Is cash surrender value of life insurance an intangible asset

Account properly for corporate-owned life insuranceHeres what you need to knowBy: James and Deborah KraftFebruary 14, 2014 September 20, 201800:36ShareFacebookLinkedInTwitterMail t

Is cash surrender value of life insurance an intangible asset

Account properly for corporate-owned life insurance

Heres what you need to know

  • By: James and Deborah Kraft
  • February 14, 2014 September 20, 2018
  • 00:36ShareFacebookLinkedInTwitterMail to a friedPrintJames and Deborah Kraft

Life insurance is a staple in most private companies.

For instance, insurance for the shareholders may be an integral part of the shareholders buy-sell arrangement. Alternatively, a lending institution may require insurance on shareholders lives as a condition of a loan agreement, or insurance may help a shareholders family fund a tax obligation that arises upon death. Still, if a corporation owns the insurance, then its important to understand the accounting treatment of transactions to ensure your client doesnt misrepresent expenses.

Theres a standard methodology that needs to be considered in all accounting transactions. Public companies must report their financial statements using International Financial Reporting Standards (IFRS).

Meanwhile, private enterprises may choose to use IFRS or Canadian accounting standards for private enterprises (ASPE). However, neither IFRS nor ASPE address the accounting and financial presentation of corporate-owned life insurance.

Heres what you need to know. The cash surrender value of a life insurance policy is an asset a company can control, so it should be recorded on its balance sheet. A future death benefit is an economic benefitone the company cant control, so it should not be recorded as an asset.

Understanding the type of life insurance is critical. Generally, if the life insurance policy has a cash surrender value, that value should appear on the balance sheet. Any cash outflow above the year-over-year increase in cash surrender value will be expensed and reflected on the income statement. Term insurance does not usually have a cash surrender value, whereas UL and WL generally do.

Life insurance policyPolicy YearAnnual premium due during the fiscal year of the corporationCash surrender value of the life insurance policy at the year-end of the corporation1$10,000$3,0002$10,000$7,0003$10,000$14,0004$10,000$22,00011$10,000$106,00012$10,000$120,00013$10,000$148,00014$10,000$178,00015zero$180,000

Case study

Take this scenario. Aco Corp. purchases a permanent insurance policy on the life of its shareholder, Ben. The death benefit is $1 million. Aco pays premiums (see Life insurance policy) and the cash surrender value of the policy increases. In year 25, Aco receives a $1 million death benefit when Ben dies (see Relevant accounting entries).

Note: the accounting treatment of corporate-owned life insurance does not reflect the income tax treatment. The payment of life insurance premiums is generally not tax deductible. So, while the annual insurance expense in each of years 1 through 14 is $10,000 and an accounting entry is made to reflect the payment, the expense is not deductible against Acos taxable income. An accountant makes this tax adjustment when preparing Acos tax returns.

The increase in the year-over-year cash surrender value is not taxable. Nor is the receipt of life insurance proceeds taxable income. Again, an accounting entry reflects receipt of the insurance proceeds. When Acos financial statements are prepared, $750,000 will be removed from income for tax purposes. The other portion of the entry ($250,000) was simply eliminating the asset from the balance sheet. So Aco receives $1 million in cash as the death benefit, which is reflected on its financial statements; however, there is no tax liability from receiving those proceeds when Ben passes.

Aco will also receive a credit to its capital dividend account when the life insurance proceeds are received. But, there is no accounting entry at that time and it is a tax-specific issue. The cash surrender value in an insurance policy represents an asset and needs to be correctly recorded on the financial statements. So consider accounting and taxation issues separately.

Relevant accounting entriesDateAccount NamesDebitCreditExplanationEach year when the annual premium is paid, Acos accountant will debit the insurance expense and credit the chequing account. This same entry is made in each of years 1 through 14.Insurance expense$10,000To record the payment of annual insurance premium dueChequing account$10,000At Acos year-end, the accountant will write an adjusting entry to reflect the year-over-year increase in the cash surrender value.Year 1Cash surrender value$3,000To record cash surrender value at the end of the first yearInsurance expense$3,000Year 2Cash surrender value$3,000To reflect the year-over-year increase in the cash surrender valueInsurance expense$4,000In year 12, the increase in the cash value ($14,000) of the life insurance policy is greater than the annual premium ($10,000). This means that on Acos income statement, there will be income of $4,000, rather than an expense.Year 12Cash surrender value$14,000To reflect the year-over-year
increase in the cash surrender valueInsurance expense$14,000In year 15, the company did not pay an annual premium but chose to use the policys internal value to fund the cost of insurance. There is still an increase in cash surrender value ($2,000) over the prior year, which needs to be recorded.Year 15Cash surrender value$2,000To reflect the year-over-year
increase in the cash surrender valueInsurance expense$2,000At the time of Bens death, Aco will receive a $1-million death benefit. The cash surrender value of the policy at the time of Bens death is $250,000. So $750,000 will appear on Acos income statement for the year.Year 25Chequing account$1,000,000To record receipt of $1 million of life insurance proceeds and to eliminate the $250,000 of cash surrender value sitting on Acos
balance sheetCash surrender value$250,000Other income$750,000

James Kraft, CPA, CA, MTax, TEP, CFP, is vice-president of Wealth Planning Services at BMO Financial Group. Deborah Kraft, MTax, TEP, CFP is director of the Master of Taxation Program at the University of Waterloo.

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