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Guaranteed residual values
Guaranteed residual values are periodically given on repurchase commitments with customers. The likelihood of the repurchase commitments being exercised
is assessed at the inception of the contract to determine whether significant risks and rewards have been transferred to the customer and if revenue should be
recognized. If significant risks and rewards have not been transferred, revenue is not recognized and the transaction is accounted for as a prepaid operating
lease. Where the initial assessment was made that significant risks and rewards were transferred and revenue was recognized, but subsequent market conditions
are considered to change the likelihood of the exercise of the buyback to become probable, the present value of the net expected future outflow is provided for,
after taking into consideration any proceeds on subsequent disposal of the equipment. All repurchase commitments as well as the related asset’s expected
values are disclosed under contingent liabilities.
Credit life and warranty products
Premiums are recognized as revenue proportionally over the period of coverage. The portion of premium received on in-force contracts that relates to
unexpired risks at the statement of financial position date is recognized as an unearned premium liability. Premiums are reflected before deduction of
commission and are gross of any taxes or duties levied on premiums.
Claims and loss adjustment expenses are charged to profit and loss as incurred based on the estimated liability for compensation owed to contract holders or
third parties damaged by the contract holders. These include direct and indirect claims settlement costs and arise from events that have occurred up to the
statement of financial position date even if it has not yet been reported to the company. Liabilities for unpaid claims are not discounted and are estimated using
the input of assessments for individual cases reported to the group and statistical analyses for claims incurred but not reported as well as the expected ultimate
cost of more complex claims that may be affected by an external factor (such as court decisions).
Acquisition costs, which include commission and other related expenses, are recognized in the period in which they are incurred.
FUTURE DEVELOPMENTS—AN INSIGHT
The IASB and FASB are undertaking a comprehensive project on the accounting for insurance contracts. The Boards’ objective is to develop a common, highquality
standard that will address recognition, measurement, presentation, and disclosure requirements for insurance contracts.
On July 31, 2010, the IASB issued ED/2010/08, Insurance Contracts, with a comment period ending November 30, 2010. The boards tentatively decided to
improve the definition of an insurance contract that is currently in IFRS 4, Insurance Contracts, to clarify the role of timing in insurance risk and specifying that
insurance risk would exist if there is at least one scenario in which the present value of net cash flows due under the insured event could exceed the present value of
premiums.
The Boards will slightly adjust the scope of the current IFRS 4. The insurer would recognize the rights and obligations arising from an insurance contract on the
earlier of the insurer being obligated to provide coverage to the policyholder for insured events and the signing of the insurance contract. The core of the proposed
insurance model is a direct measurement of the insurance contract supplemented with an allocation over time of any accounting day one gain. The measurement of an
insurance contract should include the probability weighted present value of all incremental cash flows arising from the insurer’s estimate of its fulfillment of the
contract. The discount rate should reflect the characteristics of the cash flows from the insurance contract. For recognition and measurement, a component of an
insurance contract should be unbundled if it functions independently from other components of that contract. The recognition and measurement criteria for reinsurance
assets would be based on the building blocks approach, except that measurement of reinsurance assets should include an adjustment for reinsurer’s expected credit
losses. The presentation of insurance contracts in the statement of comprehensive income will be driven by the measurement model.
1. IFRS 4 was introduced principally for what reason?
MULTIPLE-CHOICE QUESTIONS
a. To make limited improvements to the accounting for insurance accounting.
b. To completely overhaul insurance accounting.
c. As a response to recent scandals within the insurance industry.
d. Because of pressure from the financial services authorities in several countries.
2. Which of the following types of insurance contracts would probably not be covered by IFRS 4?
a. Motor insurance.
b. Life insurance.
c. Medical insurance.
d. Pension plan.
3. Which International Financial Reporting Standard would apply to those contracts that principally transfer financial risk, such as a credit derivative?
a. IAS 23.
b. IAS 18.
c. IAS 39.
d. IFRS 4.
4. If an entity gives a product warranty that has been issued directly by a manufacturer, dealer, or retailer, which International Financial Reporting Standard is likely to
cover this warranty?