Learning a new language can be an intense process. There’s often confusion on which words to use, how to pronounce them and in what situations it’s appropriate to use which words. Just try going to a restaurant with a foreign language menu and it’s clear how challenging the experience can be, learning the language of Statutory Accounting Principles (SAP) is certainly no different. Continuing in our series on SAP v Generally Accepted Accounting Principles (GAAP), this blog post will provide a summary level highlight of how the different principles impact financial statement reporting. Remember, GAAP was developed to present essential financial information in a way that investors, banks and others could use the information to assess the vitality of the enterprise and utilizes the matching concept. Whereas SAP is used by insurance companies to organize and report financial information in a way that regulators can understand and analyze liquidity. As a result, users of SAP financial statements rely heavily on the balance sheet and focus on capital or surplus utilizing the concept of conservatism. GAAP financial statement users generally rely on profitability to gauge financial performance. To help clients, prospects and others understand key differences; JLK Rosenberger has provided a broad summary below of how items are handled differently between the reporting languages.
Key Reporting Differences
- Equity/Surplus – Financial statements prepared under GAAP reflect assets minus liabilities to equal equity. Under SAP, equity is known as surplus, which is the excess of admitted assets over liabilities. Admitted assets are assets that regulators have determined to be available to pay policyholder obligations and are typically reduced or eliminated through a direct charge to surplus as non-admitted assets. Under GAAP, such items are recorded as assets and therefore have an impact on a company’s financial presentation (and ultimately value).
- Non-Admitted Assets – Assets that are not liquid or can be readily converted to cash to pay policyholder obligations are not counted and charged against surplus. Common examples of non-admitted assets are furniture and equipment, unsecured loans and prepaid expenses. Where a GAAP user might be looking to these assets as a source of collateral or to determine the level of leverage of a company, they will be non-admitted and charged against capital and surplus on a statutory balance sheet and will not be disclosed in a full set of financial statements.
- Deferred Taxes – SAP and GAAP are similar in the calculation and presentation of deferred taxes, however, SAP imposes limitations on the amount of assets that can be admitted and recorded on the balance sheet. The non-admitted portion is charged to capital and surplus. Only current or realizable portion of federal income tax are recorded in the income statement.
- Deferred Acquisition Costs – These are costs associated with entering into an insurance contract, such as broker commissions and certain underwriting costs. For GAAP, these items are recorded as deferred acquisition costs on the balance sheet and expensed over the policy period. However, SAP handles this item differently. It requires acquisition costs to be expensed immediately, therefore, a disproportionate level of expenses are recorded before the earning of premium occurs.
There are important differences between the reporting languages that have a significant impact on how financial information is viewed, interpreted, analyzed and applied.