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When Should An Insurance Agency Recognize Revenue?

"Don't count your chickens before they hatch." Very old--but very good--advice. It also happens to apply to the quandary faced by insurance agents who are not certain about when they should "count their chickens" for accounting purposes.

The problem encountered by nearly all agents is a decision about when 10 "recognize" revenue. On the surface, this appears to be a minor detail. Does it really matter when you enter the sale of a policy as income for the agency? The answer is an emphatic "Yes!"

There are two major sources of income for an insurance agency: commissions on premiums (generally a percentage of premiums billed), and fees in lieu of commissions for insurance placement services. Precisely when these funds become revenue has long been a matter of contention and confusion.

This discussion will center on recognizing revenue for financial reporting purposes. Tax accounting is a separate and distinct issue.

The timing of revenue recognition has varied with accounting methods, but generally swings between the effective date of the policy and the billing dale of the policy. Obviously, it is in everybody's best interest 10 standardize revenue recognition for financial reporting. There should be a common financial yardstick. After all, there are other, fairly important people who read your financial statements--like your banker.

Here's a strong vote for not recognizing revenue before the effective dale of the policy sold. (That is, not before protection is afforded under the policy to the customer.) Revenue should only be recognized in accordance with the arrangement the agency has for services to be provided to the customer; matching revenue with expense is the common way with which we are all familiar.

Here are some compelling reasons why...

* The effective dote is much more objective than the billing date. In many cases today, the customer is billed directly by the insurance company. The selling agency has no control over when the bill is mailed, and often no knowledge of the billing! On the other hand, when the agency bills, the agency can literally pick and choose the most convenient billing date. While such flexibility may appear 10 be advantageous, the opportunity for inconsistency and confusion is too great to leave to chance. There is no uncertainty as to the dale risk is transferred to the underwriter.

* Advance billing is not income. In fact, advance billing is a liability until the policy becomes effective.

* Figures are actual, not estimated. By the effective date of the policy, the premium amount should be a known quantity. All adjustments and changes to price and premium value should have been completed. Direct billing information should be available via computer link, or be at most a phone call away.

If revenue is recognized ahead of the effective dale of the policy, financial statements may not be indicative of the agency's true operations for the period in question.

* The effective dote offers protection for the agency. When the effective date of the policy is used as the dale of revenue recognition, services required for placing the insurance have generally been performed. There may be obligations 10 perform services after the effective date. The effective date therefore provides an objective starting point for spreading that revenue over the expense period.

The time has come for insurance agencies to standardize the method used for revenue recognition. Let's make financial statements meaningful. It only makes sense that the effective date of the policy should also be the effective date of revenue recognition.

by Marshall I. Karp, CPA

Marshall I. Karp, CPA, is a partner with Gray, Gray & Gray Certified Public Accountants, Boston, Mass. Gray, Gray & Gray specializes in family-owned and closely-held businesses, and has extensive experience in the insurance industry. Mr. Karp can be reached at (617) 482-1100.
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Title Annotation:[LOOKING BACK]
Author:Karp, Marshall I.
Publication:Insurance Advocate
Date:Feb 11, 2018
Words:622
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