 4,000 50,000
Premium Ceded
January 204,000 72,000 18,000 38,400
602
February 150,000 36,000 1,200 60,000
March 216,000 43,200 7,200 69,000
April 378,000 45,000 6,600 108,000
May 168,000 28,800 1,440 43,200
June 228,000 44,400 1,200 97,800
July 240,000 41,400 600 42,000
August 216,000 40,800 3,600 33,000
September 120,000 48,000 4,200 58,800
October 180,000 38,400 2,400 57,000
November 168,000 37,800 3,600 84,000
December 216,000 27,000 2,400 30,000
Requirements:
a. Compute for the balance of the “Provision for unearned
premiums” on December 31, 20x1.
b. Compute for the net premiums earned for the period.
Solutions:
Total excluding
Fire Motor Car Bonds Marine Cargo
a B c d = a+b+c
Gross Premiums (Direct and Assumed)
Jan 340,000 120,000 30,000 490,000
Feb 250,000 60,000 2,000 312,000
Mar 360,000 72,000 12,000 444,000
Apr 630,000 75,000 11,000 716,000
May 280,000 48,000 2,400 330,400
Jun 380,000 74,000 2,000 456,000
Jul 400,000 69,000 1,000 470,000
Aug 360,000 68,000 6,000 434,000
Sep 200,000 80,000 7,000 287,000
Oct 300,000 64,000 4,000 368,000
Nov 280,000 63,000 6,000 349,000
Dec 360,000 45,000 4,000 409,000
Premium Ceded
Jan 204,000 72,000 18,000 294,000
Feb 150,000 36,000 1,200 187,200
Mar 216,000 43,200 7,200 266,400
Apr 378,000 45,000 6,600 429,600
May 168,000 28,800 1,440 198,240
Jun 228,000 44,400 1,200 273,600
603
Jul 240,000 41,400 600 282,000
Aug 216,000 40,800 3,600 260,400
Sep 120,000 48,000 4,200 172,200
Oct 180,000 38,400 2,400 220,800
Nov 168,000 37,800 3,600 209,400
Dec 216,000 27,000 2,400 245,400
604
Requirement (b): Net premiums earned
Total
excludin Total
g Marine Earned Marine earned
Cargo Fraction portion Cargo portion
d=
a+b+c e f=dxe g h=f+g
Gross Premiums (Direct and Assumed)
From
last yr. -
Jan 490,000 23/24 469,583 64,000 533,583
Feb 312,000 21/24 273,000 100,000 373,000
Mar 444,000 19/24 351,500 115,000 466,500
Apr 716,000 17/24 507,167 180,000 687,167
May 330,400 15/24 206,500 72,000 278,500
Jun 456,000 13/24 247,000 163,000 410,000
Jul 470,000 11/24 215,417 70,000 285,417
Aug 434,000 9/24 162,750 55,000 217,750
Sep 287,000 7/24 83,708 98,000 181,708
Oct 368,000 5/24 76,667 95,000 171,667
Nov 349,000 3/24 43,625 - 43,625
Dec 409,000 1/24 17,042 - 17,042
2,653,958 1,012,000 3,665,958
Premium Ceded
From
last yr. -
Jan 294,000 23/24 281,750 38,400 320,150
Feb 187,200 21/24 163,800 60,000 223,800
Mar 266,400 19/24 210,900 69,000 279,900
Apr 429,600 17/24 304,300 108,000 412,300
May 198,240 15/24 123,900 43,200 167,100
Jun 273,600 13/24 148,200 97,800 246,000
Jul 282,000 11/24 129,250 42,000 171,250
Aug 260,400 9/24 97,650 33,000 130,650
Sep 172,200 7/24 50,225 58,800 109,025
Oct 220,800 5/24 46,000 57,000 103,000
Nov 209,400 3/24 26,175 - 26,175
Dec 245,400 1/24 10,225 - 10,225
1,592,375 607,200 2,199,575
605
Gross premiums earned 3,665,958
Less: Premiums ceded (2,199,575)
Net premium 1,466,383
DAC are initially deferred and amortized to profit or loss using the
“24th method,” except for contracts covering marine cargo risks where
commissions for the last two months of the year are recognized as
expense in the following year.
Requirements:
a. How much of the acquisition cost is recognized in profit or loss
during the period?
b. How much is the balance of the deferred acquisition costs to
be presented in the statement of financial position on December
31, 20x1?
c. Provide the adjusting journal entry on December 31, 20x1.
Solutions:
606
Requirement (c): Adjusting entry
Dec. 31, Deferred acquisition costs 2,500
20x1 Commission expense 2,500
607
Carrying amount Current estimate
Insurance contracts liabilities 1,300,000 1,250,000
Deferred acquisition costs 200,000
Solution:
608
Gross reinsurance premiums on life insurance contracts and
insurance contracts with DPF are recognized as expense at the
earlier of the inception of the contract and the date when premiums
become payable.
609
contracts also includes changes in the gross valuation of insurance
contracts and contracts with discretionary participation feature.
The gross benefits and claims for life insurance contracts include the
following:
a. Death claims
b. Surrenders
c. Maturities
d. Annuity payments
Death claims
Surrenders
Life insurance contracts accumulate “cash surrender value.” If the
policyholder decides not to continue the premium payments, he will
be entitled to this amount, which is generally less than the total
premiums he had paid on the insurance contract. (See Chapter 11 of
Financial Accounting and Reporting Part 1B for discussions on accounting for cash
surrender value by policyholders)
610
Illustration: Journal entry
ABC Insurance Co. offers life insurance. On January 1, 20x1, a
policyholder cancels a life insurance contract and is paid the cash
surrender value of ₱200,000.
611
insurance contracts; and (e) requires an impairment test for
reinsurance assets.
If the carrying amount of insurance liability, net of DAC is less
than its current estimate, the deficiency in insurance liability is
recognized in profit or loss.
Premiums from short-duration nonlife insurance contracts are
recognized using the “24th method,” except for contracts covering
marine cargo risks where premiums for the last two (2) months of
the year are recognized as revenue in the following year.
Under the “24th method,” it is assumed that policies written during
any month were issued at the middle of that month.
Accordingly, the premium revenue for the month is equal to “1/24”
of the total premiums written during that month. The remaining
“23/24” is recognized as unearned income.
Gross single premiums from life insurance contracts are
recognized as revenue at the inception of the contract.
Gross regular premiums from life insurance contracts are
recognized as revenue when they become payable by the
policyholder.
Gross reinsurance premiums on life insurance contracts and
insurance contracts with DPF are recognized as expense at the
earlier of the inception of the contract and the date when
premiums become payable.
612
PROBLEMS:
8. Bough Lex Insurance Co. uses the 24th method to recognize revenue
from its non-life insurance contracts. On March 1, 20x1, Bough Lex
writes an insurance policy for a single premium of ₱10M. Bough Lex
uses the calendar year period. To compute for the revenue earned in
20x1, Bough Lex shall multiply the gross premium of ₱10M by 17/24.
9. Ease Cam Insurance Co. writes an insurance policy for a single premium
of ₱20M on November 1, 20x1. If Ease Cam uses the 24th method to
recognize revenue from insurance contracts, the amount of revenue
earned by Ease Cam for the month ended December 31, 20x1 is equal
to ₱20M x 2/24.
10. In 20x1, Show Coy Insurance Co. was able to sell insurance policies that
cover marine cargo risks for ₱100,000 per month from January to
December. Show Coy’s December 31, 20x1 statement of financial
position shall report unearned revenue of ₱200,000.
613