Accounting for insurance contracts: a comment on ‘deprival value’ measurement for contract liabilities in revenue recognition

The ASB, FASB and IASB all have on their agendas a major project on revenue recognition in financial statements. Methods of revenue recognition and measurement can conflict with methods of liability recognition and measurement. We explore here (by reference to the examples of a magazine subscription and a short-term insurance policy) when the two measurement approaches coincide and when they conflict. The conflict most generally arises over deciding how to treat situations where enterprises expect to earn profits that cannot be identified as ‘factor costs’ in the way that 'interest' and 'reward for risk bearing' may. Moreover, in many circumstances even these two elements may not be separately estimable with any reliability from market benchmarks. In other cases, while companies may have invested in building up the necessary intangibles that enable them to achieve these apparent ‘super-profits’ thereafter, current GAAP accounting for those intangible fails properly to match investment and return. The conceptual conflict is exacerbated by the adoption of ‘fair value’ as the measurement basis for assets and liabilities rather than the theoretically sounder basis of ‘deprival value’. However, while the ‘balance sheet’ liability and the revenue recognition problems (and the problems of income statement presentation) can be resolved by the application of ‘deprival value’ reasoning (subject to accounting for the effects of price changes), this is not sufficient to resolve issues of the appropriate timing of profit recognition. Performance measurement issues still need to be addressed directly. The standard setters’ new project will therefore need to consider the whole issue of accounting for intangibles, and more generally the adequacy of a model that identifies ‘comprehensive income’ solely in terms of changes in recognized assets and liabilities, before it is likely to make any progress towards resolving the arguments over ‘revenue recognition’ issues and the appropriate presentation of the corresponding reported performance