1. Diploma in Insurance M92 Insurance Business and Finance
Chapter 6: Accounting principles and practices

2. Introduction
Purpose and function of financial accounting
Financial and management accounting
Users of financial information and their information requirements
Basic financial concepts and the accounting equation
Receipts and payments
The balance sheet (statement of financial position)

3. The income statement (profit and loss account)
Insurance broker accounts
Insurance company accounts
Cash flow statements
Management accounting
Interpreting management accounting information

4. Learning objectives By the end of this module, you should be able to:
Explain the purpose and function of financial accounting
Distinguish between financial and management accounting
Describe the users of financial information and their information requirements
Apply the basic financial concepts and the accounting equation
Describe accounting for receipts and payments
Interpret a balance sheet and an income statement (profit and loss account)
Explain the uses, format and presentation of cash flow statements
Explain the principles of management accounting
Interpret management accounts

5. Which document will best give an indication of a company’s liquidity?
A. Auditor’s report. B. Cash flow statement. C. Directors’ report. D. Income statement

6. A company purchased a machine with a useful life of eight years for £24,000.  Its residual value at  the end of this period is estimated to be £2,000.  When  using straight line depreciation, how much depreciation is shown in the  accounts solely for year two of this period?   
A. £2,750 B. £3,000 C. £5,500 D. £6,000

7. A figure has been inserted in a company’s balance sheet in respect of machinery.  Under which  heading will this normally appear?  
A. Current assets. B. Current liabilities. C. Non‐current assets. D. Non‐current liabilities.

8. Where will you find money received and paid?
A. Accounting equation B. Balance sheet C. Cash book D. Income statement

9. ‘Something lost and something gained’
‘Something lost and something gained’. What type of book keeping should this remind you of? 
Balanced
Double entry
Either or
Profit and loss

10. What is the basis of the balance sheet?
Accounting equation
Cashflow statement
Management accounting
Profit and loss account

11. A retailer has stock for resale
A retailer has stock for resale. Under which heading will this appear in the balance sheet? 
A.  Current assets. 
B.  Current liabilities. 
C.  Non‐current assets. 
D.  Non‐current liabilities.

12. What is calculated as current assets minus current liabilities?
Cash flow
Gross profit
Shareholder’s equity
Working capital
What is this also known as?
Net current assets

13. What is Turnover – Cost of Sales ?
Gross profit
Net profit
Net turnover
Revenue

14. What is usually the main source of revenue for insurance intermediaries?
Administration fees
Brokerage
Dividends
Premiums

15. What is likely to be the most significant current liability for an insurance broker?
Loan
Mortgage
Overdraft
Premiums owed to insurers

16. The income statement (profit and loss account)
Insurance broker accounts
Insurance company accounts
Cash flow statements
Management accounting
Interpreting management accounting information

17. Insurance Company accounts
Gross written premiums
Outward reinsurance premium
Net earned premium
Net investment return
Claims incurred net of reinsurance
Acquisition costs
Other operating expenses
Tax
Reconciliation of changes in equity
Provision for unearned premium
Provision for losses and loss adjustment expenses
Reinsurance liabilities
Investments
Reinsurers’ share of insurance contract liabilities
Deferred acquisition costs
Debtors

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19. Insurance Company accounts
Gross written premiums
Outward reinsurance premium
Net earned premium
Net investment return
Claims incurred net of reinsurance
Acquisition costs
Other operating expenses
Tax
Reconciliation of changes in equity
Provision for unearned premium
Provision for losses and loss adjustment expenses
Reinsurance liabilities
Investments
Reinsurers’ share of insurance contract liabilities
Deferred acquisition costs
Debtors

20. Gross written premium
Gross amounts of premium paid by policyholders during the accounting period
Gross of commission
Net of IPT
Includes:
Renewals
Premiums payable by instalments
Estimated pipeline premiums from binding authorities
Adjustment premiums

21. Net earned premium
Must understand the difference between Gross Written Premium and Net Earned Premium.
General Insurance premium paid by the customer usually covers 12 months.
A good example might be a household insurance premium:
Mr and Mrs House pay £500 for household insurance cover in advance.
At this point the Insurer has received the money (the Gross Premium) but have not actually earned it yet, as they have not provided the cover.
After providing cover for 6 months the insurer has earned £250 of the premium (net earned premium).
Only after providing cover for the full 12 months has the insurer earned the full £500 paid at the outset.
Suppose end period financial accounts prepared by the insurance company coincides exactly with the point in time Mr and Mrs House have received 6 months cover.

22. Year 2017
Gross Premium £500
Less unearned premium (£250)
Earned Premium £250
The unearned premium will then be brought forward into the 2018 accounts. How do you think that this will be displayed in the year 2018 accounts?

23. Net earned premium

24. Net investment return Gains and losses
Includes dividends, interest, rental income
Unrealised gains losses show on balance sheet but not income statement
Held to maturity – seen in income statements
Effective return from date asset purchased to date it matures
Fair value through profit or loss – seen in income statement if classified as such
E.g. Assets held for trading

25. Tax Current tax = Tax payable Includes adjustments from previous years
Deferred tax = Tax that will be included in a future tax return
Deals with timing differences in showing income and expenses and when tax will be due

26. Reconciliation of changes in equity
IFRS requires a statement reconciling equity from previous year to current year
Profit for the year per
Dividends due to shareholders
Unrealised gains from investments classified as a available for sale
Dividend is not a liability on the balance sheet until approved by the shareholders
Interim dividend approved by the board but not yet paid is a liability
Reconciliation of changes in equity

28. Insurance Company accounts
Gross written premiums
Outward reinsurance premium
Net earned premium
Net investment return
Claims incurred net of reinsurance
Acquisition costs
Other operating expenses
Tax
Reconciliation of changes in equity
Provision for unearned premium
Provision for losses and loss adjustment expenses
Reinsurance liabilities
Investments
Reinsurers’ share of insurance contract liabilities
Deferred acquisition costs
Debtors

30. Provision for losses and adjustment expenses
Gross losses shown as a liability
Expected reinsurance returns shown as an asset
Estimated ultimate cost of claims and includes:
IBNR’s
IBNER’s
Provision for losses and adjustment expenses

31. Insurance Company accounts
Gross written premiums
Outward reinsurance premium
Net earned premium
Net investment return
Claims incurred net of reinsurance
Acquisition costs
Other operating expenses
Tax
Reconciliation of changes in equity
Provision for unearned premium
Provision for losses and loss adjustment expenses
Reinsurance liabilities
Investments
Reinsurers’ share of insurance contract liabilities
Deferred acquisition costs
Debtors

32. The income statement (profit and loss account)
Insurance broker accounts
Insurance company accounts
Cash flow statements
Management accounting
Interpreting management accounting information

33. Cash flow statements Profit and cash flow are not the same thing.
Profit is based on all revenue even if it has not been received yet.
If customer defaults then the money may never be received.
Revenue = Total value of all invoices.
Outflows of money may not reflect in the income statement. Remember depreciation?  
Important that the cash flow of the business is recorded.
Stakeholders want to scrutinise both profitability and the company cash position
Businesses can face into trouble through lack of cash so the cash flow statement is important

34. Three headings in this statement
Operating activities
How much income the business generates or consumes through trading activities
Includes tax paid
Investment activities
Cash inflows and outflows from investments
Includes sale of investments and cost of investments made
Financing activities
Changes to loans and share capital
Dividends paid to shareholders
New loans/shares are shown as inflow
Paying off loans or redeeming shares shown as outflow

36. The income statement (profit and loss account)
Insurance broker accounts
Insurance company accounts
Cash flow statements
Management accounting
Interpreting management accounting information

37. Purpose of management accounting
Helps managers to:
Make sound business decisions
Take corrective action
Starts with strategic objectives
Projects future outcomes and performance
Used to set plans and targets – through the budgeting process
Monitors performance

38. Manufacturing company may include
Productivity of the factory
Drills down to productivity of individual lines/ even machines
Quality of goods being produced
Cost of producing goods (broken down to various elements - raw materials, labour, etc.)
The capital being absorbed by the business whilst work is in progress

39. Service company may include
Quality of service
Customer satisfaction
Cost of service
Financial performance of each distribution channel
The capital being absorbed by the business whilst work is in progress

40. Costing and activity based costing
Profits and contribution to overall profits
Needs a good costing system
Share of centralised functions costs allocated to each cost centre
Drawback – managers have no control over centralised costs
Costing
Establishes the activities which drive the costs
Costs centres charged according to the amount of activity from central functions
Individual managers more incentive to control costs
Activity based costing

41. The income statement (profit and loss account)
Insurance broker accounts
Insurance company accounts
Cash flow statements
Management accounting
Interpreting management accounting information

42. Interpreting management accounting information
Helps management make best decision on available information
Uncertainties always exist
Comparisons with external information helps
Used as a basis for enquiries rather than giving solutions and actions

43. What should you ask? Why is Line C unprofitable?
How has it developed or how is it expected to develop?
What could be done to improve this?
What would be the effect of closing down Line C?
Ask finance team to produce a projection on Lines A and B, if C was closed?

44. Machine
Finance team have identified that a machine commissioned last year machinery is operating at a loss. What are you going to do about it?

45. You have received a proposal to start a new line of business
You have received a proposal to start a new line of business. Expected revenues and costs look reasonable What else would you need to know before deciding whether to go ahead?
New line of business

46. What are the pros and cons of each report?