Question

Read the case linked in the assignments below carefully and identify the problem. Using FASB codification answer the problem correctly. (As followed) -

Problem identification:

Keywords: Conclusion:

Case Solution:

Case:

In order to help induce Jill Gregory to remain as president of the Reed Company, in 2000 it promises to pay her (or her estate) $200,000 per year for the next 15 years—even if she leaves the company or dies. Reed wants to properly record this transaction as deferred compensation, but is unsure of how many years it should use to amortize this cost. Moreover, Reed also purchased a “whole life” life insurance policy for Jill, naming the company as the sole beneficiary. Reed wants to ascertain if it can offset the cash surrender value of the policy against the above deferred compensation liability.

Thanks in advance!

Answer 1

Facts

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In order to help induce Jill Gregory to remain as president of the Reed Company, in 2000 it promises to pay her (or her estate) $200,000 per year for the next 15 years—even if she leaves the company or dies. Reed wants to properly record this transaction as deferred compensation but is unsure of how many years it should use to amortize this cost. Moreover, Reed also purchased a “whole life” life insurance policy for Jill, naming the company as the sole beneficiary. Reed wants to ascertain if it can offset the cash surrender value of the policy against the above deferred compensation liability.

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Issues

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1. Figuring out the number of years to amortize deferred compensation.

2. Whether there is a possibility of offsetting the cash surrender value of a life insurance policy against a deferred compensation liability.

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Conclusions

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1. The deferred compensation is to be amortized over the number of years set in the contract under ASC 710.

2. The offsetting of the cash surrender value against the deferred compensation liability is not possible under ASC 325.

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Authorities on deferred compensation

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A summary of the relevant authorities on deferred compensation is as follows:

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            Deferred compensation can be accrued as a liability for an employee’s future absences when certain conditions are met. The conditions are as follows: When the employer’s obligation relating to the employee’s rights to receive compensation for future absences can be attributed to the employee’s services already rendered; The obligation relates to rights that vest or accumulate. Vested rights are for when the employer has the obligation to make a payment even if the employee terminates so that the employer is not contingent on the employee’s future service. Then, accumulate means that the earned but unused rights to compensated absences may be carried forward to one or more future periods subsequent to the period in which they were earned, even with the limitations on the amount that can be carried forward; the payment of compensation is probable; the amount of payment can be reasonably estimated. ASC 710-10-25-1. The arrangements for deferred compensation are written to the extent of the contract terms attributing all or a portion of the expected benefits to an individual year of the employee’s service. The cost of those benefits would be recognized in only that year. If the terms are to more than a year, the cost of those benefits would be accrued over the period of the employee’s service in a systematic and rational manner. ASC 710-10-25-9.

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Authorities on investments in insurance contracts

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A summary of the relevant authorities on investments in insurance contracts is as follows:

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            For an asset that represents an investment in a life insurance contract, the amount could possibly be realized under the insurance contract as of the date of the statement of financial position. It would not be considered appropriate for the purchaser of the life insurance to be recognizing income from death benefits on the insured on an expected basis. Death benefits are not to be realized until after the actual death of the insured and having a projected basis on the death benefits would not be an appropriate measure of the asset. ASC 325-30-35-1.

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Application of authorities

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1. The Reed Company would amortize the deferred compensation for Jill over the next 15 years since this is the same number of years in the arrangement. It follows the contract terms as to how many years Reed Company promised to pay Jill (or her estate) $200,000.

2. By having the amortization recorded for the next 15 years, it follows the systematic and rational manner requirement.

3. The Reed Company cannot offset the cash surrender value against the deferred compensation liability due to the inappropriate measure of the asset by recognizing the death benefits before they are due.

4. By offsetting the cash surrender value against the deferred compensation liability, the Reed Company would have to reduce the deferred compensation. This is an inappropriate recording of the cash surrender value since Jill (or her estate) could still be alive and present.

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Keywords

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Deferred compensation arrangements, expected future benefits, employee’s service, investments, life insurance contracts, death benefits, recognizing, asset

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Thank you,