Deposit AccountingDefined with Examples, Entries & More

Written By:
Lisa Borga

What is Deposit Accounting?

Deposit accounting is a type of accounting that businesses use to recognize or measure liabilities or assets for both multi-year and short-term contracts.

The payments that a business charges or earns are used to compute the liability or deposit asset once any fees or premiums the business is keeping have been subtracted.

Insurance companies will sometimes transfer contracts to decrease the cost of claims that have been filed as well as manage the company’s risk.

When using deposit accounting, businesses must adhere to the guidelines of the United States Generally Accepted Accounting Principles when contracts that do not require the transfer of underwriting risks are being accounted for.

These guidelines also give rules that apply to reinsurance contracts in which the insurer is not compensated or protected from losses.

Are the Deposits of Policyholders Liabilities or Assets?

When individuals purchase an insurance policy, they are trying to protect themselves from liabilities or losses in certain situations, such as:

• Injuries in the workplace
• Identity theft
• Medical problems
• Automobile accidents
• Funeral expenses
• Floods

When people obtain this protection, they are required to pay premiums for this insurance to the company they purchased the insurance policy from.

Generally, people will pay these premiums either monthly or annually.

Insurance companies can keep these premiums so that they will have enough money to pay should a policyholder make a claim.

Insurance companies need to keep these funds in cash or in liquid assets that can easily be converted to cash.

Insurance companies that receive more in premiums than they had to pay out as claims are profitable.

However, if an insurance company ends up paying out more money in claims than it received in premiums, the company will need to increase its premiums.

Typically, if an insurance company has access to premium payments, these are thought to be the insurance company’s assets.

In contrast, the money the insurance company owes to its policyholders is considered a liability.

In What Situations is Deposit Accounting Considered Helpful?

Deposit accounting could be considered helpful in situations in which  reinsurance and insurance contracts are involved, including when:

• Only timing risk is transferred
• Underwriting risk is not transferred
• Prospective reinsurance is involved

When using deposit accounting, these contracts will need to be considered individually rather than as part of a portfolio.

Also, any deposit money must be accounted for as a deposit liability instead of as an asset.

In deposit accounting, the money that is paid is considered a deposit and may be recorded by the ceding party as an asset.

An insurance company will sometimes purchase insurance from another insurance company in an effort to diversify their company’s risk should they experience a substantial claim.

This process is called reinsurance.

The Different Kinds of Deposit Accounting

There are different kinds of deposit accounting, which are listed below.

Bank Deposits

When money is deposited in the bank, it typically earns interest allowing the depositor to earn on their initial deposit.

The interest rate is generally stated ahead of time.

However, in some cases, the interest rate will be based on the current market rate.

Prospective

A prospective deposit is dependent on the amount of the payment that will be made sometime in the future rather than the original investment.

The interest rate, in this case, depends on what the current market rate is.

Although, the rate could be a predetermined rate that will not be adjusted over time or a certain interest rate that is locked.

The value of this deposit will change as interest payments are made.

Retrospective

In the retrospective method, a deposit is ascertained by the initial and past payment as well as potential payments.

The interest rate will be based on the money that flows into and out of a contract. In some cases, this is beneficial.

However, it may cause there to be a negative rate if more money is going out of the contract instead of coming into it.

This is a different type of deposit being determined by the money that has flowed into the contract in the past as well as the money currently coming into the contract.

Accounting Journal Entries

For an example of a deposit accounting entry, we will consider insurance Company X.

This insurance company is considering entering a reinsurance contract that will not transfer any risk with another insurance company, Company Y.

When insurance companies make arrangements in which risk is not transferred, this must be recorded by following the deposit accounting rules of the Generally Accepted Accounting Principles.

According to these rules, Company X and Company Y are required to account for any assets or liabilities that are included in the contract.

Insurance Company X, the ceding company, would transfer liabilities to Company Y, another insurance company.

If the payment time should change, this should be recorded by Company X.

These are the necessary steps in a deposit accounting journal entry.

• Company X will need to pay $20 million to Company Y over a period of 10 years. The payments will be equal and due at the end of the year.
• This means Company X will pay Company Y a payment of $2 million each year.
• Insurance Company X will pay 16 million at the start of the contract.
• At the end of the ten years, insurance Company Y will return any part of the deposit that has not been repaid.
• Should the timing of the payments be changed, both insurance companies need to change their liability and asset balance sheets. As an example, if there is a change in the cash flow, there will also need to be a change in the deposit money. If Company X increases its deposit, the assets’ present value will change as well.

Key Takeaways

• Deposit accounting is an accounting method businesses use to record a transaction when liabilities or assets are being transferred by using reinsurance contracts.
• Reinsurance contracts that have underwriting risks or limited risks are required to be accounted for by using the United States Generally Accepted Accounting Principles.
• Reinsurance contracts are used to help diversify the risk of insurance companies as well as reduce the strain of the claims that have been filed. Should an insurance company be required to pay out significant claims, the risks associated with these claims would be divided between several insurance companies.
• The three types of deposit accounting are perspective, retrospective, and bank deposits.