f.

A credit-related guarantee (or letter of credit, credit derivative default

contract or credit insurance contract) that requires payments even if
the holder has not incurred a loss on the failure of the debtor to make
payments when due.
g. Contracts that require a payment based on a climatic, geological or
other physical variable that is not specific to a party to the contract
(commonly described as whether derivatives).
h. Catastrophe bonds that provide for reduced payments of principal,
interest or both, based on a climatic, geological or other physical
variable that is not specific to a party to the contract.

Recognition and measurement

Insurance companies are temporarily permitted under PFRS 4 (pending the
finalization of the phase two of IASB’s project) to continue developing their
own accounting policies (or continue using their existing accounting policies)
for insurance contracts without regard to the requirements of PAS 8
Accounting Policies, Changes in Accounting Estimates and Errors (i.e.,
hierarchy of reporting standards) and the Conceptual Framework.

However, PFRS 4 expressly

a. Prohibits provisions for possible claims under contracts that are not in
existence at the reporting date (referred to as catastrophe or
equalization provisions)
b. Requires a test for the adequacy of recognized insurance liabilities
(referred to as the “liability adequacy test”)
c. Requires the retention of insurance liability in the statement of financial
position until the obligation is extinguished (i.e., discharge or cancelled
or expires)
d. Prohibits the off-setting of
i. reinsurance assets against the related insurance liabilities; or
ii. income or expense from reinsurance contracts against the
expense or income from the related insurance contracts.
e. Requires an impairment test for reinsurance assets. Impairment loss is
recognized when, after the initial recognition of an insurance asset, an
event has occurred that leads to amounts due under the contract not
being recoverable in full, and a reliable estimates of the loss can be
assessed.

Liability adequacy test

At each reporting period, an insurer shall assess whether its recognized
liabilities are adequate using current estimates of the future

581
cash flows, and related items such as handing costs, arising under the
insurance contracts.

If the assessment shows that the carrying amount of the insurance

liabilities (less related deferred acquisition costs and related intangible assets)
is in adequate compared to the current estimate, the deficiency is
recognized in profit or loss.

Current
Carrying amount of estimate
insurance liability of Deficiency of
(less related deferred insurance insurance
Less than =
acquisition costs and liability at liability
related intangible end of recognized in
assets) reporting profit or loss
period

If the insurer’s accounting policies do not required a liability adequacy test

to be carried out, as described above, then an assessment is still required of
the potential net liability (i.e., the relevant insurance liabilities less any
related deferred acquisition costs). In these circumstances, the insurer is
required to recognized at least the amount that would be required to be
recognized as a provision under PAS 37 Provisions, Contingent Liabilities and
Contingent Assets. Any deficiency in insurance liability is also recognized in
profit or loss.

PFRS 4 provides the following definitions:

 Insurance liability – an insurer’s net contractual obligations under
an insurance contract.
 Insurance asset – an insurer’s net contractual rights under an
insurance contract.
 Reinsurance assets – a cedant’s net contractual rights under a
reinsurance contract.

Changes in accounting policies

An insurer is permitted under PFRS 4 to change its accounting policies for
insurance contracts if the change results to more relevant and no less reliable,
or more reliable and no less relevant, financial information. The general
principles in PAS 8 shall be applied in judging relevance and reliably of
financial information, but full compliance with the criteria in PAS 8 is not
required.

582
Specific issues in changes in accounting policies
a. Current interest rates – insurers are permitted to designate liabilities
to be valued at current market interest rates with changes in values
recognized in profit or loss. This election is irrevocable. Once a liability
is designated to be valued a current market interest rates, it shall be
valued as much until the liability is extinguished.

b. Continuation of existing practices – an entity is permitted to continue

using any of the following accounting practices, but is prohibited from
introducing any of them if they were not used previously:
i. Measuring insurance liabilities on an undiscounted basis
ii. Measuring contractual rights to the future investment
management fees at an amount that exceeds their fair value
iii. Using non-uniform accounting policies for the insurance liabilities
of a subsidiary

c. Prudence – an insurer is not required to change its accounting policies

on insurance contracts in order to eliminate excessive prudence.
However, an insurer that uses sufficient prudence is not required to
introduce additional prudence.

d. Future investment margins – an insurer need not to change its

accounting policies for insurance contracts to eliminate future
investment margins. However, entities cannot change to an accounting
policy that adjusts their liabilities to reflect future investment margins
unless, for example, this is part of a wider switch to a comprehensive
investor-based accounting system.

e. Shadow accounting – Realized gains or losses on an insurer’s assets

may have a direct impact on the measurement of some or all of the
insurance liabilities and related deferred acquisition costs and
intangible assets. In such cases, an insurer is permitted, but not
required, to use ”shadow accounting”.

Shadow accounting means that unrealized gains or losses on assets, which

are recognized in other comprehensive income, are reflected in the
measurement of the insurance liabilities (or deferred acquisition costs or
intangible assets) in the same way as realized gains or losses. The related
adjustment to the insurance liability (or deferred acquisition costs or
intangible assets) shall be recognized in other comprehensive income if the
unrealized gains or losses are also recognized in other comprehensive
income.

583
Insurance contracts acquired in a business combination
When accounting for business combinations, an insurer may recognize an
intangible asset for the difference between the fair value and the carrying
amount of insurance liabilities acquired. The intangible asset recognized is
excluded from the scope of both PAS 36, Impairment of Assets and
Intangible Assets.

Contracts with discretionary participation features

Some insurance contracts contain a discretionary participation feature as
well as a guaranteed element.

PFRS 4 provides the following definitions:

 Discretionary participation feature (DPF) – a contractual right to
receive, as a supplement to guaranteed benefits, additional benefits:
a. that are likely to be a significant portion of the total contractual
benefits;
b. whose amount or timing is contractually at the discretion of the
issues; and
c. that are contractually based on:
i. the performance of a specified pool of contracts or a
specified type of contract;
ii. realized and /or unrealized investment returns on a
specified pool of assets held by the issuer; or
iii. the profit or loss of the company, fund or other entity that
issues the contract.

 Guaranteed element – an obligation to pay guaranteed benefits,

included in a contract that contains a discretionary participation feature.
 Guaranteed benefits – payments or other benefits to which a
particular policyholder or investor has an unconditional right that is not
subject to the contractual discretion of the issuer.

Accounting requirements
a. Contracts with DPF are continued to be accounted for using existing
accounted policies. PFRS 4 does not require a new measurement basis.
b. The guaranteed element may or may not be recognized separately
from the DPF.

If the guaranteed element is recognized separately from the DPF:

 the guaranteed element shall be classified as liability; while

584
  the DPF shall be classified either as a liability or a separate
component of equity.

If the guaranteed element is not recognized separately from the

DPF, the whole contract shall be classified as a liability.

c. Any liability recognized is subject to the ”liability adequacy test”.

d. All premiums received may be recognized as revenue without

separating any portion that relates to the equity component.

Unbundling of deposit components

Some insurance contracts contain both an insurance component and a
deposit component.

PFRS 4 provides the following definitions:

 Deposit component – a contractual that is not accounted for as a
derivative under PFRS 9 and would be within the scope of PFRS 9 if it
were a separate instrument.
 Unbundle – account for the components of a contract as if they were
separated contracts.

Unbundling is required when both the following conditions are met:

a. The deposit component can be measured separately without
considering the insurance component, and
b. The insurer’s accounting policies does not require it to recognize all
obligations and rights arising from the deposit component.

Unbundling is permitted, but not required, when the insurer can measure
the deposit component separately from the insurance contract but its
accounting policies requires it to recognized the deposit component.

Unbundling is prohibited if an insurer cannot measure the deposit

component separately.

When a contract is unbundled, the insurer shall apply PFRS 4 to the insurance
component separately.

Existing accounting policies for insurance contracts

The succeeding discussions pertain to existing accounting policies, practices
and principles relevant to insurance contracts. Although, these are not
specifically required under PFRS 4, they are temporarily permitted pending
the finalization of the phase two of IASB’s project.

585
Overview of accounting for insurance contracts:
Item Accounting treatment under
Phase 1 of PFRS 4
1. Insurance contracts  Existing accounting policies
2. Investment or insurance  Existing accounting policies
contracts with discretionary
participation features
3. Investment contracts without  PFRS 9 (fair value or
discretionary participation amortized cost)
features

These are various types of insurance contracts, as much as there are various
types of risks that can be insured. The examples enumerated previously are
just a few (and are only intended to provide general descriptions) of the
insurance contracts available in the market today.

For purposes of our succeeding discussions, we shall broadly classify

insurance contracts into life and non-life. We shall focus our discussions
on the following classes of insurance contracts, based on classifications
under the Insurance Code of the Philippines:

Non-life:
1. Marine insurance – provides protection against loss or damage of
boats, ship, cargo, and terminals during a certain voyage, shipment,
stage of preparation or for a fixed period of time.

2. Fire insurance – provides protection against loss or damage of

property caused by fire. Under the Insurance Code, fire insurance may
also cover losses resulting from “lighting, windstorm, tornado or
earthquake and other allied risks, when such risks are covered by
extension to fire insurances policies or under separate policies.”

Insurance coverage may include:

a. Building,
b. Contents of the building, or
c. Both the building and its contents.

3. Casualty insurance – a board category of insurance covering loss or

liability arising from the accident and other events not within the scope
of marine and fire insurance as defined under the Insurance Code. The
following are examples of casualty insurance:

586
 a. Motor Insurance (vehicle insurance, car insurance, or auto insurance)
– is insurance purchased for cars, trucks, public utility vehicles,
motorcycles, and other road vehicles. It protects the policyholder
against financial loss in case of accident, theft and physical damage.

Insurance coverage may include:

i. Property coverage – protection against damage to or theft of the
vehicle.
ii. Liability coverage – protection against responsibility to others for bodily
injury or property damage.

Motor insurance is a legal requisites in the registration of motor vehicles.

b. Personal accident insurance – provides financial protection against

losses from injury and disability caused by accident.

c. Travel insurance – covers losses incurred while travelling, such as

losses arising from lost baggage and other personal belongings,
medical expenses, travel delay, and personal liabilities.

d. Burglary and theft insurance – covers losses of property due to

burglary, robbery or larceny.

e. Health insurance (as written by non-life insurance companies) –

provides financial protection against incurrence of medical expenses in
case of illness.

4. Surety – is a contract whereby one part (the surety) guarantees the

performance of another party (the principal or obligor) in favor of a
third party (the obligee). A surety is accounted for under PFRS 4 if it
transfers significant insurance risk to the issuer.

A common example of a surety contract is fidelity bond. A fidelity bond is

a form of insurance that provides financial protection to an employer in cases
of losses due to employees’ fraudulent actions (e.g., embezzlement, forgery,
or fraudulent trading).

Example:
ABC Bank employs three cashiers, each of whom, are given access to ABC’s
cash. To protect against employee embezzlement, ABC Bank obtains fidelity
bonds from XYZ

587
Insurance Co. for each of the three employees. In case of embezzlement,
ABC Bank may claim compensation from XYZ. In turn, XYZ is subrogated to
the rights of ABC in claiming from the dishonest employee.

In the example above, XYZ Insurance Co. is surety, the bonded employee is
the principal or obligor, and ABC Bank is the oblige.

Life:
5. Life insurance – “Life insurance is insurance on human lives and
insurance appertaining thereto or connected therewith.” (Sec. 179, The
Insurance Code of the Philippines)

Types of life insurance

1. Term life insurance – is a life insurance which provides coverage at
a fixed rate of payments for a limited period of time. After that period
expires, coverage at the previous rate of premiums is no longer
guaranteed and the client must either forgo coverage or potentially
obtain further coverage with different payments and/or conditions. If
the insured dies during the term, the death benefit will be paid to the
beneficiary.

2. Permanent life insurance – is a life insurance policy that remains

in force for the insured’s whole life and requires (in most cases)
premiums to be paid every year into the policy.
a. Whole life coverage – covers the insured’s entire life and the
proceeds (face amount) are paid only upon death of the insured.
b. Universal life coverage – provides greater flexibility in
premium payment and the potential for greater growth of cash
values.
c. Limited-pay – premiums are paid only for a specified period,
after which no additional premiums are required.
d. Endowments – the cash value of the policy equals the death
benefit at a certain age (endowment age). Benefits are paid
whether the insured lives or dies, after a specific age.

588
Accounting for non-life insurance contracts

Peculiar accounts and line-items – non-life insurance

Assets:

1. Insurance receivable – this consists of the following:

a. Due from policyholders, agents and brokers – this represents the
outstanding balance of premiums receivable from direct
insurance contracts issued.
b. Due from ceding company – this represents the outstanding
balance of premiums receivable from reinsurance contracts
issued.

Most non-life insurance contracts are of short duration. Many insurance

companies recognize insurance receivables on policy inception dates.

Insurance receivables are recognized on policy inception dates. Most non-

life insurance contracts are short-term. Thus, many insurers initially measure
insurance receivables at the transaction price (original invoice amount).
Subsequently, the insurance receivable is measured at the unpaid balance
of the transaction price less allowances for uncollectability and impairment
losses. Estimates of uncollectability are recognized in profit or loss in the
period where collection becomes improbable. Accounts are written-off when
they become worthless.

2. Deferred acquisition costs (DAC) – this consists of deferred cost

representing commissions and other acquisition costs that vary with
and are directly related to securing new insurance contracts or
renewing existing contracts. These costs are deferred to the extent
that they are recoverable out of future premiums. All other acquisition
costs are recognized as an expense when incurred.

Subsequently, these costs are amortized as expense using the “24th method,”
except for the last two months of the year are recognized as expense in the
following year.

DAC is considered when performing the “liability adequacy test” at each

reporting date.

589
 3. Reinsurance assets – this represents balances due from reinsurance
companies. Reinsurance assets are reviewed from impairment at each
reporting period.

Liabilities:

4. Insurance contracts liabilities – this account consists of the

following:
a. Provision for unearned premiums (Reserve for unearned
premiums) – represents premiums already received but not yet
expired. Premium from short-duration insurance contracts are
recognized as revenue using the “24th method” over the life of
the contract, except for contracts covering marine cargo risks
where premiums for the last two months of the year are
recognized as revenue in the following year.

b. Provision for Claims reported and Incurred but not reported

(IBNR) – this represents unpaid claims and related adjustment
expenses arising from the occurrence of insured events, whether
or not these claims. These provisions do not include possible
claims from insured events that have not yet occurred as of the
reporting date (referred to as catastrophe or equalization
provisions).

c. Provision for premium deficiency – this represents additional

liability for the deficiency in insurance contract liabilities arising
from the performance of the ”liability adequacy test.”

5. Insurance payable – this account consists of payables related to

insurance or reinsurance contracts, other than provisions included in
“insurance contracts liabilities,” and may include the following:
a. Due to reinsurers – this represents premiums payable to
reinsurers resulting from contracts ceded to them.
b. Funds held for reinsurers – this represents the portion of
reinsurance premiums withheld by ceding companies on
accordance with treaty agreements.

6. Deferred reinsurance commissions – pertains to the unexpired

portion of commissions from reinsurance contracts. These are

590
recognized in profit or loss on the same basis as the related acquisition costs
are recognized in profit or loss.

Revenue:

7. Gross premiums – consists of the total premiums receivable over the

duration of insurance contracts written during the period. These also
include adjustments made during the reporting period relating to
contracts written in prior reporting periods. Gross premiums are
recognized at the inception date of policies.

Premiums from short-duration insurance contracts are recognized as

revenue over the period of the contracts using the “24th method,”
except for contracts covering marine cargo risks where premiums for
the last two months are considered earned in the following reporting
period.

The unexpired portion of portion of premiums written are accounted

for as “Provision for unearned premiums” included in “Insurance
contracts liabilities” and presented in the liabilities section of the
statement of financial position. The net changes in the Provision for
unearned premiums” are accounted for as adjustments to the “Gross
premium.”

8. Premiums ceded to reinsurers – consists of the total premiums

payable over the duration of insurance contracts ceded to reinsurers.
These also include adjustments made during the reporting period
relating to the contracts ceded in prior reporting periods. Premiums
ceded to reinsurers are recognized at the inception date of policies.

9. Net premium – is gross premium minus premiums ceded to

reinsurers

Expenses:

10. Gross benefits and claims – consists of all claims occurring

during the period, whether reported or not, including direct costs of
processing and settling the claims, reduced by salvage value and other
recoveries, and adjusted for changes in claims outstanding from
previous periods.

11. Claims ceded to reinsurers – the portion of claims occurring

during the period which are recoverable from reinsurers.

591
 12. Net benefits and claims – is gross benefits and claims minus
claims ceded to reinsurers.

Some insurers present net benefits and claims in the statement of profit
or loss and other comprehensive income by reconciling the cash basis
benefits and claim (i.e., ‘Gross benefits and claims paid’) to accrual basis.
This is done by adjusting the benefits and claims paid for the changes in
insurance contracts liabilities. (See illustrative statement of profit of loss and
other comprehensive income below)

Illustrative Statement of financial position of an insurance

company

ABC Insurance Co.

Statement of financial position
as of December 31, 20x1
ASSETS
Cash and cash equivalents ₱ 250,000
Held for trading securities 660,000
Insurance receivables - net 1,900,000
Accrued income 1,150,000
Deferred acquisition costs 95,000
Reinsurance assets 260,000
Property, plant and equipment - net 960,000
Total assets ₱ 5,275,000

LIABILITIES
Insurance contract liabilities ₱ 1,055,000
Accrued expenses and other liabilities 96,000
Income tax payable 32,000
Insurance paybales 184,000
Deferred reinsurance commissions 60,000
Total liabilities 1,427,000

EQUITY
Share capital 2,000,000
Retained earnings 1,748,000
Other components of equity 100,000
Total equity 3,844,000
Total liabilities and equity ₱ 5,275,000

592
Illustrative Statement of profit or loss and other comprehensive
income of an insurance company

ABC Insurance Co.

Statement of profit or loss and other comprehensive income
As of December 31, 20x1

Notes
Gross premiums 6 ₱ 800,000
Premiums ceded to reinsurers 6 (200,000)
Net premiums 600,000
Fees and commission income 120,000
Investment income 60,000
Other revenue 180,000
Total revenue 780,000
Gross benefits and claims paid (450,000)
Claims ceded to reinsurers 100,000
Gross change in contract liabilities (80,000)
Change in contract liabilities ceded to reinsurers 20,000
Net benefit and claims (410,000)
Finance costs (15,000)
Other operating and administrative expenses (270,000)
Other expenses (285,000)
Total benefits, claims and other expenses (695,000)
Profit before tax 85,000
Income tax expense (18,000)
Profit for the year 67,000
Other comprehensive income, after tax:
Items that will not be reclassified subsequently to profit or loss:
Gains on property revaluation 8,000
Other comprehensive income for the year, net of tax 8,000
TOTAL COMPREHENSIVE INCOME FOR THE YEAR ₱ 75,000

Selected notes
Note 6: Net premiums
Gross premiums written
Direct a 900,000
Assumed b
300,000
Total gross premiums on insurance contracts 1,200,000
Change in provision for unearned premiums (400,000)
Gross premium 800,000
Premiums ceded to reinsurers c (300,000)
Change in provisions for unearned premiums 100,000
Premiums ceded to reinsurers (200,000)
Net premiums 600,000

593
a
Direct premiums – premiums received or receivable directly from brokers,
agents, or insured individuals, before deducting premiums paid or payable
to reinsurers.

b
Assumed premiums – premiums received or receivable from other
insurance companies for reinsurance contracts written.

c
Premiums ceded to reinsurers – direct and assumed premiums paid or
payable to reinsurers for reinsurance contracts obtained.

Initial recognition

Illustration 1: Journal entries – direct insurance contract

ABC Insurance Co. offers fire insurance. On January 1, 20x1, ABC received
notice from its broker of a sale of one-year fire insurance for a premium of
₱ 1,000. The broker’s commission is 10%.

The journal entry are as follows:

Jan. 1, Insurance receivable – direct 900
20x1 Commission expense 100
Gross premiums revenue – 1,000
Direct

Taxes are ignored in order to simplify the illustration. Of taxes are considered,
additional credits shall be made for taxes payable, such as “Documentary
Stamp Tax (DST) payable,” “Output Value-Added Tax (VAT) payable,” Local
government tax payable, and other relevant taxes.

The account “Due from the policyholders, agents and brokers” may be used
in lieu of “Insurance receivable – direct.”
The “Commission expense” and “Gross premiums revenue” will be adjusted
for their unexpired and unearned portions, respectively, at the end of the
year.
 The unexpired portion of the “Commission expense” will be debited
to “Deferred acquisition costs” – an asset account.
 The unearned portion of the “Gross premiums revenue” will be
credited to “Provision for unearned premiums” – a liability account.
These will be discussed further momentarily.

594
Illustration 2: Journal entries – Reinsurance contract written
ABC Insurance Co. writes a reinsurance contract for XYZ Insurance Co. for a
premium of ₱1,000. Commission expense incurred on the reinsurance
contract issued is 10%.

The journal entry is as follows:

Jan. Insurance receivable – assumed 900
1, Commission expense 100
20x1 Gross premiums revenue – assumed 1,000

The account “Due from ceding company” may be used in lieu of “insurance
receivable – assumed.”

Gross premiums are recorded in a premium register also known as

“bordereaux” (pronounced as “bor”-“deh”-“row”). This register is the equivalent
of a sales register maintained by a trading company.

Illustration 3: Journal entries – Reinsurance contract (Book of

cedant and Books or reinsurer)
ABC Insurance Co. offers fire insurance. On January 1, 20x1, ABC received
notice from its broker of a sale of one-year fire insurance for a premium of
₱1,000. The broker’s commission is 10%.

ABC Insurance Co. then ceded 80% of the insurance contract with Mr. Juan
to XYZ Insurance Co. commission earned on the reinsurance is ₱80. Per
agreement, ABC Insurance Co. shall withhold half of the premiums due to
XYZ Insurance Co.

The journal entries for the reinsurance are as follows:

Books of ABC (Cedant) Books of XYZ (Reinsurer)

Insurance receivable 900
- direct
Commission expense 100
Gross premiums No entry
revenue – direct 1,000

to record the issuance of direct insurance

Premiums ceded to Insurance receivable
reinsurers 800 - assumed 320
Commission income 80 Funds held by cedant 400
Funds held for reinsurer 400 Commission expense 80
Due to reinsurer 320 Gross premiums
revenue – assumed 800

595
Revenue recognition – 24th Method
Most insurance contracts issued by nonlife insurance companies are of short
duration, normally one year. Premiums from these types of contracts are
recognized as revenue over the period of the contracts using the “24th
method,” except for contracts covering marine cargo risks.

The unexpired portion of premiums written are accounted for as “Provision

for unearned premiums” included in “Insurance contracts liabilities” and
presented in the liabilities section of the statement of financial position. The
net changes in the “Provision for unearned premiums” are accounted for as
adjustments to the gross premium” recognized in profit or loss for the period.

The “24th method” assumes that the average date of issue of all policies
written during any month is the middle of that month.

Illustration 1: 24th Method–Policy issued at the beginning of period

On January 1, 20x1, ABC Insurance Co. issues a one-year, fire insurance
contract for a total premium of ₱12,000.

Requirements:
a. How much are the earned portions of the premium for the months
ended January 31, February 28, and March 31, 20x1, respectively?
b. How much are the unearned portions of the premium for the months
ended January 31, February 28, and March 31, 20x1, respectively?
c. How much is the earned portion of the premium for the year ended
December 31, 20x1?
d. How much is the unearned portion of the premium for the year ended
December 31, 20x1?
e. Provide the journal entries on January 1, 20x1 to recognize the gross
premium and the adjusting entry on December 31, 20x1 to recognized
the adjustment to the gross premium.

Solutions:
Requirement (a): Earned portions – 1st quarter
Jan. 31 Feb. 28 Mar. 31
Gross premium 12,000 12,000 12,000
Multiplied by: 1/24 2/24 2/24
Earned portions 500 1,000 1,000

596
Under the 24th method, it is assumed that the average date of issue of all
policies written during any month is the middle of that month. Therefore,
in January (date of issue) “1” is used in the numerator equal to one-half
month. In the succeeding months, the numerator is “2” – equal to whole
month.

Jan. 31 Feb. 28 Mar. 31

Gross premium 12,000 12,000 12,000

Multiplied by: 23/24 21/24 19/24

Earned portions 11,500 10,500 9,500

The numerators in the fractions are determined as follows:

 Jan. 31: (24 – 1 earned in Jan.) = 23 unearned portion
 Feb. 28: (24 – 1 earned in Jan. – 2 earned in Feb.) = 21 unearned potion
 Mar. 31: (24 – 1 – 2 – 2) = 19 unearned portion

Requirement (c): Earned potion – Dec. 31, 20x1

Gross premium 12,000
Multiplied by: 23/24
Earned portion – Dec. 31, 20x1 11,500

Requirement (d): Unearned portion – Dec. 31, 20x1

Gross premium 12,000
Multiplied by: 1/24
Unearned portion – Dec. 31, 20x1 500

Requirement (e): Journal entries

The entry on January 1, 20x1 is as follows:
Jan. 1, Insurance receivable – direct 12,000
20x1 Gross premiums revenue –
Direct 12,000

The adjusting entry on December 31, 20x1 is as follows:

Dec. Change in provision for unearned 500
31, premiums
20x1 Provisions for unearned 500
Premiums

597
The “Change in provisions for unearned premiums” is recognized in profit or
loss as an adjustment to “Gross premiums” to compute for the earned
portion.

The “Provision for unearned premiums” is presented in the statement of

financial position as part of “Insurance contract liabilities.”

Gross premium earned will be disclosed in the notes as follows:

Gross premiums written 12,000

Change in provision for unearned premiums (increase) (500)
Gross premium earned 11,500

Notice that the method of recording used is the “income method,” as

opposed to the “liability method.”

Alternatively, the adjusting entry may also be made by directly reducing the
gross premiums revenue account, as shown below:

Dec. Gross premiums revenue – direct 500

31, Provisions for unearned
20x1 Premiums 500

Illustration 2: 24th Method – Policy issued during the period

In March 20x1, ABC Insurance Co. issues a one-year, fire insurance contract
for a total premium of ₱12,000.

Requirements:
a. How much is the earned portion of the premium for the year ended
December 31, 20x1?
b. How much is the unearned portion of the premium for the year ended
December 31, 20x1?

Solutions:

Requirement (a): Earned portion – Dec. 31, 20x1

Gross premium 12,000
Multiplied by: 19/24
Earned portion – Dec. 31, 20x1 9,500

The numerator in the fraction is computed as follows: (1 earned in March) = (2

earned in each of April to December) = 1 = (2 x 9) = 1 + 18 = 19

598
Requirement (a): Net premium earned – Dec. 31, 20x1
Gross premium 12,000
Multiplied by: 5/24
Unearned portion – Dec. 31, 20x1 2,500

The numerator in the fraction is computed as follows: (24 – 19) = 5.

Illustration 3: 24th Method – Premiums ceded

In April 20x1, ABC Insurance Co. writes fire insurance policies for a total
premium of ₱36,000. During the same period, total premiums of ₱12,000
were ceded to reinsurers.

Requirement: compute for the following:

a. Net premium earned for the year ended December 31, 20x1.
b. Balance of provision for unearned premiums as of December 31, 20x1.

Solutions:

Requirement (a): Net premium earned – Dec. 31, 20x1

Gross premium 36,000
Multiplied by: 17/24
Earned portion – Dec. 31, 20x1 25,500

Premiums ceded (12,000)

Multiplied by: 17/24
Earned portion by reinsurers – Dec. 31, 20x1 (8,500)

Net premium earned – Dec. 31, 20x1 (25,500) – 8,500) 17,000

Requirement (b): Provsion for unearned premium – Dec. 31, 20x1

Gross premium 36,000
Multiplied by: 7/24
Unearned portion – Dec. 31, 20x1 10,500

Premiums ceded (12,000)

Multiplied by: 7/24
Unearned portion by reinsurers – Dec. 31, 20x1 3,500)

Provision for unearned premiums, Net – Dec. 31, 20x1 7,000

599
Illustration 4: 24th Method – Adjustments to premiums earned
During 20x1, ABC Insurance Co. wrote fire insurance policies for a total
premium of ₱5,000,000, ₱3,000,000 of which were ceded to reinsurers. The
following are the balances in the provision for unearned premiums:

Provision for
Provision for Premiums unearned
unearned ceded to premiums –
premiums reinsurers Net
A b c=a–b
Balance, Jan. 1 2,000,000 1,000,000 1,000,000
Balance, Dec. 31 2,800,000 1,200,000 1,600,000

Requirement: Compute for the net premiums earned during the period.

Solution:

Gross premiums 5,000,000

Change in provision for unearned premiums
- increase in unearned premium (2.8M – 2M) (800,000)
Gross premiums – earned 4,200,000

Gross premiums 3,000,000

Change in provision for unearned premiums
- increase in unearned premium (1.2M – 1M) (200,000)
Gross premiums – earned 2,800,000

Net premiums earned (4.2M – 2.8M) 1,400,000

Checking: We can check the accuracy of our answer above by using T-

account analysis, as shown below:

Provision for unearned

premiums – Net
Jan. 1 1M
Premiums written net
of premiums ceded Net premiums
(5M – 3M) 2M 1.4M earned (squeeze)
1.6M Dec. 31s

600