At date of death, the remaining difference between the face value of the policy and its carrying amount is recognized as a gain. Although this method recognizes income during the life of the policy, it does not take into account the time value of money. COMPARING THE METHODS The three alternative methods are conceptually more realistic than the cash surrender value method for two reasons. First, each reports an asset in the balance sheet at amounts that properly reflect the investment nature of the purchased policies.
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The general ledger account Accumulated Depreciation will have a credit balance that grows larger when the current period’s depreciation is recorded. As the credit balance increases, the book (or carrying) value of these assets decreases. Land refers to the land used in the business, such as the land on which the production facilities, warehouses, and office buildings were (or will be) constructed.
What are surrender fees?
- It assumes the company purchasing the life insurance contract intends to continue paying the premiums, if any, on the policy until the insured’s death, and therefore also capitalizes the premiums.
- The investment method is not as conservative as the cash surrender value method in recognizing a loss at acquisition.
- ALTERNATIVE ACCOUNTING OPTIONS The cash surrender value method has a number of serious shortcomings when it comes to fairly accounting for the new breed of life-insurance products.
Useful life is used in computing depreciation on an asset, instead of using the physical life. For example, a computer might physically last for 100 years; however, the computer might be useful for only three years due to technology enhancements that are occurring. As a consequence, for financial statement purposes the computer will be depreciated over three years. The amount of a long-term asset’s cost that has been allocated to Depreciation Expense since the time that the asset was acquired.
The cash value and cash surrender value may be the same amount if a policyholder has held the policy long enough. Policyholders should review their policies to determine surrender fee amounts. It is best to contact the insurance company to get the exact cash surrender value. It may be worth waiting until the policy is out of the surrender charge period, or accessing the cash value through alternative means (such as borrowing against it, among other options). The calculation is based on the premiums paid by the policyholder and the interest earned by the insurance company on invested money.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. David S. Chang, ChFC®, CLU® is an award-winning entrepreneur, keynote speaker, author, and consultant. He has over two decades of experience in the wealth management space and has been featured in dozens of news, radio, and podcast programs nationwide.
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The cash value amount depends on the premium paid, the duration of the policy, and the interest rate the policy earns. Despite FASB’s support for the cash surrender value method, many alternatives have been proposed. Revenue-based alternatives, such as the pro-ratable income and present value income methods, also have been proposed. They allow recognition of income before the insured’s death as well as recognition of and increase to the asset amount reported in the balance sheet. We propose a third alternative, referred to as the investment method.
The company will debit cash for that amount while eliminating the accumulated cash surrender value account. A gain will be booked for the difference – note that this might qualify as an extraordinary gain to be reported separately on the income statement. The cash surrender value is not taxable on the premiums paid cash surrender value of life insurance balance sheet classification into the policy.
He currently works as Head of IoT for the West Region of a Fortune 200 company. He is a graduate of the United States Military Academy at West Point and currently a Lieutenant Colonel in the California Army National Guard. He is an East-West Graduate Degree Fellow and has an MBA from the UCLA Anderson School of Management. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.