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Accounting for multiyear RRCs and sales and lease-backs of assets leased to other parties.

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity Wiht Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies Financial Accounting Standards Board emerging issues task force (EITF) consensuses as sources of established generally accepted accounting principles.

This month's column lists 1993 EITF consensuses adopted from March 16 through September 23, 1993 (see the sidebar on page 97). In addition, two consensuses are summarized: (1) accounting for multiyear retrospectively rated contracts (RRCs) by ceding and assuming enterprises and (20 sales and leasebacks of assets leased to other parties. The summaries are presented in the order of importance from broad to narrow applicability. This month's column also reports on new Securities and Exchange Commission staff positions that now are included in EITF Abstracts.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7. P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700.

ISSUE NO. 93-6

Issue no. 93-6, Accounting for Multiple-Year Retorspectively Rated Contracts by Ceding and Assuming Enterprise, is a specialized industry issue that affects property-casualty insurers (ceding enterprises) and reinsurers (assuming enterprises). Multiyear RRCs include a provision that provides for (1) changes in the amount or timing of the contractual cash flows, including premium adjustments, settlement adjustments or refunds to the ceding enterprise or (2) changes in the contracths coverage. In addition, part of all of the retrospective rating provision is obligatory, meaning it creates future rights and obligations as a result of past events. RRCs that can be canceled by either party without further obligation and indefinite-term RRCs are not covered by this issue.

The EITF addressed three issues relating to such contracts.

The first issue addreses whether the ceding enterprise should recognize a liability and the assuming enterprise should recognize an asset if the ceding enterprise is obligated to pay the reinsurer amounts that would not have been required absent experience to date under the contract (for example, payments that would not have been required if losses had not been experienced).

The second issue addresses whether the ceding enterprise should recognize an asset and the assuming enterprise should recognize a liability if the ceding enterprise is entitled to receive a payment from the reinsurer based on experience to dat under the contract (for example, if the ceding enterprise will receive a payment if not future losses occur).

The third issues addresses how to account for changes in coverage based on past experience under the contract. The consensuses reached were limited to RRCs that qualify for reinsurance accounting. Effective with the adoption of FASB Statemen no. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, reinsurance accounting requires reinsurance receivables and the liabilities related to reinsured contracts to be presented gross in the balance sheet.

The EITF reached a consensus that to qualify for reinsurance contract accounting, a contract that reinsures risks arising from short-duration insurance contracts must meet three conditions that relate to qualification as a short-duration contract, risk-transfer issues and the nature of the ultimate premium expected to be paid or received under the contract. If any of these conditions is not met, a deposit method of accounting should be applied by the ceding and assuming enterprises.

The EITF reached the following consensuses for RRCs that meet all the conditions for reinsurance accounting:

* The ceding enterprise should recognize a liability and the assuming enterprise should recognize an asset to the extent that the ceding enterprise has an obligation to pay cash (or other consideration) to the reinsurer absent experiecne under the contract. The amount recognized in the current period should be computed using a with-and-without method. EITF Abstracts provides application guidance for this method.

* The ceding enterprise should recognize an asset and the assuming enterprise should recognize a liability to the extent that any cash (or other consideration) would be payable from the assuming enterprise to the ceding enterprise based on experience to date under the contract.

* The ceding enterprise and the assuming enterprise should account for changes in coverage in the same manner as changes in other contract costs. For example, the effects of decreases in coverage without a commensurate reduction in premiums should be recognized as losses by the ceding enterprise and as gains by the assuming enterprise when the event causing the decrease in coverage takes place.

See EITF Abstracts for guidance on the effective date and transition rules for these consensuses and special disclosure requirements for SEC registrants. Appendix D of the Abstracts also includes the FASB staff's views on Issue no. 93-6 and the FASB Viewpoints article, "Accounting for Reinsurance: Questions and Answers about Statement 113."

ISSUE NO. 93-8

Issue no. 93-8, Accounting for the Sale and Leaseback of an Asset That Is Leased to Another Party, addresses the accounting by a seller-lessee for a sale-leaseback of personal property when

* The asset is or will be subleased by a third party under an operating lease or is subject to an operating lease at the time of sale.

* The seller-lessee retains substantial risks of ownership in the property through the temrs of the leaseback.

These transactions are outside the scope of FASB Statement no. 98, Accounting for Leases, because personal property rather than real estate is involved.

The issue is whether these transactions should be accounted for as borrowings in accordance with paragraphs 21 and 22 of FASB Statement no. 13, Accounting for Leases, or as sale-leaseback transactions in accordance with paragraphs 32 and 33 of FASB Statement no. 13, as amended by FASB Statement no. 28, Accounting for Sales with Leasebacks. According to paragraphs 21 and 22, sales of property subject to operating leases or sales of property leased by or intended to be leased by the third-party purchaser to another party should be treated as borrowings if the seller retains substantial ownership risks, as defined in these paragraphs, in the leased property. These paragraphs do not address sale-leaseback transactions specifically.

Paragraphs 32 and 33, however, say a seller-lessee should follow sale-leaseback accounting (that is, the seller should remove the asset and any related liabilities from the balance sheet and recognize the sale) for sale-leaseback transactions involving personal property.

The EITF reached a consensus that the seller-lessee should account for the transaction as a sale-leaseback in accordance with paragraphs 32 and 33, as amended. That is, the seller-lessee records the sale, removes the asset from its balance sheet, classifies the leaseback in accordance with paragraph 6 of Statement no. 13 and recognizes or defers any gain on the transaction in accordance with paragraph 33 of Statement no. 13, as amended.


Attention, SEC registrants! At the September 23, 1993, EITF meeting, the SEC observer requested that SEC staff positions be announced at EITF meetings as a way of improving communication with registrants. The EITF agreed to include these communications in appendix D of the EITF Abstracts beginning with the September 1993 update. The SEC observer discussed the following issues at the September meeting:

* Selection of discount rates in measuring defined pension benefit and other postretirement benefit obligations under FASB Statements no. 87, Employers' Accounting for Pensions, and no. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, respectively.

* Classification of in-substance foreclosed assets.

* The reclassification of securities in anticipation of adoption of FASB Statement no. 115, Accounting for Certain Debt and Equity Securities.
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Title Annotation:retrospectively rated contracts
Publication:Journal of Accountancy
Date:Nov 1, 1993
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