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Accounting for business life insurance.

Premium Payments. With cash value insurance the excess of net premiums paid (i.e., the premiums paid less dividends declared, if any) over the increase in cash surrender values is considered an insurance expense. Because premium payments are generally not deductible as a business expense, they are usually considered an "Extraordinary Item" and placed on the profit and loss statement before "Net Income Before Taxes," as at B on page 361. Alternatively, the insurance expense could be shown on the balance sheet as a direct charge to capital, with no entry being made on the profit and loss statement (note that this method highlights the non-tax-deductible nature of the expense).

Cash Values. The general rule is that cash values are carried on the balance sheet under "Noncurrent Assets," as at A on page 361 ("noncurrent assets" are also referred to as "other assets"). It has been suggested that with universal life containing surrender charges the full cash values should be carried as an asset. However, this is not consistent with the position taken by the Financial Accounting Standards Board in FASB Technical Bulletin No. 85-4, entitled "Accounting for Purchases of Life Insurance." When responding to the question of how to account for an investment in life insurance, the bulletin states: "The amount that could be realized under the insurance contract as of the date of the statement of financial position should be reported as an asset.... the current capacity to realize contract benefits is limited to settlement amounts specified in the contract" [emphasis added]. When it is intended to surrender a universal life policy value during the normal operating cycle, the surrender values might be carried on the balance sheet as a "Current Asset," as opposed to a "Noncurrent Asset."

Policy Loans. Usually there is no intention of repaying the policy loan within the current year, in which case the loan should be reflected on the balance sheet as a deduction from the cash surrender value (i.e., net cash surrender values should be shown). If there is an intention to repay within the current year, the loan should be carried as a current liability and the full cash surrender value shown as an asset.

Death Benefits. The amount of the death benefit in excess of the cash surrender values is considered a gain to corporate surplus. The entry can be made as a negative expense under Extraordinary Items on the profit and loss statement (B on page 361). Assuming cash surrender values of $36,000 and a death benefit of $250,000, the actual entry would read, "Plus: proceeds of officers life insurance in excess of cash surrender value ... 214,000."

  Cash                              $450,000
  Notes and accounts receivable      850,000
  Land                               300,000
  Buildings                          550,000
  Machinery and equipment            220,000
  Prepaid insurance, taxes, etc.      18,500
  Life insurance cash surrender
    values                          36,000 A
  Total Assets                                              $2,424,500

  Notes and loans payable banks     $145,000
  Accounts payable                    85,000
  Liability for income taxes          42,500
  Mortgages                          735,000
  Total Liabilities                            $1,007,500
  Common stock authorized and
    issued                          $900,000
  Retained earnings                  517,000
  Total Stockholder Equity                      1,417,000
  Total Liabilities and
    Stockholder Equity                                      $2,424,500


Net Sales                                       $ 869,000
Less: Cost of Sales and
Operating Expenses
  Cost of goods sold                $260,000
  Depreciation                        95,000
  Selling and administrating
    expenses                         184,000
Operating Profit                                             $ 330,000
Other Income
  Interest and dividends                                         5,000
Total Income                                                 $ 335,000
Extraordinary Item
  Less: life insurance expense                               (7,000) B
Net Income Before Taxes                                      $ 328,000
Provision for Income Tax                                     (113,900)
Net Profit for Year                                          $ 214,100
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Title Annotation:Terms & Concepts
Publication:Field Guide to Estate, Employee, & Business Planning
Date:Jan 1, 2010
Previous Article:Accelerated death benefit.
Next Article:Accumulated earnings tax.

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