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Revenue Rule Could Affect Insurance Contracts

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The U.S. Financial Accounting Standards Board and the International Accounting Standards Board say they could include insurance contracts in a revenue recognition principles project.[@@]

FASB, Norwalk, Conn., and IASB, London, refer to insurance several times in a newly released discussion paper on preliminary views on revenue recognition in contracts with customers.

FASB and IASB are thinking about teaming up for a revenue recognition project because the U.S. Generally Accepted Accounting Principles approach is much different from the International Financial Reporting Standards approach, officials at the boards say.

The IFRS system uses 2 conflicting standards that can be difficult to understand and apply, and the U.S. GAAP system uses many different industry-specific standards, many of which conflict, officials say.

“The boards’ objective is to improve the existing guidance in both IFRSs and US GAAP by developing a single revenue model that can be applied consistently regardless of industry,” officials say.

The boards note that they already are working on an insurance contracts project.

In the discussion paper itself, officials write that IASB and FASB still could decide to exclude insurance contracts from the scope of a revenue recognition standard.

For most types of revenue, the boards tend to prefer a revenue recognition approach called the “allocated transaction price” approach.

When a company uses the allocated transaction price approach, “performance obligations are measured initially at the transaction price,” officials write. “That transaction price is allocated to each performance obligation on the basis of the relative stand-alone selling prices of the goods and services underlying the performance obligation. The amount initially allocated to each performance obligation is not updated subsequently (the initial measurement is “locked-in”) unless a performance obligation is deemed onerous.”

The allocated transaction price approach works better for contracts with relatively predictable outcomes than for contracts with highly variable outcomes, officials write.

“The outcome of an insurance contract can be highly variable because uncertainty is an inherent characteristic of insurance contracts and those contracts often cover many reporting periods,” officials write.

In 2007, officials note, IASB tentatively rejected the idea of applying an allocated transaction price approach to insurance.

Some want to develop a different approach relying on measurements of performance obligations at each financial statement date, rather than only by exception when deemed onerous, officials write.

“If the boards were to specify another measurement approach for some performance obligations, they would need to specify which types of performance obligations should be subject to that other approach,” officials warn. “It would be difficult to draw the line between two measurement approaches–any line is bound to be somewhat arbitrary. “

But, if the boards create a different approach for recognizing insurance revenue, they will have to draw that line, anyway, officials write.

“That is because an insurance contract contains elements that might otherwise be accounted for in a revenue recognition standard,” officials write.

“Instead of having an explicit measurement approach only for insurance contracts, the boards could develop a second measurement approach in a revenue recognition standard that would be suitable for contracts with specified characteristics (for example, those with highly variable outcomes),” officials write. “That second approach could also apply to some insurance contracts. Insurance contracts without those characteristics could then be accounted for in accordance with the allocated transaction price approach.”

Comments on the discussion paper are due June 19, 2009.

A copy of the revenue recognition draft is available here.


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