FASB Takes up Insurance Accounting Essay Example

Board (FASB) and the International Accounting Standards Board (IASB) collaborated in creating a standard that ensures consistent accounting treatment for contracts with similar economic characteristics regardless of where they are issued.

Initially, their focus was on defining what constitutes an insurance contract. According to their definition, an insurance contract involves one party, known as the insurer, assuming significant insurance risk from another party called the policy holder. Under this agreement, the insurer agrees to compensate the policy holder if a specified uncertain event in the future adversely affects them. This definition establishes that a contract is considered an insurance contract only if it transfers significant risk other than financial risk from the policy holder to the issuer of the contract.

The importance lies in determining if an insured event could lead to substantial extra benefits being paid by the insurer unless it lacks commercial substance.According to Carlino (2010), the Financial Accounting Standards Board (FASB) has incorporated insurance contracts and accounting rules for insurance contracts into ASC 944. This change means that an insurance contract cannot transfer insurance risk unless there is a situation where the net outflows exceed the cash inflows.

The scope of the DP issued by the IASB included insurance contracts issued by an insurer and reinsurance contracts held by an insurer. It also proposed excluding warranties of products issued by manufacturers, retailers, or dealers, assets and liabilities of employer under employee benefit plans, rights and obligations contingent on the future use of a non-financial item, guarantees of residual value in a lease or given by manufacturers, retailers, or dealers, fixed fee service contracts (unless issued by an insurer), and other issues. A key difference between

these boards is that FASB decided not to include financial instruments with discretionary participation features in their insurance contract standard. These features give the contract issuer flexibility in providing additional benefits beyond the guaranteed benefits.

Both the accounting models for the two entities were initially different, presenting two main distinctions; the approach to initial measurement and the treatment of uncertainty in the new accounting model. However, after discussions and negotiations, the two boards reached an agreement that both models will have the same basis for measurement. FASB also agreed to consider the IASB approach to address uncertainty, aligning it with US GAAP (Reback 2009).
One requirement states that the initial measurement should include acquisition costs incurred when obtaining insurance contracts. It was mutually agreed by FASB and IASB to prohibit the capitalization of these costs as an asset. Despite this agreement, FASB maintained its position on calibrating against the gross consideration received from the policy holder during the initial measurement of insurance contracts.

The FASB chose this approach in conjunction with the initial measurements principles that will be applied to all customer contracts once the project to create a common accounting standard for revenue recognition is finished. Essentially, the FASB wanted to ensure that there would be no difference in how insurance contracts and other types of goods or services are accounted for. By making this argument, the FASB was able to persuade many IASB members to change their previous decision and adjust the liability of insurance contracts based on the customer consideration minus the incremental costs of acquisition. Together, the FASB and IASB implemented measures to ensure that acquisition costs are expensed as they are

incurred.

This implies that both models generate a loss on the first day due to the calibration of the insurance contract compared to the gross premium. Additionally, it requires that all acquisition costs be recorded as an expense. The Financial Accounting Standards Board (FASB) explained that it saw no valid reason to grant special treatment for insurance contract revenue accounting. FASB believed that providing special treatment for insurance contractors would create industry-specific revenue accounting, which is viewed as a negative aspect of US GAAP. Therefore, FASB aimed to completely eliminate this issue (Reback, 2009). Under the revenue recognition principles, FASB also approved that commission payments or any acquisition costs to any involved party do not indicate an obligation towards a policyholder and therefore should not be recognized as revenue. Following this principle, FASB further discussed the possibility of considering asset recognition for acquisition expenses.

The FASB and IASB have proposed measures to simplify insurance accounting, which involve using a current model for measuring insurance contracts based on expected cash flows and re-measuring estimates at each reporting period. However, experts argue that these proposals may lead to increased volatility and place additional demands on data and modeling systems. To gather stakeholders' input, a discussion paper was issued to address various issues, such as whether the IASB's proposal is an adequate improvement to US GAAP or if targeted improvements to existing guidelines would be more effective. Additionally, accounting issues where the FASB's preliminary views differ from IASB's Exposure Draft were examined (Dollho pf ; Foroughi, 2010).

The board recognized the importance of gathering information at this stage of the project in order to make informed decisions on improving financial reporting

for insurance contracts. This information will be valuable for both Boards during their discussions. FASB also intends to hold a series of public meetings in December to gather input from stakeholders. These efforts demonstrate FASB's commitment to a demanding work plan for themselves and their constituents. If FASB can meet its schedule, constituents can expect to receive twelve significant due-process documents in the first half of the year. Following this, an even larger number of final documents will be produced from July 2010 to June 2011, after which constituents will need to consider implementation issues.

FASB has stated that the effective date of their MoU with IASB will be treated as a package, rather than on a standard-by-standard basis. This approach aims to ensure a smooth transition, regardless of whether it is seen as a move towards IFRS or a continuation of US GAAP reporting. The need to address concerns raised by stakeholders about the flaws in insurance accounting standards was one of the motivations for FASB and IASB to collaborate on a joint project to develop new, universal standards.

The IASB and FASB have presented disparate proposals on how to handle insurance accounting. The current proposals by both boards will greatly transform the existing standards and bring about numerous significant changes in the measurement of insurance contract liabilities. These changes will establish a global standard for insurance accounting, incorporating economic and risk-based measurements. However, the present form of these proposals raises serious concerns that necessitate further considerations to ensure the resulting financial statements are applicable to users. Consequently, discussions on this matter are ongoing.