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ADVANCED 

Financial Accounting & 
Reporting 

Part 1

2017 Edition 
BASED ON  
PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRSs) 

Nation’s Foremost CPA Review Inc. (NCPAR)


4F Pelizloy Centrum, Lower Session Road, Baguio City 2600,
Philippines
Mobile Number: (0917) 870 6962
E-mail: ncpar@yahoo.com
ALL RIGHTS RESERVED
2017

No part of this work covered by the


copyright hereon may be reproduced or
used in any form or by any means -
electronic or mechanical, including
photocopying – without the written
permission of the author or the publisher.

ISBN 978-621-8029-03-3

Any copy of this book not bearing the


signature of the author shall be considered
as proceeding from an illegal source.

_______________________________________

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.

This book is a labor of love and it is dedicated to you, my reader. I


have written this book with the following goals in mind: completeness,
conciseness, simplicity, fun to learn and practical application.
Complex accounting concepts are not eliminated simply because they
are difficult to comprehend but rather they are simplified to the
highest possible extent.

This book is based on current Philippine Financial Reporting


Standards (PFRSs) adapted by the Financial Reporting Standards
Council (FRSC) from the International Financial Reporting Standards
(IFRSs) issued by the International Accounting Standards Board
(IASB).

This textbook is a part of the following series of books:

Title of book Topics included


1. Financial Accounting and Reporting Current assets
Part 1A
2. Financial Accounting and Reporting Noncurrent assets
Part 1B
3. Financial Accounting and Reporting Liabilities and Equity
Part 2
4. Financial Accounting and Reporting Financial statement
Part 3 presentation and PFRS
for SMEs
5. Advanced Financial Accounting Partnership,
and Reporting Part 1 Insurance Contracts,
Build-Operate-
Transfer, etc.
6. Advanced Financial Accounting and Business Combination,
Reporting Part 2 Derivatives, etc.

The textbooks are patterned after the Commission on Higher


Education (CHED) Curriculum.

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
zeus.millan@yahoo.com.

I would like to extend my sincere gratitude to my family and relatives


for their support all throughout the writing of this book; to my wife
Eureka and son Devin Joshua for their sacrifices; to my Dad and
Mom for the source of inspiration; to my in-laws Engr. John L. Socalo,
Sr. and Dominga S. Socalo for the assistance and trust; to my sister
Donna Pamela for the extra help; to my college instructors who have
taught me most of the techniques I have incorporated in this book; to
Mr. Darrell Joe Asuncion, Dean Renante D. Balocating, Mr. Rex B.
Banggawan, Mr. Christopher U. Ismael, Mr. John Carlo G. Bandolin,
and Mr. Einroul Aljohnza A. Bandolin for the much needed
encouragement and support; to my fellow instructors at NCPAR;
colleagues in the profession; previous clients; previous students; to
the members of the Bandolin Enterprise group; and friends who in
one way or another have contributed, directly or indirectly, to the
completion of this book.

Zeus Vernon B. Millan



About the author


The author is a 6th Placer in the October 2006 CPA board
examinations. He is a co-founder of, and a CPA reviewer at, Nation’s
Foremost CPA Review, Inc. (NCPAR), a teacher, and an
entrepreneur.

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:

1. Re-solve the illustrations independently.


After reading a chapter, re-solve the illustrations independently by
covering the suggested solutions with a piece of paper.

2. Read and reread the chapter summaries


Be sure to read the summary after reading each chapter. This will
reinforce what you have just learned. It is also advisable to reread
the chapter summaries from time to time to ensure that you are
not forgetting the concepts you have learned as you learn
additional concepts.

Long-term memory is invaluable in passing the board exams (as


well as making professional judgments in the exercise of the
profession). However, the human memory is not without limit. The
human brain tends to forget information as new information is
learned. To avoid this, one will need to recall information
previously learned repeatedly as many times as needed. Studies
show that when one forgets information learned previously, he will
need to spend the same effort in learning that information again!

3. Enjoy learning. Nothing is difficult if you have the passion in


doing it.

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

Chapter 6 Joint Arrangements 179


Related standards:
PFRS 11 Joint Arrangements
PAS 28 Investments in Associates and Joint Ventures
Chapter 7 Construction Contracts 243
Related standard: PFRS 15 Revenue from Contracts with Customers
Chapter 8 Accounting for Franchise Operations
- Franchisor 358
Related standard: PFRS 15 Revenue from Contracts with Customers
Chapter 9 Consignment Sales 420
Related standard: PFRS 15 Revenue from Contracts with Customers
Chapter 10 Installment Sales Method 436
Chapter 11 Home office, Branch and Agency accounting 492
Chapter 12 Insurance Contracts 570
Related standard: PFRS 4 Insurance Contracts
Chapter 13 Accounting for Build-operate-transfer (BOT) 623
Related standards:
IFRIC Interpretation 12 Service Concession Arrangements
PFRS 15 Revenues from Contracts with Customers
SIC Interpretation 29 Service Concession Arrangements: Disclosures
Appendices – Contents at a glance
 Financial Accounting and Reporting – Part 1A 659
 Financial Accounting and Reporting – Part 1B 660
 Financial Accounting and Reporting – Part 2 661
 Financial Accounting and Reporting – Part 3 662
 Advanced Financial Accounting and Reporting – Part 2 663

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 
 

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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 

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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 

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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 

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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 

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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.

PFRS 4 does not apply to contracts and other transactions


specifically dealt with under other relevant standards. Specifically,
PFRS 4 does not apply to the following:
a. Product warranties (PFRS 15 and PAS 37)

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.”

PFRS 4 provides the definitions for the following terms:


 Insurer – the party that has an obligation under an insurance
contract to compensate a policyholder if an insured event occurs.
 Policyholder – a party that has a right to compensation under an
insurance contract if an insured event occurs.
 Insured event – an uncertain future event that is covered by an
insurance contract and creates insurance risk.

The definition of an insurance contract determines which contracts


are within the scope of PFRS 4 rather than other PFRSs. Thus, an
entity shall apply PFRS 4 to all policies it issues or holds that falls
within the definition of “insurance contract” as provided under PFRS
4.

Essential elements in the definition of an insurance contract


1. Transfer of significant insurance risk – there is transfer of
significant insurance risk from the insured (policy holder) to the
insurer (insurance provider).

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.

Significant insurance risk


Risk (or uncertainty) is a fundamental element of an insurance
contract. At least one of the following is uncertain at the inception of
an insurance contract:
a. the occurrence of an insured event;
b. the timing of the event; or
c. the level of indemnification that the insurer will need to pay the
insured if the event occurs.

Risk – is the possibility of loss or injury when an uncertain future


event occurs. Risk can be:
a. Speculative risk – a risk that can result in either gain or loss, e.g.,
fluctuation in the prices of commodities, or
b. Pure risk – a risk that can produce a loss only.

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.

Insurance risk is significant if an insured event could cause an


insurer to pay significant additional benefits in any scenario,
excluding scenarios that lack commercial substance

Additional benefits refer to amounts that exceed those that would be


payable if no insured event occurred

A contract that transfers only an insignificant insurance risk may not


be accounted for under PFRS 4. Such contract shall be accounted for
under other relevant PFRSs.

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.

A contract that exposes the issuer to financial risk without significant


insurance risk is not an insurance contract. From the definitions
above, insurance risk includes only “pure risk.”

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.”

Indemnification against loss


Generally, indemnification on insurance contracts is in the form of
cash. However, some insurance contracts require or permit payments
to be made in kind (i.e., non-cash). For example, the insurer may
indemnify the insured
a. by replacing the insured property, instead of reimbursing the
insured; or
b. by providing services, such as
i. medical services using the insurer’s own medical facilities
and staff
ii. repair services and other services for the insured’s property.

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.

1. Principle of Insurable Interest – the insured must have an


insurable interest in the property or life insured. The insured has
an insurable interest in the property if he is benefited by the
property’s existence and prejudiced by its destruction. The
existence of an insurable interest is a requisite to the legal
enforcement of an insurance contract in order to prevent the
deliberate destruction of life or property for profit.

2. Principle of Utmost Good Faith (Uberrimae fidei) – all insurance


contracts must be negotiated with utmost honesty and fairness
because the contracting parties do not have the same access to
relevant information. Material facts must be disclosed.

3. Principle of Indemnity – the insured is compensated for the loss


he incurred and reverted back to his previous financial condition
before the occurrence of the loss event. The insured neither
profits nor incurs loss due to the occurrence of the loss event.
This principle does not apply to life insurance because the value
of human life cannot be measured in monetary terms.

4. Principle of Contribution – this principle is a consequence of the


principle of indemnity. The principle of contribution applies when
the insured obtains insurance from more than one insurer. In
case of a loss event, the insured can only claim compensation for
the actual losses he incurred from either insurer or both insurers
on a proportionate basis. There is no “double” compensation for
actual losses incurred by the insured. If any of the insurers,
compensates in full the insured, that insurer can claim from the
other insurers their shares on the losses incurred by the insured.

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.

 Principle of Insurable Interest – the insurable interest is Mr.


John’s health.
 Principle of Utmost Good Faith – the full disclosure of all
material facts is an application of the principle of utmost good
faith.

A year later, Mr. John had an appendectomy (i.e., the surgical


removal of the vermiform appendix). This is covered under both
of Mr. John’s health insurances. The accredited hospital billed Mr.
John a total of ₱65,000, ₱20,000 of which is covered under Mr.
John’s PhilHealth. Mr. John’s hospital bill was settled as follows:

Total hospital bill 65,000


Less: Amount insured under PhilHealth (20,000)
Balance 45,000
Less: Balance insured under Care Bear Insurance (45,000)
Net amount due -

 Principle of Indemnity – Mr. John is indemnified only up to


extent of the costs he incurred. Mr. John did not gain profit
from his appendectomy.

 Principle of Contribution – Both insurers shared in


indemnifying Mr. John for the actual costs he incurred. Mr.
John is prevented from collecting twice from his insurers in
respect of the same loss event.

5. Principle of Subrogation – this principle is an extension and


another consequence of the principle of indemnity. Subrogation
means substituting one entity (e.g., the insurer) for another
entity’s (e.g., the insured) legal right to collect a debt or damages.

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

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₱2M and at the same time filed a law suit against Ms. Jane for
₱2.4M, the fair value of the destroyed house.

 Principle of Subrogation – Mr. John’s right to claim damages


from Ms. Jane is transferred to the insurance company.

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.

6. Principle of Loss Minimization – in cases of sudden loss events


(e.g., fire), the insured should try his best to minimize the loss of
his insured property by taking all necessary steps to control and
reduce the losses and save what is left of the property (e.g.,
calling the fire department in case of fire). This prevents the
insured from neglecting the loss event just because the property
is insured.

7. Principle of Proximate Cause (Causa Proxima) – when a loss is


caused by more than one loss events, the closest (proximate)
cause, not the furthest cause, is taken into consideration when
determining the extent of the insurer’s liability. This principle does
not apply to life insurance.

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.

2. Propriety insurance – owned by stockholders and operated for


profit. Policyholders are not among the owners of the business.

576
3. Mutual insurance – owned by the policyholders themselves, who
elect the board of directors, e.g., cooperative insurance.

Types of insurance contracts


For purposes of applying PFRS 4, insurance contracts may be
classified as:
1. Direct insurance contract – an insurance contract where the
insurer directly accepts risk from the insured and assumes the
sole obligation to compensate the insured in case of a loss event.
PFRS 4 defines a direct insurance contract as “an insurance
contract that is not a reinsurance contract.”

2. Reinsurance contract – an insurance contract issued by one


insurer (the reinsurer) to compensate another insurer (the cedant)
for losses on one or more contracts issued by the cedant.

Relevant terms:
1. Reinsurer – the party that has an obligation under a
reinsurance contract to compensate a cedant if an insured
event occurs.

2. Cedant – the policyholder under a reinsurance contract.

Types of reinsurance contracts


a. Proportional – the cedant and the reinsurer share on the
premiums and claims in proportion to the risk assumed.
Proportional reinsurance contracts may be either:
i. Treaty (Obligatory) – the reinsurer shares in all risks
arising from all of the insurance policies issued by the
cedant that are within the scope of the reinsurance
contract.
ii. Facultative (Specific) – the reinsurer shares only on
specific risks on individual insurance policies ceded by
the cedant.

b. Non proportional (Excess of loss reinsurance) – in cases of


loss events, the reinsurer is obliged to pay only for claims
exceeding a predetermined amount (also known as the
cedant’s ‘retention limit’ or ‘net retention’).

Examples:

Case #1: Direct insurance contract


Mr. Juan obtained fire insurance for his house from ABC Insurance
Co. In case of fire, ABC Insurance Co. shall be liable in compensating

577
Mr. Juan for the losses incurred. This is an example of a direct
insurance contract.

Case #2: Reinsurance contract


ABC Insurance Co. is concerned about possible losses on the
insurance contract with Mr. Juan. Thus, ABC Insurance Co. obtains
insurance from XYZ Insurance Co. for protection against possible
losses on the insurance contract with Mr. Juan. In case of fire, ABC
Insurance Co. shall compensate Mr. Juan, but this time, ABC
Insurance Co. can claim compensation from XYZ Insurance Co.

This is an example of a reinsurance contract (simply described as


‘insurance of an insurance’). ABC Insurance Co. is referred to as the
cedant (or ceding company or primary insurer) while XYZ
Insurance Co. is referred to as the reinsurer.

By entering into the reinsurance contract, ABC Insurance Co. is


managing the risk of loss from the direct insurance contract with Mr.
Juan.

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.

Case #3: Retrocession


Assume that XYZ Insurance Co. also obtains insurance from another
reinsurer, 123 Insurance Co., for protection against possible losses
from the reinsurance contract with ABC Insurance Co.

This is an example of “retrocession” (simply described as ‘reinsurance


of a reinsurance’). 123 Insurance Co. is referred to as the
retrocessionaire and the risk transferred is referred to as the
retrocession.

Examples of insurance contracts


PFRS 4 provides the following examples of contracts that are
insurance contracts, if the transfer of insurance risk is significant:
a. Insurance against theft or damage to property.

b. Insurance against product liability, professional liability, civil


liability or legal expenses.

578
c. Life insurance and prepaid funeral plans.

d. Life-contingent annuities and pensions (i.e., contracts that provide


compensation for the uncertain future event, the survival of the
annuitant or pensioner, to assist the annuitant or pensioner in
maintaining a given standard of living, which would otherwise be
adversely affected by his or her survival).

e. Disability and medical cover.

f. Surety bonds, fidelity bonds, performance bonds and bid bonds


(i.e., contracts that provide compensation if another party fails to
perform a contractual obligation, for example an obligation to
construct a building).

g. Credit insurance that provides for specified payments to be made


to reimburse the holder for a loss it incurs because a specified
debtor fails to make payment when due under the original or
modified terms of a debt instrument.

These contracts meet the definition of a financial guarantee


contract which is within the scope of PFRS 9 and PAS 32. Thus,
these contracts may only be accounted for under PFRS 4, if the
issuer has previously asserted explicitly that it regards such
contracts as insurance contracts and has used accounting
applicable to insurance contracts. See also previous discussions.

PFRS 4 defines a financial guarantee contract as “a contract that


requires the issuer to make specified payments to reimburse the
holder for a loss it incurs because a specified debtor fails to make
payment when due in accordance with the original or modified
terms of a debt instrument.”

h. Product warranties issued by another party for goods sold by a


manufacturer, dealer or retailer.

Product warranties issued directly by a manufacturer, dealer or


retailer are outside the scope of PFRS 4 because they are within
the scope of PFRS 15 and PAS 37.

i. Title insurance (i.e., insurance against the discovery of defects in


title to land that were not apparent when the insurance contract
was written). In this case, the insured event is the discovery of a
defect in the title, not the defect itself.

579
j. Travel assistance (i.e., compensation in cash or in kind to
policyholders for losses suffered while they are travelling).

k. Catastrophe bonds that provide for reduced payments of


principal, interest or both if a specified event adversely affects the
issuer of the bond (unless the specified event does not create
significant insurance risk, for example if the event is a change in
an interest rate or foreign exchange rate).

l. Insurance swaps and other contracts that require a payment


based on changes in climatic, geological or other physical
variables that are specific to a party to the contract.

m. Reinsurance contracts.

PFRS 4 provides the following examples of items that are not


insurance contracts:
a. Investment contracts that have the legal form of an insurance
contract but do not expose the insurer to significant insurance
risk, for example life insurance contracts in which the insurer
bears no significant mortality risk (such contracts are non-
insurance financial instruments or service contracts)
b. Contracts that have the legal form of insurance, but pass all
significant insurance risk back to the policyholder through non-
cancellable and enforceable mechanisms that adjust future
payments by the policyholder as a direct result of insured losses,
for example some financial reinsurance contracts or some group
contracts (such contracts are normally non-insurance financial
instruments or service contracts).
c. Self-insurance, in other words retaining a risk that could have
been covered by insurance (there is no insurance contract
because there is no agreement with another party).
d. Contracts (such as gambling contracts) that require a payment if
a specified uncertain future event occurs, but do not require, as a
contractual precondition for payment, that the event adversely
affects the policyholder. However, this does not preclude the
specification of a predetermined payout to quantify the loss
caused by a specified event such as death or an accident.
e. Derivatives that expose one party to financial risk but not
insurance risk, because they require that party to make payment
based solely on changes 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.

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.

Recognition and measurement


Insurance companies are temporarily permitted under PFRS 4
(pending the finalization of the phase two of IASB’s project) to
continue developing their own accounting policies (or continue using
their existing accounting policies) for insurance contracts without
regard to the requirements of PAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors (i.e., hierarchy of reporting
standards) and the Conceptual Framework.

However, PFRS 4 expressly:


a. Prohibits provisions for possible claims under contracts that are
not in existence at the reporting date (referred to as catastrophe
or equalization provisions)
b. Requires a test for the adequacy of recognized insurance
liabilities (referred to as the “liability adequacy test”)
c. Requires the retention of insurance liability in the statement of
financial position until the obligation is extinguished (i.e.,
discharged or cancelled or expires)
d. Prohibits the off-setting of
i. reinsurance assets against the related insurance liabilities; or
ii. income or expense from reinsurance contracts against the
expense or income from the related insurance contracts.
e. Requires an impairment test for reinsurance assets. Impairment
loss is recognized when, after the initial recognition of an
insurance asset, an event has occurred that leads to amounts
due under the contract not being recoverable in full, and a reliable
estimate of the loss can be assessed.

Liability adequacy test


At each reporting period, an insurer shall assess whether its
recognized liabilities are adequate using current estimates of future

581
cash flows, and related items such as handling costs, arising under
the insurance contracts.

If the assessment shows that the carrying amount of the insurance


liabilities (less related deferred acquisition costs and related
intangible assets) is inadequate compared to the current estimate,
the deficiency is recognized in profit or loss.

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

If the insurer’s accounting policies do not require a liability adequacy


test to be carried out, as described above, then an assessment is still
required of the potential net liability (i.e. the relevant insurance
liabilities less any related deferred acquisition costs). In these
circumstances the insurer is required to recognize at least the
amount that would be required to be recognized as a provision under
PAS 37 Provisions, Contingent Liabilities and Contingent Assets. Any
deficiency in insurance liability is also recognized in profit or loss.

PFRS 4 provides the following definitions:


 Insurance liability – an insurer’s net contractual obligations
under an insurance contract.
 Insurance asset – an insurer’s net contractual rights under an
insurance contract.
 Reinsurance assets – a cedant’s net contractual rights under a
reinsurance contract.

Changes in accounting policies


An insurer is permitted under PFRS 4 to change its accounting
policies for insurance contracts if the change results to more relevant
and no less reliable, or more reliable and no less relevant, financial
information. The general principles in PAS 8 shall be applied in
judging relevance and reliability of financial information, but full
compliance with the criteria in PAS 8 is not required.

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.

b. Continuation of existing practices – an entity is permitted to


continue using any of the following accounting practices, but is
prohibited from introducing any of them if they were not used
previously:
i. Measuring insurance liabilities on an undiscounted basis
ii. Measuring contractual rights to future investment
management fees at an amount that exceeds their fair value
iii. Using non-uniform accounting policies for the insurance
liabilities of a subsidiary

c. Prudence – an insurer is not required to change its accounting


policies on insurance contracts in order to eliminate excessive
prudence. However, an insurer that uses sufficient prudence is
not required to introduce additional prudence.

d. Future investment margins – an insurer need not change its


accounting policies for insurance contracts to eliminate future
investment margins. However, entities cannot change to an
accounting policy that adjusts their liabilities to reflect future
investment margins unless, for example, this is part of a wider
switch to a comprehensive investor-based accounting system.

e. Shadow accounting – Realized gains or losses on an insurer’s


assets may have a direct impact on the measurement of some or
all of the insurance liabilities and related deferred acquisition
costs and intangible assets. In such cases, an insurer is
permitted, but not required, to use “shadow accounting.”

Shadow accounting means that unrealized gains or losses on


assets, which are recognized in other comprehensive income, are
reflected in the measurement of the insurance liabilities (or
deferred acquisition costs or intangible assets) in the same way
as realized gains or losses. The related adjustment to the
insurance liability (or deferred acquisition costs or intangible
assets) shall be recognized in other comprehensive income if the
unrealized gains or losses are also recognized in other
comprehensive income.

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.

Contracts with discretionary participation features


Some insurance contracts contain a discretionary participation feature as
well as a guaranteed element.

PFRS 4 provides the following definitions:


 Discretionary participation feature (DPF) – a contractual right
to receive, as a supplement to guaranteed benefits, additional
benefits:
a. that are likely to be a significant portion of the total
contractual benefits;
b. whose amount or timing is contractually at the discretion of
the issuer; and
c. that are contractually based on:
i. the performance of a specified pool of contracts or a
specified type of contract;
ii. realized and/or unrealized investment returns on a
specified pool of assets held by the issuer; or
iii. the profit or loss of the company, fund or other entity that
issues the contract.

 Guaranteed element – an obligation to pay guaranteed benefits,


included in a contract that contains a discretionary participation
feature.
 Guaranteed benefits – payments or other benefits to which a
particular policyholder or investor has an unconditional right that
is not subject to the contractual discretion of the issuer.

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.

If the guaranteed element is recognized separately from the DPF:


 the guaranteed element shall be classified as a liability;
while

584
 the DPF shall be classified either as a liability or a separate
component of equity.

If the guaranteed element is not recognized separately from the


DPF, the whole contract shall be classified as a liability.

c. Any liability recognized is subject to the “liability adequacy test.”

d. All premiums received may be recognized as revenue without


separating any portion that relates to the equity component.

Unbundling of deposit components


Some insurance contracts contain both an insurance component and
a deposit component.

PFRS 4 provides the following definitions:


 Deposit component – a contractual component that is not
accounted for as a derivative under PFRS 9 and would be within
the scope of PFRS 9 if it were a separate instrument.
 Unbundle – account for the components of a contract as if they
were separate contracts.

Unbundling is required when both the following conditions are met:


a. The deposit component can be measured separately without
considering the insurance component, and
b. The insurer’s accounting policies does not require it to recognize
all obligations and rights arising from the deposit component.

Unbundling is permitted, but not required, when the insurer can


measure the deposit component separately from the insurance
contract but its accounting policies require it to recognize the deposit
component.

Unbundling is prohibited if an insurer cannot measure the deposit


component separately.

When a contract is unbundled, the insurer shall apply PFRS 4 to the


insurance component and PFRS 9 to the deposit component.

Existing accounting policies for insurance contracts


The succeeding discussions pertain to existing accounting policies,
practices and principles relevant to insurance contracts. Although,
these are not specifically required under PFRS 4, they are temporarily
permitted pending the finalization of the phase two of IASB’s project.

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

There are various types of insurance contracts, as much as there are


various types of risks that can be insured. The examples enumerated
previously are just a few (and are only intended to provide general
descriptions) of the insurance contracts available in the market today.

For purposes of our succeeding discussions, we shall broadly classify


insurance contracts into life and non-life. We shall focus our
discussions on the following classes of insurance contracts, based on
classifications under the Insurance Code of the Philippines:

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.

2. Fire insurance – provides protection against loss or damage of


property caused by fire. Under the Insurance Code, fire insurance
may also cover losses resulting from “lightning, windstorm,
tornado or earthquake and other allied risks, when such risks are
covered by extension to fire insurance policies or under separate
policies.”

Insurance coverage may include:


a. Building,
b. Contents of the building, or
c. Both the building and its contents.

3. Casualty insurance – a broad category of insurance covering


loss or liability arising from accident and other events not within
the scope of marine and fire insurance as defined under the
Insurance Code. The following are examples of casualty
insurance:

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.

Insurance coverage may include:


i. Property coverage – protection against damage to or
theft of the vehicle.
ii. Liability coverage – protection against legal responsibility
to others for bodily injury or property damage.

Motor insurance is a legal requisite in the registration of motor


vehicles.

b. Personal accident insurance – provides financial protection


against losses from injury and disability caused by accident.

c. Travel insurance – covers losses incurred while travelling,


such as losses arising from lost baggage and other personal
belongings, medical expenses, travel delay, and personal
liabilities.

d. Burglary and theft insurance – covers losses of property


due to burglary, robbery or larceny.

e. Health insurance (as written by non-life insurance


companies) – provides financial protection against incurrence
of medical expenses in case of illness.

4. Surety – is a contract whereby one party (the surety) guarantees


the performance of another party (the principal or obligor) in favor
of a third party (the obligee). A surety is accounted for under
PFRS 4 if it transfers significant insurance risk to the issuer.

A common example of a surety contract is fidelity bond. A


fidelity bond is a form of insurance that provides financial
protection to an employer in cases of losses due to employees’
fraudulent actions (e.g., embezzlement, forgery, or fraudulent
trading).

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.

In the example above, XYZ Insurance Co. is surety, the bonded


employee is the principal or obligor, and ABC Bank is the obligee.

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)

Types of life insurance


1. Term life insurance – is a life insurance which provides
coverage at a fixed rate of payments for a limited period of
time. After that period expires, coverage at the previous rate
of premiums is no longer guaranteed and the client must
either forgo coverage or potentially obtain further coverage
with different payments and/or conditions. If the insured dies
during the term, the death benefit will be paid to the
beneficiary.

2. Permanent life insurance – is a life insurance policy that


remains in force for the insured's whole life and requires (in
most cases) premiums to be paid every year into the policy.
a. Whole life coverage – covers the insured’s entire life
and the proceeds (face amount) are paid only upon death
of the insured.
b. Universal life coverage – provides greater flexibility in
premium payment and the potential for greater growth of
cash values.
c. Limited-pay – premiums are paid only for a specified
period, after which no additional premiums are required.
d. Endowments – the cash value of the policy equals the
death benefit at a certain age (endowment age). Benefits
are paid whether the insured lives or dies, after a specific
age.

588
Accounting for non-life insurance contracts

Peculiar accounts and line-items – non-life insurance

Assets:

1. Insurance receivable – this consists of the following:


a. Due from policyholders, agents and brokers – this represents
the outstanding balance of premiums receivable from direct
insurance contracts issued.
b. Due from ceding company – this represents the outstanding
balance of premiums receivable from reinsurance contracts
issued.

Most non-life insurance contracts are of short duration. Many


insurance companies recognize insurance receivables on policy
inception dates

Insurance receivables are recognized on policy inception dates. Most


non-life insurance contracts are short-term. Thus, many insurers
initially measure insurance receivables at the transaction price
(original invoice amount). Subsequently, the insurance receivable is
measured at the unpaid balance of the transaction price less
allowances for uncollectability and impairment losses. Estimates of
uncollectability are recognized in profit or loss in the period where
collection becomes improbable. Accounts are written-off when they
become worthless.

2. Deferred acquisition costs (DAC) – this consists of deferred


costs representing commissions and other acquisition costs that
vary with and are directly related to securing new insurance
contracts or renewing existing contracts. These costs are
deferred to the extent that they are recoverable out of future
premiums. All other acquisition costs are recognized as an
expense when incurred.

Subsequently, these costs are amortized as expense 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.

DAC is considered when performing the “liability adequacy test”


at each reporting date.

589
3. Reinsurance assets – this represents balances due from
reinsurance companies. Reinsurance assets are reviewed for
impairment at each reporting period.

Liabilities:

4. Insurance contracts liabilities – this account consists of the


following:
a. Provision for unearned premiums (Reserve for unearned
premiums) – represents premiums already received but not
yet expired. Premiums from short-duration insurance
contracts are recognized as revenue using the “24th method”
over the life of the contract, except for contracts covering
marine cargo risks where premiums for the last two months of
the year are recognized as revenue in the following year.

b. Provision for Claims reported and Incurred but not reported


(IBNR) – this represents unpaid claims and related
adjustment expenses arising from the occurrence of insured
events, whether or not these claims have been reported to
the insurer. These provisions are based on the estimated
ultimate cost of settling the claims. These provisions do not
include possible claims from insured events that have not yet
occurred as of the reporting date (referred to as catastrophe
or equalization provisions).

c. Provision for premium deficiency – this represents additional


liability for the deficiency in insurance contract liabilities
arising from the performance of the “liability adequacy test.”

5. Insurance payable – this account consists of payables related to


insurance or reinsurance contracts, other than provisions
included in “insurance contracts liabilities,” and may include the
following:
a. Due to reinsurers – this represents premiums payable to
reinsurers resulting from contracts ceded to them.
b. Funds held for reinsurers – this represents the portion of
reinsurance premiums withheld by ceding companies in
accordance with treaty agreements.

6. Deferred reinsurance commissions – pertains to the unexpired


portion of commissions from reinsurance contracts. These are

590
recognized in profit or loss on the same basis as the related
acquisition costs are recognized in profit or loss.

Revenue:

7. Gross premiums – consists of the total premiums receivable


over the duration of insurance contracts written during the period.
These also include adjustments made during the reporting period
relating to contracts written in prior reporting periods. Gross
premiums are recognized at the inception date of policies.

Premiums from short-duration insurance contracts are recognized


as revenue over the period of the contracts using the “24th
method,” except for contracts covering marine cargo risks where
premiums for the last two months are considered earned in the
following reporting period.

The unexpired portion of premiums written are accounted for as


“Provision for unearned premiums” included in “Insurance
contracts liabilities” and presented in the liabilities section of the
statement of financial position. The net changes in the “Provision
for unearned premiums” are accounted for as adjustments to the
“Gross premium.”

8. Premiums ceded to reinsurers – consists of the total premiums


payable over the duration of insurance contracts ceded to
reinsurers. These also include adjustments made during the
reporting period relating to contracts ceded in prior reporting
periods. Premiums ceded to reinsurers are recognized at the
inception date of policies.

9. Net premium – is gross premium minus premiums ceded to


reinsurers

Expenses:

10. Gross benefits and claims – consists of all claims occurring


during the period, whether reported or not, including direct costs
of processing and settling the claims, reduced by salvage value
and other recoveries, and adjusted for changes in claims
outstanding from previous periods.

11. Claims ceded to reinsurers – the portion of claims occurring


during the period which are recoverable from reinsurers.

591
12. Net benefits and claims – is gross benefits and claims minus
claims ceded to reinsurers.

Some insurers present net benefits and claims in the statement of


profit or loss and other comprehensive income by reconciling the
cash basis benefits and claims (i.e., ‘Gross benefits and claims
paid’) to accrual basis. This is done by adjusting the benefits and
claims paid for the changes in insurance contracts liabilities. (See
illustrative statement of profit of loss and other comprehensive income below)

Illustrative Statement of financial position of an insurance company

ABC Insurance Co.


Statement of financial position
As of December 31, 20x1
ASSETS
Cash and cash equivalents ₱ 250,000
Held for trading securities 660,000
Insurance receivables - net 1,900,000
Accrued income 1,150,000
Deferred acquisition costs 95,000
Reinsurance assets 260,000
Property, plant and equipment - net 960,000
Total assets ₱ 5,275,000

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

Illustration 1: Journal entries - Direct insurance contract


ABC Insurance Co. offers fire insurance. On January 1, 20x1, ABC
received notice from its broker of a sale of one-year fire insurance for
a premium of ₱1,000. The broker’s commission is 10%.

The journal entry is as follows:


Jan. 1, Insurance receivable – direct 900
20x1 Commission expense 100
Gross premiums revenue – 1,000
Direct

Taxes are ignored in order to simplify the illustration. If taxes are


considered, additional credits shall be made for taxes payable, such
as “Documentary Stamp Tax (DST) payable,” “Output Value-Added
Tax (VAT) payable,” Local government tax payable, and other
relevant taxes.

The account “Due from policyholders, agents and brokers” may be


used in lieu of “Insurance receivable – direct.”

The “Commission expense” and “Gross premiums revenue” will be


adjusted for their unexpired and unearned portions, respectively, at
the end of the year.
 The unexpired portion of the “Commission expense” will be
debited to “Deferred acquisition costs” – an asset account.
 The unearned portion of the “Gross premiums revenue” will be
credited to “Provision for unearned premiums” – a liability
account. These will be discussed further momentarily.

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%.

The journal entry is as follows:


Jan. Insurance receivable – assumed 900
1,
Commission expense 100
20x1
Gross premiums revenue – assumed 1,000

The account “Due from ceding company” may be used in lieu of


“Insurance receivable – assumed.”

Gross premiums are recorded in a premium register also known as


“bordereaux” (pronounced as “bor”-“deh”-“row”). This register is the
equivalent of a sales register maintained by a trading company.

Illustration 3: Journal entries - Reinsurance contract (Books of


cedant and Books of reinsurer)
ABC Insurance Co. offers fire insurance. On January 1, 20x1, ABC
received notice from its broker of a sale of one-year fire insurance for
a premium of ₱1,000. The broker’s commission 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.

The journal entries for the reinsurance are as follows:

Books of ABC (Cedant) Books of XYZ (Reinsurer)


Insurance receivable 900
– direct
Commission expense 100
Gross premiums No entry
revenue – direct 1,000

to record the issuance of direct insurance


Premiums ceded to Insurance receivable
reinsurers 800 – assumed 320
Commission income 80 Funds held by cedant 400
Funds held for reinsurer 400 Commission expense 80
Due to reinsurer 320 Gross premiums
revenue – assumed 800

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 unexpired portion of premiums written are accounted for as


“Provision for unearned premiums” included in “Insurance contracts
liabilities” and presented in the liabilities section of the statement of
financial position. The net changes in the “Provision for unearned
premiums” are accounted for as adjustments to the “Gross premium”
recognized in profit or loss for the period.

The “24th method” assumes that the average date of issue of all
policies written during any month is the middle of that month.

Illustration 1: 24th Method – Policy issued at the beginning of period


On January 1, 20x1, ABC Insurance Co. issues a one-year, fire
insurance contract for a total premium of ₱12,000.

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.

Requirement (b): Unearned portions – 1st quarter


Jan. 31 Feb. 28 Mar. 31
Gross premium 12,000 12,000 12,000
Multiplied by: 23/24 21/24 19/24
Unearned portions 11,500 10,500 9,500

The numerators in the fractions are determined as follows:


 Jan. 31: (24 – 1 earned in Jan.) = 23 unearned portion
 Feb. 28: (24 – 1 earned in Jan. – 2 earned in Feb.) = 21 unearned portion
 Mar. 31: (24 – 1 – 2 – 2) = 19 unearned portion

Requirement (c): Earned portion – Dec. 31, 20x1


Gross premium 12,000
Multiplied by: 23/24
Earned portion - Dec. 31, 20x1 11,500

Requirement (d): Unearned portion – Dec. 31, 20x1


Gross premium 12,000
Multiplied by: 1/24
Unearned portion - Dec. 31, 20x1 500

Requirement (e): Journal entries


The entry on January 1, 20x1 is as follows:
Jan. 1, Insurance receivable – direct 12,000
20x1 Gross premiums revenue –
Direct 12,000

The adjusting entry on December 31, 20x1 is as follows:


Dec. Change in provision for unearned 500
31, premiums
20x1 Provision for unearned 500
Premiums

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.

The “Provision for unearned premiums” is presented in the statement


of financial position as part of “Insurance contract liabilities.”

Gross premium earned will be disclosed in the notes as follows:

Gross premiums written 12,000


Change in provision for unearned premiums (increase) (500)
Gross premium earned 11,500

Notice that the method of recording used is the “income method,” as


opposed to the “liability method.”

Alternatively, the adjusting entry may also be made by directly


reducing the gross premiums revenue account, as shown below:

Dec. Gross premiums revenue – direct 500


31, Provision for unearned
20x1 Premiums 500

Illustration 2: 24th Method – Policy issued during the period


In March 20x1, ABC Insurance Co. issues a one-year, fire insurance
contract for a total premium of ₱12,000.

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:

Requirement (a): Earned portion – Dec. 31, 20x1


Gross premium 12,000
Multiplied by: 19/24
Earned portion - Dec. 31, 20x1 9,500

The numerator in the fraction is computed as follows: (1 earned in March) + (2


earned in each of April to December) = 1 + (2 x 9) = 1 + 18 = 19

598
Requirement (b): Unearned portion – Dec. 31, 20x1
Gross premium 12,000
Multiplied by: 5/24
Unearned portion - Dec. 31, 20x1 2,500

The numerator in the fraction is computed as follows: (24 – 19) = 5.

Illustration 3: 24th Method – Premiums ceded


In April 20x1, ABC Insurance Co. writes fire insurance policies for a
total premium of ₱36,000. During the same period, total premiums of
₱12,000 were ceded to reinsurers.

Requirement: Compute for the following:


a. Net premium earned for the year ended December 31, 20x1.
b. Balance of provision for unearned premiums as of December 31,
20x1.

Solutions:

Requirement (a): Net premium earned – Dec. 31, 20x1


Gross premium 36,000
Multiplied by: 17/24
Earned portion - Dec. 31, 20x1 25,500

Premiums ceded (12,000)


Multiplied by: 17/24
Earned portion by reinsurers - Dec. 31, 20x1 (8,500)

Net premium earned - Dec. 31, 20x1 (25,500 – 8,500) 17,000

Requirement (b): Provision for unearned premium – Dec. 31, 20x1


Gross premium 36,000
Multiplied by: 7/24
Unearned portion - Dec. 31, 20x1 10,500

Premiums ceded (12,000)


Multiplied by: 7/24
Unearned portion by reinsurers - Dec. 31, 20x1 (3,500)

Provision for unearned premiums, Net - Dec. 31, 20x1 7,000

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

Requirement: Compute for the net premiums earned during the


period.

Solution:

Gross premiums 5,000,000


Change in provision for unearned premiums
– increase in unearned premium (2.8M – 2M) (800,000)
Gross premiums - earned 4,200,000

Premiums ceded to reinsurers 3,000,000


Change in provision for unearned premiums
– increase in unearned premium (1.2M – 1M) (200,000)
Premiums ceded to reinsurers – earned 2,800,000

Net premiums earned (4.2M - 2.8M) 1,400,000

Checking: We can check the accuracy of our answer above by using


T-account analysis, as shown below:

Provision for unearned


premiums - Net
Jan. 1 1M
Premiums written net
of premiums ceded Net premiums
(5M - 3M) 2M 1.4M earned (squeeze)
1.6M Dec. 31

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.

Illustration 1: Marine cargo risks


During the year, ABC Insurance Co. wrote insurance policies covering
marine cargo risks. Premiums from these policies are shown below:

Gross premiums Premiums Ceded


January 60,000 36,000
February 100,000 82,000
March 115,000 70,000
April 108,000 85,000
May 77,000 54,000
June 106,000 83,000
July 70,000 50,000
August 57,000 33,000
September 97,000 76,000
October 95,000 74,000
November 146,000 119,000
December 50,000 34,000
Totals 1,081,000 796,000

Requirements: Compute for the following:


a. Provision for unearned premiums as of December 31, 20x1.
b. Net premiums earned for the year ended December 31, 20x1
assuming the total gross premiums written and premiums ceded
in November and December 20x0 totaled ₱15,000 and ₱10,000,
respectively.

Solution:

Requirement (a): Provision for unearned premium – Dec. 31, 20x1


Provision for
Gross Premiums unearned premiums
premiums Ceded – net
a b c=a–b
November 146,000 119,000 27,000
December 50,000 34,000 16,000
Totals 196,000 153,000 43,000

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.

Requirement (b): Net premiums earned


Gross Premiums Net
premiums Ceded premium
A b c=a-b
From Nov. and Dec.
20x0 15,000 10,000 5,000
January 60,000 36,000 24,000
February 100,000 82,000 18,000
March 115,000 70,000 45,000
April 108,000 85,000 23,000
May 77,000 54,000 23,000
June 106,000 83,000 23,000
July 70,000 50,000 20,000
August 57,000 33,000 24,000
September 97,000 76,000 21,000
October 95,000 74,000 21,000
Totals 900,000 653,000 247,000

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:

The totals of non-life insurance policies written, excluding marine


cargo are computed as follows:

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

Requirement (a): Provision for unearned premiums – Dec. 31, 20x1


Total Total
excluding Unearned Marine
Marine
Fraction unearned
portion Cargo
Cargo portion
d = a+b+c E f=dxe g h=f+g
Gross Premiums (Direct and Assumed)
Jan 490,000 1/24 20,417 - 20,417
Feb 312,000 3/24 39,000 - 39,000
Mar 444,000 5/24 92,500 - 92,500
Apr 716,000 7/24 208,833 - 208,833
May 330,400 9/24 123,900 - 123,900
Jun 456,000 11/24 209,000 - 209,000
Jul 470,000 13/24 254,583 - 254,583
Aug 434,000 15/24 271,250 - 271,250
Sep 287,000 17/24 203,292 - 203,292
Oct 368,000 19/24 291,333 - 291,333
Nov 349,000 21/24 305,375 140,000 445,375
Dec 409,000 23/24 391,958 50,000 441,958
2,411,442 190,000 2,601,442
Premium Ceded
Jan 294,000 1/24 12,250 - 12,250
Feb 187,200 3/24 23,400 - 23,400
Mar 266,400 5/24 55,500 - 55,500
Apr 429,600 7/24 125,300 - 125,300
May 198,240 9/24 74,340 - 74,340
Jun 273,600 11/24 125,400 - 125,400
Jul 282,000 13/24 152,750 - 152,750
Aug 260,400 15/24 162,750 - 162,750
Sep 172,200 17/24 121,975 - 121,975
Oct 220,800 19/24 174,800 - 174,800
Nov 209,400 21/24 183,225 84,000 267,225
Dec 245,400 23/24 235,175 30,000 265,175
1,446,865 114,000 1,560,865

Unearned portion - Gross premiums 2,601,442


Less: Unearned portion - Premiums ceded (1,560,865)
Provision for unearned premiums - net 1,040,577

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

Subsequent measurement of Deferred acquisition costs (DAC)


Deferred acquisition costs (DAC) are similar to “prepaid assets”
recognized by other types of businesses. For insurance companies,
DAC consists of direct acquisitions costs of issuing or renewing
insurance contracts. These costs may include commissions and
premium taxes.

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.

Illustration: Subsequent recognition of DAC


In March 20x1, ABC Insurance Co. issues a one-year, fire insurance
contract. The costs of commission incurred on the issuance of the
contract amounted to ₱12,000.

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:

Requirement (a): Acquisition costs recognized in profit or loss


Total deferred acquisition costs 12,000
Multiplied by: 19/24
Expired portion 9,500

Requirement (b): Deferred acquisition costs – Dec. 31, 20x1


Total deferred acquisition costs 12,000
Multiplied by: 5/24
Unexpired portion 2,500

606
Requirement (c): Adjusting entry
Dec. 31, Deferred acquisition costs 2,500
20x1 Commission expense 2,500

Gross benefits and claims and Liability adequacy test

Illustration 1: Journal entries – Benefits and claims


ABC Insurance Co. offers fire insurance. On December 1, 20x1, ABC
Co. paid a ₱100,000 claim of a policyholder for losses incurred on his
insured property.

Case #1: Claims paid


The journal entry is as follows:
Dec. 1, Gross benefits and claims 100,000
20x1 Cash in bank 100,000

The “Gross benefits and claims” is recognized as expense in profit or


loss.

Case #2: Claims incurred but not yet paid


Assume that the claim of the policyholder is not yet paid.

The journal entry is as follows:


Dec. 1, Gross benefits and claims 100,000
20x1 Provision for claims 100,000

The Provision for claims is included in “Insurance contracts liabilities”


presented in the statement of financial position.

Case #3: Claims incurred but not reported (IBNR)


Assume that ABC Insurance Co. was made aware of the loss event
but the policyholder did not yet file a notice of claim to ABC.

The journal entry is as follows:


Sept. 1, Gross benefits and claims 100,000
20x1 Provision for claims - IBNR 100,000

Illustration 2: Journal entries – Liability adequacy test


ABC Insurance Co. is performing its first year-end “liability adequacy
test” for its insurance liabilities. The following amounts were
determined:

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Carrying amount Current estimate
Insurance contracts liabilities 1,300,000 1,250,000
Deferred acquisition costs 200,000

Requirement: Compute for the deficiency in insurance liability, if any.


Provide the journal entry.

Solution:

Insurance contracts liabilities - carrying amount 1,300,000


Deferred acquisition costs (200,000)
Net amount 1,100,000
Insurance contracts liabilities - current estimate 1,250,000
Deficiency in insurance contracts liabilities* (150,000)

* There is deficiency because the net amount of insurance contracts


liabilities is less than the required balance of insurance contracts
liabilities of ₱1,250,000 (i.e., current estimate).

The journal entry is as follows:


Dec. 31,
Gross benefits and claims 150,000
20x1 Provision for premium deficiency 150,000

The Provision for premium deficiency is included in “Insurance


contracts liabilities” presented in the statement of financial position.

Accounting for life insurance contracts and Contracts with


Discretionary participation feature (DPF)
The accounts and line items used for life insurance contracts are
similar to those used for non-life insurance contracts. However, some
recognition and measurement principles may differ for life insurance
contracts. These differences are discussed below.

Premiums from life insurance contracts or insurance contracts with


discretionary participation feature are either:
a. Single premium – the policyholder is required to make a lump
sum payment at the inception of the contract. Revenue is
recognized at the inception of the contract.
b. Regular premium – the policyholder is required to make
payments at regular periods over the term of the contract, e.g.,
monthly, annually. Revenue is recognized when the premium
becomes due from the policyholder.

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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.

Illustration 1: Journal entries – Single premium


ABC Insurance Co. offers life insurance. On January 1, 20x1, ABC
issues life insurance for a single premium of ₱1,000.

The journal entry is as follows:


Jan. 1, Cash 1,000
20x1
Gross premiums revenue – direct 1,000

Illustration 2: Journal entries – Regular premium


ABC Insurance Co. offers life insurance. The life insurance policies
written by ABC require recurring regular payments of ₱1,000 due at
the beginning of each month.

The entry on February 1, 20x1 to record the renewal of an existing


contract is as follows:
Feb. 1, Insurance receivable 1,000
20x1
Gross premiums revenue – direct 1,000

The entry to record the collection on February 7, 20x1 is as follows:


Feb. 7, Cash 1,000
20x1 Insurance receivable 1,000

Life insurance contract liabilities


Life insurance contract liabilities are recognized at the inception of the
contract. These liabilities are determined actuarially using various
assumptions, including assumptions on mortality, morbidity,
expenses, investment returns and surrenders. Since life insurance
contract liabilities are subject to the “liability adequacy test,” the
assumptions may be either based on current assumptions or
assumptions established at the inception of the contract. In the latter
case, allowances and adjustments for risk and deviation are included.

Gross benefits and claims


Aside from claims arising during the period and the related costs and
adjustments described previously in our discussions on non-life
insurance contracts, the gross benefits and claims from life insurance

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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

An annuity contract is a type of insurance contract that functions like


an investment account wherein the annuitant is guaranteed to receive
a series of payments (e.g., monthly payments), which may commence
immediately or at some future date, until the annuitant dies.

Death claims and surrenders are recognized as notifications are


received. Maturities and annuity payments are recognized when they
become due.

Death claims

Illustration: Journal entries


ABC Insurance Co. offers life insurance. On January 1, 20x1, ABC
receives notification of the death of a policyholder. The sum insured is
₱1,000,000.

The journal entry is as follows:


Jan. 1, Gross benefits and claims 1,000,000
20x1 Claims payable 1,000,000

The beneficiaries submitted the death certificate and other required


documents and the claim is settled on February 8, 20x1.

The journal entry is as follows:


Feb. 8, Claims payable 1,000,000
20x1
Cash in bank 1,000,000

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)

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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.

The journal entry is as follows:


Jan. 1, Gross benefits and claims 200,000
20x1 Cash in bank 200,000

Chapter 12: Summary


 PFRS 4 applies to insurance and reinsurance contracts issued by
an insurer, reinsurance contracts that it holds, and contracts that
it issues with discretionary participation feature (DPF).
 PFRS 4 does not apply to contracts and other transactions
specifically dealt with under other relevant standards.
 Insurance contract is 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.”
 Insurance risk is risk, other than financial risk, transferred from
the holder of a contract to the issuer.
 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.
 Insurance contracts are either (a) direct insurance contract or (b)
reinsurance contract.
 Reinsurance contract is an insurance contract issued by one
insurer (the reinsurer) to compensate another insurer (the cedant
or ceding company) for losses on one or more contracts issued
by the cedant. Direct insurance contract is an insurance contract
that is not a reinsurance contract.
 PFRS 4 temporarily permits insurance companies to continue
using or developing their own accounting policies for insurance
contracts. However, PFRS 4: (a) prohibits the recognition of
catastrophe or equalization provisions; (b) requires the
performance of the “liability adequacy test” at each reporting
period; (c) permits derecognition of insurance liabilities only when
they are extinguished; (d) prohibits off-setting of reinsurance
assets against related insurance liabilities and income and
expenses from reinsurance contracts against those from related

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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.

 Notable difference between the provisions of the full PFRSs and


the PFRS for SMEs:
Full PFRSs PFRS for SMEs
Accounting for insurance contracts
PFRS 4 Insurance Contracts Since insurers do not normally
specifies the financial reporting for qualify as SME, the accounting
insurance contracts by an insurer for insurance contracts by an
that issues such contracts. insurer is excluded from the
PFRS for SMEs.

The Section 12 of PFRS for


SMEs shall apply only to rights
under insurance contracts that
could result in a loss to either
party as a result of contractual
terms that are unrelated to:
(i) changes in the insured risk;
(ii) changes in foreign exchange
rates; or
(iii) a default by one of the
counterparties.

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PROBLEMS:

PROBLEM 12-1: TRUE OR FALSE


1. Maker Co., a manufacturer and dealer of household appliances, agrees
to indemnify a customer for any loss or damage that the customer
sustains from the use of a purchased appliance. The contract to
indemnify the customer in case of a loss event is accounted for under
PFRS 4.

2. Under an insurance contract, the party that has a right to compensation if


the insured event occurs is referred to as the insurer.

Use the following information for the next three questions:


Ms. Banana obtains a health insurance from Monkey Insurance Co. Monkey
Co. insures the health of Ms. Banana with Bacchus Insurance Co.

3. The contract between Monkey and Bacchus is referred to as a


reinsurance contract.

4. Ms. Banana is referred to as the cedant.

5. Monkey is referred to as the reinsurer.

6. Insurance companies are temporarily allowed to continue to develop


their accounting policies (or continue using their existing accounting
policies) for insurance contracts pending the finalization of the phase 2 of
PFRS 4.

7. When performing a “liability adequacy test,” if the carrying amount of an


insurance liability, net of related deferred acquisition costs and related
intangible assets, exceeds the current estimate of insurance liability at
the end of reporting period, the resulting difference is recognized as an
expense and a liability.

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.

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