What is Insurance?
The term insurance represents a contract between two parties to protect an underlying asset. The first party is the insured party, which receives the protection. This party owns the underlying asset. Insured entities may include individuals, businesses, organizations, etc. In contrast, the second party is the insurer. This party promises to compensate the insured party in case of damage to the underlying asset.
Usually, the insured party makes regular payments to the insurer. This payment is known as the insurance premium. During the insurance contract, the insurer is responsible for reimbursing the insured party for damages to their asset. However, the insurance contract terms must cover the type of damage. In most cases, the contract will specify the types of perils it will recover.
Is Insurance Liability or Asset?
Insurance can be a liability or an asset depending on the type of entity that accounts for it. Before understanding how it can be either, it is crucial to know what each of these is.
What is an Asset?
An asset is a resource owned or controlled by an entity and will result in future inflows of economic benefits. Assets include all resources that companies use to generate income. For example, these may consist of property, land, or cash. However, assets don’t have to be tangible. Intangible assets such as brand value, trademark, patents also meet the definition of assets. However, they must have measurable values.
What is a Liability?
A liability is an obligation for entities that result in future outflows of economic benefits. For most companies, liabilities represent a type of finance that they can use to run their operations. These funds may be long- or short-term. Regardless, these are obligations that an entity must reimburse in the future. Liabilities may include loans, accounts payable, accruals, etc.
When is Insurance an Asset?
Insurance is an asset for the insured party. Any party that makes a regular insurance premium to an insurance provider must recognize an asset. It is because this asset represents a resource that they own or control. Similarly, it can result in future inflows of economic benefits. However, the insured party must recognize an asset until it hasn’t consumed the gains from it. In other words, once the party expenses out the insurance premium, they must derecognize the asset.
For the insured party, insurance is primarily an expense. In most cases, however, insurance providers require payments in advance. Therefore, any payments made in advance become assets until the provider renders the related services.
When is Insurance a Liability?
For the insurance provider, insurance is a liability. The insurance provider must recognize a liability in its financial statements because it matches the definition. For this party, insurance is an obligation towards the insured party and can result in future outflows of economic benefits. When the provider provides the related services to the insured party, they will convert this liability to revenues.
Similar to the insured party, the insurance provider must recognize a liability for advance receipts. These liabilities are known as deferred revenues or earnings. Once the insurance provider provides the services, they can record the related revenues.
Insurance is a contract between two parties for the protection of an asset. For the insured party, insurance is an asset. However, once they receive the services, the amount becomes an expense. In contrast, for the provider, insurance is a liability. Once the provider renders the services, the amount becomes revenue.
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