Accounting for Life Insurance Under FASB Bulletin No. 85-4

Financial Accounting Standards Board (FASB) guidance applies when a company purchases a life insurance policy on an employee for its own benefit. The primary directive is to standardize the accounting for these policies by requiring a method that recognizes the policy’s realizable value. This ensures financial statements reflect the policy as both an expense and an investment.

Recognizing the Policy’s Value as an Asset

The accounting guidance is to treat the policy as an asset based on the amount that can be contractually realized from it. While this is often the policy’s cash surrender value (CSV)—the amount the insurer would pay if the policy were voluntarily terminated—it can also include other contractually recoverable amounts. This asset represents the investment component of the life insurance policy, reflecting the funds the company can realize.

This approach treats the policy as a hybrid instrument, containing both an insurance protection element and a savings or investment element. The portion of the premium payment that increases the policy’s asset value is not an expense; it is an increase in an asset. The insurance expense recorded for any accounting period is the total premium paid less the corresponding increase in the policy’s realizable value during that same period. This calculation isolates the cost of the insurance coverage itself from the growth in the policy’s investment value.

Recording Premiums and Changes in Value

When a company pays a life insurance premium, the accounting entry reflects the dual nature of the policy. For an initial premium payment where no realizable value has yet accumulated, the entire payment might be recorded as an expense. For example, a $15,000 premium payment would be recorded as a debit to “Insurance Expense” and a credit to “Cash” for the full amount. This entry reflects the cash outlay for the insurance coverage.

In subsequent years, as the policy builds a cash surrender value, the accounting becomes more nuanced. Assume in the second year, the same $15,000 premium is paid, but the policy’s cash surrender value increases by $5,000. The journal entry must split the payment between the asset and the expense. The “Life Insurance Asset” account is debited for $5,000, “Insurance Expense” is debited for the remaining $10,000, and “Cash” is credited for the total $15,000 payment.

Accounting for Policy Proceeds

The final accounting event occurs when the insured individual passes away and the company receives the death benefit. The accounting entry must recognize this inflow of cash, remove the carrying value of the policy from the books, and record any resulting gain. This gain is reported as non-operating income on the income statement.

For instance, if a company receives a $1,000,000 death benefit from a policy that has a carrying value of $150,000 on the balance sheet, the journal entry would be a debit to “Cash” for $1,000,000. To balance this entry, there would be a credit to the “Life Insurance Asset” account for $150,000, which removes it from the books. The remaining difference of $850,000 is credited to a “Gain on Life Insurance Proceeds” account.

This final entry closes out the company’s accounting for the life insurance policy. The cash received increases the company’s liquid assets, the policy asset is derecognized, and the income statement reflects the financial gain realized from the proceeds exceeding the accumulated investment. This gain is considered non-operating because it falls outside the primary business activities of the company.