Question 1: How would you recognize revenues associated with this type of catastrophe insurance contract?
As with any accounting transaction the attempt is to capture the economic reality of the transaction. By recognizing all of the revenue up front upon the cash collection of the policy, it does not accurately portray the liability that Tokyo AFM has over the term of the policy. In order for a company to be able to recognize revenue it must be both earned and realized or realizable. Meaning that Tokyo AFM must fulfill the obligations of the contract of 5 years, and secondly that it has been paid for the services. Furthermore in SAB 101 4 basic conditions exist that help clarify revenue recognition:
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Question 3: What accounting treatment would you choose for expected losses (a) associated with automobile contracts and (b) associated with catastrophes? From a shareholder’s perspective, what concerns do you think could arise with respect to the accounting treatment of expected losses?
A. In an attempt to accurately represent the amount of liability owed in automobile claims Tokyo AFM should show a line item of a liability. Because these claims can be reasonably estimated, and paid out within the current fiscal year reporting. Based on historical information Tokyo can estimate it’s liabilities within a 10 percent ratio, as stated in exhibit 1. The company must be cognizant of economic reality, and estimates that 70% of claims made will be payable due to automobile claims. Under or overstating its liabilities due to automobile premiums could result in misstating financial information and depict a financial environment that in fact is not reality.
B. In dealing with a situation like a catastrophe, or trying to accurately represent this economic event on a balance sheet, I would think you would treat it as an item disclosed in the financial statement notes, but not accrued as a liability. There is no level of certainty in which this event can be predicted, from a time