Deferred Acquisition Costs - Accrual Accounting of DAC

Accrual Accounting of DAC

Accrual accounting and deferring implies timewise matching(synchronization) of income and expenses: an incurred cost is capitalized and does not become an expense until it is recognized in the financial statements of the company. In an accounting sense, it is the amortization of that cost, and not the original cost itself, that becomes the expense. Hence, certain costs which are incurred to acquire insurance contracts should not be recognized as an expense in the accounting period in which they are incurred but should be capitalized as an asset on the balance sheet and gradually amortized over the lifetime of the insurance contracts. Such costs are called Deferred Acquisition Expenses (DAE) and capitalization of DAE results in setting up of an asset called Deferred Acquisition Costs (DAC).

Establishment of the DAC asset tends to reduce the policy’s first year strain and generally produces a smoother pattern of earnings.

To meet the capitalization criteria, these expenses must vary with and be primarily related to the acquisition of new business.

Examples of Deferrable Acquisition Expenses:

• Commissions in excess of ultimate commissions
• Underwriting costs
• Policy Issuance costs

All other expenses associated with the new business that do not vary with and are not primarily related to new policies are classified as non-deferrable acquisition expenses.