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Accounting For Life Insurance. Appendix H Tools & Techniques of Life Insurance Planning. Financial statements Complete set includes An accountant’s report An income statement A balance sheet A statement of changes in stockholder’s equity A statement of cash flows

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Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements

    • Complete set includes

      • An accountant’s report

      • An income statement

      • A balance sheet

      • A statement of changes in stockholder’s equity

      • A statement of cash flows

      • Notes to financial statements


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Accountant’s report

      • Compilation

        • Accountant presents the client’s information in the appropriate financial statement without expressing any assurance as to whether the numbers provided are correct or not

      • Review

        • Analytical review, inquiries of management, and other procedures to give limited assurance as to whether the statements are prepared in accordance with GAAP

      • Audit

        • Understanding of internal controls and assessment of risk

        • Designed to provide the highest degree of assurance that the statements are prepared in conformity with GAAP


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Accountant’s report (cont’d)

      • Audit (cont’d)

        • Types

          • Unqualified

          • Qualified

          • No opinion

          • Disclaimer

      • Other important information

        • Departures from GAAP and the effect on the financial statement

        • Omissions

        • Concerns as to whether the company will continue operating


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Income statement

      • Shows the current period’s income and expenses since the prior period’s financial statements

      • Interim, part-year, or full year basis

      • Broken down into operating activities and non-operating activities


Income Statement

Income Statement

For the Year Ended December 31, xxxx

For the Year Ended December 31, xxxx

Gross Sales

Gross Sales

$

$

1,000,000

1,000,000

Less: Returns and Allowances

Less: Returns and Allowances

10,000

10,000

Net Sales

Net Sales

$

$

990,000

990,000

Less: Cost of Goods Sold

490,000

490,000

Gross Profit

Gross Profit

$

$

500,000

500,000

Less: General Selling and Administrative

300,000

300,000

Net Profit from Operations

Net Profit from Operations

$

$

200,000

200,000

Less: Nonoperating Activities

0

0

Income before taxes and extraordinary items

Income before taxes and extraordinary items

200,000

200,000

Less: Income taxes

Less: Income taxes

30,000

30,000

Income before extraordinary item

Income before extraordinary item

$

$

170,000

170,000

Less: Loss from extraordinary item

Less: Loss from extraordinary item

100,000

100,000

Net Income

Net Income

$

$

70,000

70,000

Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Balance sheet

      • Snapshot of the company’s financial position at the end of business activity on a given day

      • It will include the company’s assets, liabilities, and owners’ or shareholders’ equity. Assets are shown at their “historical cost”

      • Fundamental accounting equation:

        ASSETS = LIABILITIES + EQUITY

      • Exceptions to the historical cost rule

        • Obsolescent inventory

        • Loss on marketable securities

        • Fixed assets shown at original cost less depreciation


Balance Sheet

As of December 31, xxxx

ASSETS

Current Assets

Cash and cash equivalents

$

40,000

Accounts receivable -trade

100,000

Inventories

50,000

Prepaid Insurance

10,000

Total current assets

$

200,000

Property Plant and Equipment (net of depreciation)

300,000

Other Asset- Cash Surrender Value of Insurance

10,000

Total Assets

$

510,000

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities

Accounts payable

$

25,000

Total current liabilities

25,000

Long-Term Debt

75,000

Deferred Income Taxes

10,000

Total Liabilities

110,000

$

STOCKHOLDERS’ EQUITY

Common Stock

100,000

Retained earnings

$

300,000

Total Stockholders’ equity

$

400,000

Total Liabilities and Stockholders’ equity

$

510,000

Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning


Statement of Changes in Stockholders’ equity

For the Year Ended December 31, xxxx

Total

Common

Retained

Stockholders’

Stock

Earnings

Equity

Balance as of

January 1, xxxx

$

100,000

$

250,000

$

350,000

Net Income

70,000

70,000

Dividends

(20,000)

(20,000)

Balance as of

January 1, xxxx

$

100,000

$

300,000

$

400,000

Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Statement of changes (in stockholders’ equity)

      • Reflects all activity occurring to equity accounts during the financial statement period


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Statement of cash flows

      • Shows changes in the cash element (in terms of sources and uses of cash) and cash flows of the company that took place during the financial statement period

      • It is relevant in determining whether sufficient cash flow is available to meet the needs of the business and fund other objectives such as

        • Life insurance premiums

        • Nonqualified deferred compensation contributions

        • Contributions to employee benefit or retirement plans


Statement of Cash Flows

For the Year Ended December 31, xxxx

Cash Flows Provided from (Used by) Operating activities

Income from continuing operations

$

170,000

Adjustment to reconcile income from continuing operations to

net cash provided from continuing operations

10,000

Depreciation and amortization

10,000

Changes in assets and liabilities:

Accounts receivable-trade

1,000

Inventories

(2,200)

Accounts payable

1,000

Other assets and liabilities

250

Net Cash provided from Operating Activities

$

180,050

Cash Flows provided from (Used by) Investing Activities

Capital additions

$

(120,000)

Net cash (Used by) Investing Activities

$

(120,000)

Repayment of long-term debt

$

(10,000)

Cash dividends paid

(20,000)

Net Cash (Used by) Financing Activities

$

(30,000)

$

Increase (Decrease) in Cash and Cash Equivalents

30,050

Cash and Cash Equivalents as of January 1, xxxx

9,950

Cash and Cash Equivalents as of December 31, xxxx

$

40,000

$

Interest Paid (Continuing Operations)

7,500

$

Income Taxes Paid (Continuing Operations)

30,000

Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Financial statements (cont’d)

    • Notes to the financial statement

      • Accounting methods utilized

      • leases and terms

      • Loans and loan repayment terms

      • Detained fixed asset information

      • Related party transactions

      • Income taxes

      • Subsequent events information, after financial statement closing but before financial statement release


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Accounting basics

    • Double entry accounting

      • Assets = Liabilities + Equity

      • Debts = Credits

    • Assets generally have debit balances. Therefore, liability and equity accounts must have credit balances.

    • Expense and loss accounts ordinarily have debit balances. Revenue and gain accounts must therefore ordinarily have credit balances.

    • Journal Entries

      • Debit (Dr.) Cash 100

      • Credit (Cr.) Sales 100


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Accounting basics (cont’d)

    • Basic Rules – Accounting for life insurance

      • Cash surrender values will generally be assets of the company

        • Assuming the company is the owner and beneficiary of the policy

      • Cash values will carry debit balances on the balance sheet

      • The current insurance expense will also carry a debit balance on the income statement

      • Any income from the policy, including a death benefit, or any increase in the cash surrender value in excess of premiums paid in the current period will be a credit entry to an income (credit) account


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Accounting rules specifically affecting life insurance

    • Accounting guidelines

      • Unearned premiums are classified as part of “working capital,” but cash surrender values are not

      • Policy loans should be classified as current liabilities, when they are expected to be repaid within 12 months

      • If a loan is intended to be liquidated from the policy death benefit or upon the policy’s maturity or cancellation, the obligation should be excluded from current liabilities

      • The amount of the loans should be shown to reduce the cash surrender value

      • For corporate life insurance maintained for the purposes of stock redemption, the footnote disclosure should first show the cash surrender value on the balance sheet and then indicate disclosure of any commitments


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Accounting rules specifically affecting life insurance (cont’d)

    • Examples of accounting journal entries

      • Corporation pays an insurance premium of $4,800 on a $100,000 policy on its president. The cash value increases from $20,000 to $22,000.

        Life Insurance Expense (Dr.) $2,800

        Cash Surrender Value of Insurance (Dr.) 2,000

        Cash (Cr.) $4,800

        If the insured died half-way through the most recent period of coverage (assuming cash surrender value of $21,000 and refund of one-half of premium paid):

        Cash $102,400

        Cash Surrender Value of Insurance 21,000

        Life Insurance Expense 2,400

        Gain on Life Insurance Coverage $ 79,000


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Accounting rules specifically affecting life insurance (cont’d)

    • Alternative methods

      • Ratable charge method

        • Amortizes or expenses the true cost of the insurance coverage in a straight line

        • Based on the premise that a company buys a policy to cover a fixed period of time and the net costs should be recognized evenly over that period of time

    • FASB Technical Bulletin 85-4 (Accounting for Purchases of Life Insurance)

      • The amount that could be realized under the life insurance contract, as of the date of the statement of financial position, should be reported as an asset

      • The change in cash surrender value or contract value during the period is an adjustment of premiums paid in determining the expense or income to be recognized under the contract for the period


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Summary

    • GAAP continues to recognize only the cash surrender value method of accounting

    • Accounting for key employee life insurance

      • Term insurance

        • Premium payments represent a pure current expense. Such costs should be charged against current income rather than retained earnings.

      • Permanent (cash value)

        • Premium payments are bifurcated. To the extent that a premium payment generates an increase in the cash value, a charge should be made to an asset account.

        • To the extent that a premium payment exceeds the increase in the cash value, a charge should be made to expense.


Accounting For Life Insurance

Appendix H

Tools & Techniques of Life

Insurance Planning

  • Summary (cont’d)

    • Accounting for key employee life insurance (cont’d)

      • Cash values

        • The firm’s balance sheet should show policy cash values as a “non-current” asset

      • Death proceeds

        • When an insured dies, the gain upon receipt of the insurance payment is typically reflected as a “special entry for non-recurring amounts” on the annual statement of operations.

        • Alternatively, the gain on receipt by a corporation of death proceeds may be carried directly to the business’s retained earnings account since it is, in effect, adjusting prior years’ activities.


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