Insurance Contracts in International Accounting Standards - Essay Example

IFRS 4 –AN ANALYSIS Table of Contents S.NO HEADING PAGE NO History 3 2 Objectives 4 3 Underlying Rational of IFRS 4 5 4 Conceptual Framework of IFRS 4 5 5 IFRS 4 Vs US GAAP 5 6 IFRS 4 –INSURANCE CONTRACTS 6 7 Salient features of IFRS 4 6 8 IFRS 4 in Company Balance sheets. 8 9 List of References 10 History IFRS 4 is the first ever accounting standard on insurance contracts from International Accounting Standards Board.(IASB). The suggestions spelled out in IFRS 4 are quite reticent in nature as contrasted to refurbishment of insurance accounting that is visualised by the IASB. (Mirza et al 2008:350). In the commercial world, guarantees are commonly used phenomenon. These guarantees can range from negotiated arrangements designed to help sales of services and products of a business and guarantees to bank loans as accommodations to business associates. The IFRS 4 was introduced in March 2004 mainly to regulate the insurance industry. (Epstein et al 2008:614). Before March 2004, there was non- existence of international standard to deal with different practices of accounting of insurance contracts. IASB, like any other analogues controversial issues, has split the IFRS 4 project into two phases. Under Phase 1 (a), to introduce restricted enhancements or improvements to accounting practices for insurance contracts without resorting to any major transformations that may be annulled in Phase II. Under Phase II (b), to demand to reveal that a) recognises and elucidates the figures in an insurer’s financial statements emanating from insurance contracts b) assists those analysts of these financial statements to recognise the amount, vagueness of future and timing of cash flows mainly from insurance contracts. Thus, Phase I resulted in the release of IFRS 4 which is fundamentally a demonstration and disclosure standard. Phase II will be dealt with the appreciation and evaluation of insurance contracts. (Alexander, David et al 2007: 408). Prior to the mid -2005 amendment made to IFRS 4 and IAS 39, guarantees had not been widely addressed by IFRS. However, IFRS 4 is designed with a sole aim to deal with some special financial guarantee contracts or insurance contracts. (Epstein et al 2008:614).This research essay discusses about IASB in general and IFRS 4 in particular in an exhaustive manner. Objectives The introduction of IFRS 4 was mainly intended to permit insurance companies to adhere with the espousal of International Financial Reporting Standard (IFRS) in European Union and in other nations from 2005 onwards. IFRS is mainly intended to make restricted improvements to accounting practices in insurance industry and to offer an insight into the major areas that pertains to accounting of insurance contracts. (Mirza et al 2008:350). The main aim of IFRS 4 is to suggest upgradation of accounting norms for insurance contracts by the insurance companies and to demand disclosures that recognises and addresses the amounts associated to insurance contracts. IFRS 4 helps the users of financial statements to appreciate the figures relating to insurance, to know about uncertainty of future cash flows and timings of insurance contracts. (Greuning 2009:324) The other objectives of the IFRS 4 are to oblige business entities to make disclosures in their financial statements that facilitate users to assess: The importance of financial instruments for the business organization’s financial status and performance; and The nature and degree of risks emanating from financial instruments to which the business organisation is vulnerable during the period and at the close of the financial reporting period and how the business organisations administer the risks. (IASB 2009:753). Underlying Rational of IFRS 4 One of the underlying rational of IFRS 4 is that it permits the insurer to change or modify their accounting policy only in case, where the new valuation method is shifting in the direction of market value, which is also known as “market consistent valuation.” The underlying rationale of IFRS which harmonizes the principles for acknowledging, evaluating and presenting financial liabilities and assets in IAS 32. (IASB 2009:753). Conceptual Framework of IFRS 4 The general notion of a conceptual framework is an endeavor to develop an internationally comprehensive and consistent structure for all features of the financial accounting discipline for insurance contracts. IFRS 4 Vs US GAAP Under US GAAP which is now codified as ASC 450, which was known as FAS 5, there had been a long practice of a minimum disclosure about guarantees and in many scenarios, the accrual of expected loss to be borne by the guarantor. Now, IFRS has been transformed to offer assistance on the accounting for all financial guarantees, especially for those which in force as insurance, the accounting for the same has now been directed by the provisions of IFRS 4. Of late, US GAAP witnessed the proliferation of an exhaustive standard. Earlier, the standard was known as FIN 45, and now it is codified as ASC 46O, which stipulates a new rule for identifying, accounting and reporting of all insurance guarantees. (Epstein et al 2008:614). Under IFRS 4, for defining the accounting policy for the valuation of investment, no freedom is available where as it is available under US GAAP. Under IFRS 4, no provisions can be made for catastrophe or equalisation or to offset reinsurance assets with direct insurance liabilities, whereas it can be made under US GAAP. IFRS 4 –INSURANCE CONTRACTS IFRS 4 was initiated mainly to recommend standards for “financial accounting for insurance contracts “by any business that carries on the business of insurance. It is applicable to any insurance contracts issued and financial instruments issued with a flexible feature and reinsurance contracts. However, IFRS 4 will not be applicable to the following: Under the employee benefit schemes, all the employee’s assets and liabilities.( covered by IAS 26 & 19) Product warranties (covered by IAS 37 and 18). Under the IAS 39, any financial guarantees entered into. Contractual privileges that are probable on the right to use or future use of non-financial items and residual value guarantees on finance leases covered under IAS 38,17 &18. If a business holds as a policy holder, then it relates to directing insurance contracts. (Kirk 2008 :472} Salient features of IFRS 4 As per IFRS 4, an “insurance contract is an “agreement “wherein the insurer acknowledges the importance of insurance risks from the policyholder by consenting to reimburse the assured on happening of a particular future event which may negatively impact the policyholder. (Epstein & Jermakowicz 2008:965). The salient features of IFRS 4 about insurance contracts are. 1. It bars the identification of a liability for the provision is to be made for any future claims, especially under insurance contracts, which are not present at the date of reporting. For instance, equalisation provisions and catastrophe. 2. It demands an evaluation of the adequacy of acknowledged insurance commitments and the acknowledgement of any destruction of reinsurance assets. 3. It demands a business to maintain insurance liabilities on their balance sheet until they are cancelled or discharged or expired to make sure that insurance liabilities is outlined without any counterbalancing against associated reinsurance assets. Under IFRS 4, a business shall not implement the under-mentioned practices, though, if presently perused, it may continue to employ them. 1. On an undiscounted basis, assessing insurance liabilities. 2. Assessing contractual privileges to future fees on investment management at a sum that is in excess of their fair value as denoted by as contrast with present fees booked by other participants in the market for analogues services. 3. Employing uneven accounting policies for the insurance contracts of their subsidiaries. 4. Assessing with excessive prudence of the insurance liabilities.(Kirk 2008 :472} IFRS 4 concentrates on those insurance contracts that consist of both a deposit element and an insurance component. In certain cases, an insurance company is needed or authorised to separate those elements and to apply “Financial Instruments: Measurements and Recognition” dealt by IAS 39 to the deposit element and to extend IFRS 4, “Insurance contracts” to the insurance element. A business entity is required to evaluate the needed standards on a contract to contract basis and to give weight to all elements of making transformation to its accounting system so as to make sure that in consonance with IFRS. (Ernst & Young 2009). IFRS 4 also elucidates the relevance of a practice namely “shadow accounting.” Under this concept, an insurer can fine tune their liabilities for any changes that happened due to unrealisable losses or gains on assets that have been realised. Thus, a change in accounting policy can be made by an insurer such that accredited but unrealised losses or gains can also be fine tuned according to their liabilities. Any changes in the liability can be acknowledged in equity only if unrealised losses or gains are acknowledged in equity. (Mirza et al 2008:423). IFRS 4 in Company Balance sheets. Groupe SEB is EU based global leader in Small Household Equipments. SEB’s global market share in household appliances symbolises about 10 percent. Further, SEB is also holding about 15% of global cookware market. (groupeseb.com). In their notes to accounts for the year 2004, they reported as follows: “The new accounting standards under IFRS 4 intend to transform the categorisation of insurance contracts and will not have a great impact on the P&L account of the company. The company further reported that there is a negative impact of SEK -229 million on the initial balance of equity mainly due to the estimation of equity and due to acquisition cost in the year 2004. (hugin.info 2005) BARLOWORLD is a South Africa based company. The notes to the consolidated annual financial statements for the year ended 30th-september state as follows: Insurance Contracts: The group has entered into some transactions as an insurer which will fall under the category of IFRS 4 –Insurance Contracts. Some of the salient items are described as follows: In the motor segment, credit life and warranty products sold along with vehicles. In the sale of industrial distribution, equipment and motor segment, specific segments of maintenance contracts on vehicles and equipment sold were included. On vehicles and equipment, there has been guaranteed residual values especially in the motor and equipment sectors. (Mirza et al 2008:425). List of References Alexander, David & Archer Simon. (2008). International Accounting / Financial Reporting Standards Guide. New York: CCH Alexander, David et al. (2007) International Financial Reporting and Analysis. London: Cengage Learning. Epstein, Barry J & Jermakowicz Eva k. (2008). Wiley IFRS 2008: Interpretation and Application of International Accounting. London: Wiley Publishers. Ernst & Young. (2009). IFRS Guidelines Related to Specific Industries. [online] available from < http://www.ey.com/CA/en/Issues/Governance-and-reporting/IFRS/IFRS-Industry-Guidance> accessed on 24 March 2010. Greuning , Hennie Van. (2009 ) International Financial Reporting Standards: A Practical Guide. New York: World Bank Publications. Growthorpe, Catherine. (2007).CIMA Official Learning System Financial Analysis. New York: Butterworth-Heinemann. Hugin.info (2005) The SEB Group Accounts as per New Accounting Standards IFRS. [online] available from < http://hugin.info/1208/R/991627/149436.pdf> accessed on 24 March 2010. IASB (2009). International Financial Reporting Standards. IFRS 2008. London: Kluwer International. Kirk, Robert. (2008). IFRS: A Quick Reference Guide. New York: Butterworth-Heinemann. Mirza, Abbas Ali, Ornell Magnus & Holt, Graham J. (2008). Wiley IFRS: Practical Implementation of Guide and Workbook. London: Wiley Publishers. Stolowy Herve & Lebas Michel. (2006). Financial Accounting and Reporting: A Global Perspective. London: Cengage Learning. Read More