How do you record life insurance in accounting?

Recording life insurance on a company’s financial statements involves tracking the cash surrender value and premium payments. Here is an overview of how to account for corporate-owned life insurance policies.

Why Businesses Own Life Insurance

There are several reasons a business may purchase a life insurance policy:

• Key person insurance – Replace income lost if a top executive or employee dies

• Buy-sell funding – Fund a buyout of a deceased owner’s share of the business

• Informal executive benefits – Provide supplemental retirement or death benefits

• Formal executive benefits – Fund split-dollar arrangements or deferred compensation

Permanent life insurance can provide long-term financial protection and tax advantages.

Accounting Overview

When a corporation purchases a life insurance policy, it must record the asset and related transactions properly on its books. Here are the key accounting considerations:

Balance Sheet

• The cash surrender value (CSV) is recorded as an asset that changes each year.

• Premium payments reduce cash.

• Policy loans increase cash but are tracked separately.

Income Statement

• Premiums paid are an expense.

• Increases in CSV are recorded as income.

• The net impact reduces net income if premiums exceed CSV growth.

Death Benefit

• Proceeds received increase cash.

• CSV is removed as an asset.

• Excess of proceeds over CSV is an increase to income.

Let’s look at how to record these transactions.

Recording Premium Payments

When a life insurance premium is paid, the accounting entry is:

Debit: Insurance Expense

Credit: Cash

This records the premium payment as an expense and reduces cash.

For example, if the annual premium is $10,000, the entry would be:

Debit: Insurance Expense $10,000

Credit: Cash $10,000

The insurance expense account on the income statement increases by the premium amount.

Recording Cash Value Changes

As the policy’s cash value increases each year, an adjusting entry is made:

Debit: Life Insurance Asset (Cash Value)

Credit: Insurance Income

The cash value increase is recorded as an asset on the balance sheet. The offsetting credit increases income.

For example, if the cash value increases by $5,000 in a year, the entry would be:

Debit: Life Insurance Asset $5,000

Credit: Insurance Income $5,000

The net impact of premiums paid minus the cash value increase hits the income statement each year.

Recording Policy Loans

If the corporation takes out a policy loan from the insurer, the cash received increases cash on hand:

Debit: Cash

Credit: Loan Payable

Repaying the loan reverses the entry. The loan balance is tracked as a liability.

Death Benefit Accounting

When the death benefit is received, the cash account is increased by the full proceeds amount. The existing cash value asset is removed, and any gain is recorded:

Debit: Cash

Credit: Life Insurance Asset

Credit: Insurance Income (for gain)

For example, if the company had a $50,000 cash value asset and received a $1M death benefit, entries would be:

Debit: Cash $1,000,000

Credit: Life Insurance Asset $50,000

Credit: Insurance Income $950,000

The gain is reported on the income statement but is not taxable.

Illustrative Example

Here is an example to demonstrate the accounting for a $1M corporate owned life insurance policy:

• Annual premiums of $10,000 for 10 years

• Cash value increases from $3,000 to $110,000 over 10 years

Year 1 Entries:

Debit: Insurance Expense $10,000

Credit: Cash $10,000

Debit: Life Insurance Asset $3,000

Records premium paid and year-end cash value.

Year 2 Entries:

Debit: Insurance Expense $5,000

Debit: Life Insurance Asset $5,000

Credit: Cash $10,000

Records premium and cash value increase of $5,000.

Year 10 Entries:

Debit: Life Insurance Asset $12,000

Credit: Insurance Income $2,000

Credit: Cash $10,000

Records premium paid and cash value increase of $12,000. Insurance income is reported for the excess over premiums.

Insured’s Death:

Debit: Cash $1,000,000

Credit: Life Insurance Asset $110,000

Credit: Insurance Income $890,000

Records receipt of $1M death benefit. Removes cash value asset and records gain.

Notes on Financial Statements

Life insurance owned by the company is typically disclosed in the notes to the financial statements. Notes describe the cash surrender value, death benefit, insured persons, and other relevant details.

Recording business life insurance properly is key for accurate financial reporting. Consult with your CPA on the appropriate accounting treatment in your specific situation.