1 Introductory Insurance Accounting Flashcards
What are the 5 qualitative accounting information criteria?
- Understandability
- Relevance
- Faithful Representation
- Comparability and Consistency
- Lack of Bias
What is Understandability?
The ability for the information to be understood in the context of the intended users and intended use cases.
What is Relevance?
The information must be timely, have predictive value, and provide useful feedback about previously made decisions.
What is Faithful Representation?
Information needs to be verifiable, complete, and neutral, in addition to representing what it claims to represent.
What is Comparability and Consistency?
Accounting information must allow for comparisons between time periods and among entities; therefore, it must be consistent.
What is Lack of Bias?
Biased information is helpful only if users understand the bias; the bias is consistently applied across time periods, firms, or industries; and the users can adjust the reported results to reflect their own desired bias. The United States’ requirements are reflected in ASOP 21.
What is Cost-Benefit Effectiveness?
The cost in resources to produce accounting information should be reasonable in relation to the expected benefit of the information.
Compare Relevance vs. Reliability
- In many cases, a trade-off exists between relevance and reliability
- The relationship between relevance and reliability also affects the valuation of difficult-to-estimate insurance liabilities
Compare Lack of Bias and Reliability
- A conflict can arise between lack of bias and reliability of information where uncertainty exists. The rationale for conservatism in such circumstances is that an uncertain asset, or an uncertain value, can’t be relied on.
- In the face of uncertainty, accounting frameworks may call for reporting of unbiased estimates accompanied by disclosure of the uncertainty rather than reporting biased estimates.
What is GAAP Accounting?
Accounting frameworks designed for a broad range of users (including investors, creditors, and owners) are usually called general purpose accounting rules, or generally accepted accounting principles.
- GAAP accounting typically focuses on the value or performance of an organization as a going concern.
- Many liabilities or assets would have a significantly different value for a going concern than they would for an entity in runoff.
What Regulatory/Supervisory Accounting?
Regulators interested in solvency regulation may have more interest in runoff values than going-concern values.
- This may lead them to develop their own specialized accounting frameworks, such as the statutory accounting principles produced by the NAIC.
- Such rules may require a different set of valuation assumptions resulting in accounting values materially different from GAAP values.
What is Tax Accounting?
- Tax authorities may desire, demand, or be legally required to use their own specialized accounting frameworks to calculate tax owed by an entity.
- Such accounting frameworks may be directed or influenced by social engineering, public policy, political, or verifiability concerns. They may be materially different from either GAAP or statutory accounting frameworks.
- In the United States, the tax accounting rules used by insurers are based on statutory accounting, with modification. In many parts of the world, GAAP, regulatory, and tax accounting rules are the same.
- An advantage to having one set of accounting rules is reduced cost and confusion in creating the information, and a disadvantage is the because all users needs are not the same, compromises must be made that are suboptimal to one or more sets of users.
What is Management Accounting?
GAAP, regulatory, and tax accounting frameworks may still not meed the needs of an organization’s management. As a result, many organizations create one or more additional sets of accounting frameworks on which to base their management decisions. These are generally based on either GAAP or regulatory accounting rules, with modifications.
What is Fair Value?
The price that would be received to sell an asset or paid to transfer a liability in an orderly transactions between market participants at the measurement date. A fair value estimate that’s based on a model rather than actually observed market value is called mark-to-model.
What is Historical Cost?
The price at which an asset or liability was originally obtained. It is generally more reliably determinable, but less relevant, than fair value.