Chapter 13, Problem 25P

To determine

Prepare journal entries to record the transactions of Corporation K related to cash surrender value of life insurance from the year 2018 through 2021.

Explanation of Solution

Cash surrender value of life insurance

A company which buy a life insurance policy for its officers, this policy usually taken to compensate the loss of executive skill at the time of sudden death of the officer. Many a time accumulated premium are considered as a savings plan. When the policy is cancelled, then the company will receive the cash surrender value of the policy.

Corporation K paid life insurance for the life of its president, vice president, controller, and treasurer. Life insurance covers $100,000 for each officer. Corporation K paid annual premium of $16,800$\left(\$4,200\times 4\text{ officers}\right)$.

There is an increase of 4% in the cash surrender value of life insurance each year. Therefore, every year the cash surrender value of life insurance would be increased by $672$\left[\left(\$4,200\times 4\%\right)\times 4\text{officers}\right]$.

An amount of difference between the prepaid insurance paid each year and increased cash surrender value of life insurance would be recognized as insurance expense of each year. Corporation K recognizes $16,128 $\left(\$16,800-\$672\right)$ as an insurance expense each year.

Prepare journal entries in the books of Corporation K.

For the year 2018:

Record the cash payment made for premium.

Date	Account Title and Explanation	Debit	Credit
January 1, 2018	Prepaid insurance	$16,800
	Cash		$16,800
	(To record the payment of premium for 4 officers)

Table (1)

Description:

Corporation K paid life insurance premium for one year for 4 of its officers. Prepaid insurance is increased therefore, it is debited. Cash is decreased, therefore, it is credited.

Record the adjusting entry to increase in the cash surrender value at the end of the year.

Date	Account Title and Explanation	Debit	Credit
December 31, 2018	Insurance expense	$16,128
	Cash surrender value of life insurance	$672
	Prepaid insurance		$16,800
	(To adjust the increase in cash surrender value and recognize the expense)

Table (2)

Description:

Cash surrender value of life insurance is increased. Therefore, it is debited. Usually, company records the part of the yearly premium that does not increase the Cash surrender value of the policy as insurance expense. Therefore, insurance expense is debited. Prepaid insurance is decreased; therefore, it is credited.

Record the amount of dividend received.

Step 1: Determine the amount of cash received as dividend.

$\begin{array}{c}\text{Cash = Amount of dividend received per year }\times \text{ 4 officers}\\ \text{=\$450}\times 4\\ =\$1,800\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2018	Cash	$1,800
	Insurance expense		$1,800
	(To record the cash received as dividend)

Table (3)

Description:

Cash is an asset. There is an increase in asset. Therefore, it is debited. Whenever, there is a dividend income from an insurance policy, it should be recorded as decrease in insurance expense. Therefore, insurance expense account is credited here.

For the year 2019:

Record the cash payment made for premium.

Date	Account Title and Explanation	Debit	Credit
January 1, 2019	Prepaid insurance	$16,800
	Cash		$16,800
	(To record the payment of premium for 4 officers)

Table (4)

Description:

Corporation K paid life insurance premium for one year for 4 of its officers. Prepaid insurance is increased therefore, it is debited. Cash is decreased, therefore, it is credited.

Record the adjusting entry to increase in the cash surrender value at the end of the year.

Date	Account Title and Explanation	Debit	Credit
December 31, 2019	Insurance expense	$16,128
	Cash surrender value of life insurance	$672
	Prepaid insurance		$16,800
	(To adjust the increase in cash surrender value and recognize the expense)

Table (5)

Description:

Cash surrender value of life insurance is increased. Therefore, it is debited. Usually, company records the part of the yearly premium that does not increase the Cash surrender value of the policy as insurance expense. Therefore, insurance expense is debited. Prepaid insurance is decreased; therefore, it is credited.

Record the amount of dividend received.

Step 1: Determine the amount of cash received as dividend.

$\begin{array}{c}\text{Cash = Amount of dividend received per year }\times \text{ 4 officers}\\ \text{=\$575}\times 4\\ =\$2,300\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2019	Cash	$2,300
	Insurance expense		$2,300
	(To record the cash received as dividend)

Table (6)

Description:

Cash is an asset. There is an increase in asset. Therefore, it is debited. Whenever, there is a dividend income from an insurance policy, it should be recorded as decrease in insurance expense. Therefore, insurance expense account is credited here.

For the year 2020:

Record the cash payment made for premium.

Date	Account Title and Explanation	Debit	Credit
January 1, 2020	Prepaid insurance	$16,800
	Cash		$16,800
	(To record the payment of premium for 4 officers)

Table (7)

Description:

Corporation K paid life insurance premium for one year for 4 of its officers. Prepaid insurance is increased therefore, it is debited. Cash is decreased, therefore, it is credited.

Record the adjusting entry to increase in the cash surrender value at the end of the year.

Date	Account Title and Explanation	Debit	Credit
December 31, 2020	Insurance expense	$16,128
	Cash surrender value of life insurance	$672
	Prepaid insurance		$16,800
	(To adjust the increase in cash surrender value and recognize the expense)

Table (8)

Description:

Cash surrender value of life insurance is increased. Therefore, it is debited. Usually, company records the part of the yearly premium that does not increase the Cash surrender value of the policy as insurance expense. Therefore, insurance expense is debited. Prepaid insurance is decreased; therefore, it is credited.

Record the amount of dividend received.

Step 1: Determine the amount of cash received as dividend.

$\begin{array}{c}\text{Cash = Amount of dividend received per year }\times \text{ 4 officers}\\ \text{=\$550}\times 4\\ =\$2,200\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2020	Cash $\left(\$550\times 4\right)$	$2,200
	Insurance expense		$2,200
	(To record the cash received as dividend)

Table (9)

Description:

Cash is an asset. There is an increase in asset. Therefore, it is debited. Whenever, there is a dividend income from an insurance policy, it should be recorded as decrease in insurance expense. Therefore, insurance expense account is credited here.

For the year 2021:

Record the cash payment made for premium.

Date	Account Title and Explanation	Debit	Credit
January 1, 2021	Prepaid insurance	$16,800
	Cash		$16,800
	(To record the payment of premium for 4 officers)

Table (10)

Description:

Corporation K paid life insurance premium for one year for 4 of its officers. Prepaid insurance is increased therefore, it is debited. Cash is decreased, therefore, it is credited.

On February 1, 2021, Corporation K’s treasurer died. Hence, Corporation K collected the face value of treasurer policy along with 11 months’ premium.

Record the adjusting entry to increase in the cash surrender value at February 1, 2021.

Step 1: Determine the increase in cash surrender value of life insurance for 1 month for treasurer.

$\begin{array}{c}\begin{array}{l}\text{Increase in cash surrender}\\ \text{value of life insurance for}\\ \text{1 month for treasurer}\end{array}\}=\left[\frac{\text{Premium paid for treasurer}}{12\text{months}}\right]\times \text{percentage increase}\\ \text{=}\left[\frac{\$4,200}{12}\right]\times 4\%\\ =\$14\end{array}$

Step 2: Determine the amount of decrease in the prepaid insurance for 1 month for treasurer.

$\begin{array}{c}\begin{array}{l}\text{Decrease in prepaid insurance}\\ \text{for 1 month for treasurer}\end{array}\}=\left[\frac{\text{Premium paid for treasurer}}{12\text{months}}\right]\\ \text{=}\left[\frac{\$4,200}{12}\right]\\ =\$350\end{array}$

Step 3: Determine the amount of insurance expense incurred for 1 month for treasurer.

$\begin{array}{c}\begin{array}{l}\text{Insurance expense incurred}\\ \text{for 1 month for treasurer}\end{array}\}=\left[\begin{array}{l}\text{Increase in cash surrender value of}\\ \text{ life insurance }-\text{Prepaid insurance}\end{array}\right]\\ =\$350-\$14\\ =\$336\end{array}$

Step 4: Record the adjusting entry.

Date	Account Title and Explanation	Debit	Credit
February 1, 2021	Insurance expense	$336
	Cash surrender value of life insurance	$14
	Prepaid insurance		$350
	(To adjust the increase in cash surrender value and recognize the expense for 1 month on treasurer's policy)

Table (11)

Description:

Cash surrender value of life insurance is increased. Therefore, it is debited. Usually, company records the part of the yearly premium that does not increase the Cash surrender value of the policy as insurance expense. Therefore, insurance expense is debited. Prepaid insurance is decreased; therefore, it is credited.

Record the gain on insurance policy due to the death of the treasurer.

Date	Account Title and Explanation	Debit	Credit
February 1, 2021	Cash	$103,850
	Cash surrender value of life            insurance		$518
	Prepaid insurance		$3,850
	Gain on death of treasurer		$99,482
	(To record the gain on death of treasurer)

Table (12)

Description:

Collection of prepaid insurance premium for 11 months on treasurer’s policy is $3,850 $\left(\$4,200-\$350\right)$. Collection of cash is $103,850$\left(\$100,000+\$3,850\right)$. Cash surrender value of life insurance $\left(\text{\$4,200 premium×4\% increase in surrender value}\times \frac{37\text{month}}{12\text{month}}\right)$ $518. Corporation K received $103,850 from insurance company on death of the treasurer. Therefore, cash account is debited. Cash surrender value of life insurance is ceased to exist, therefore, it is credited. The difference between $\left(\$103,850-\$518-\$3,850\right)$ is credited to record the gain on death of treasurer.

Record the adjusting entry to increase in the cash surrender value for remaining 3 officers’ policy at the end of the year 2021.

Step 1: Determine the amount of increase in the cash surrender value of life insurance.

$\begin{array}{c}\begin{array}{l}\text{Increase in the cash surrender}\\ \text{value of life insurance}\end{array}\}=\left[\begin{array}{l}\text{Premium}\times \text{Percentage of increase in}\\ \text{the cash surrender value}\times \text{3 officers}\end{array}\right]\\ =\$4,200\times 4\%\times 3\\ =\$504\end{array}$

Step 2: Determine the amount of decrease in the prepaid insurance for 3 officers.

$\begin{array}{c}\begin{array}{l}\text{Decrease in prepaid insurance}\\ \text{for 3 officers}\end{array}\}=\text{Premium paid }\times \text{3 officers}\\ =\$4,200\times 3\\ =\$12,600\end{array}$

Step 2: Determine the amount of insurance expense.

$\begin{array}{c}\text{Insurance expense = }\left[\begin{array}{l}\text{Prepaid insurance}-\text{Cash surrender}\\ \text{value of life insurance}\end{array}\right]\\ =\$12,600-\$504\\ =\$12,096\end{array}$

Step 4: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2021	Insurance expense	$12,096
	Cash surrender value of life insurance	$504
	Prepaid insurance		$12,600
	(To adjust the increase in cash surrender value and recognize the expense)

Table (13)

Description:

Cash surrender value of life insurance is increased. Therefore, it is debited. Usually, company records the part of the yearly premium that does not increase the Cash surrender value of the policy as insurance expense. Therefore, it is debited. Prepaid insurance is decreased; therefore, it is credited.