Chapter 10 Insurance Contracts, Accounting For Build-Operate-Transfer (BOT)

PROFE01-ACCOUNTING FOR SPECIAL TRANSACTIONS
Chapter 10 Insurance Contracts, Accounting for Build-operate-transfer (BOT)
Learning Objectives
State the scope and applicability of PFRS 17.
Define an insurance contract.
Describe the level of aggregation and measurement of insurance contracts.
Define a “build-operate-transfer” (BOT) arrangement that is within the scope of IFRIC

Interpretation 12 and SIC Interpretation 29.
Differentiate the accounting procedures for a BOT arrangement depending on the type
of consideration received by the “operator.”
Account for BOT arrangements.
Scope
• PFRS 17 prescribes the principles for the recognition, measurement, presentation and
disclosure of insurance contracts by an insurer. PFRS 17 applies to:
a. insurance and reinsurance contracts issued by an insurer;
b. reinsurance contracts held by an insurer; and
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c. investment contracts with discretionary participation features issued by an

insurer.
• Insurer (issuer of insurance contract) is the party that has an obligation under an
insurance contract to compensate a policyholder if an insured event occurs (e.g.,
insurance company).
Insurance contract
• An insurance contract is “a contract under which one party (the issuer) accepts
significant insurance risk from another party (the policyholder) by agreeing to
compensate the policyholder if a specified uncertain future event (the insured event)
adversely affects the policyholder.” (PFRS 17.Appendix A)
• Policyholder – “a party that has a right to compensation under an insurance contract if

an insured event occurs.”
• Insured event – “an uncertain future event that is covered by an insurance contract and
creates insurance risk.”
Essential elements in the definition of an insurance contract
a. Transfer of significant insurance risk – there is a transfer of significant insurance risk

from the insured (policyholder) to the insurer (insurance provider).
b. Payment from the insured (premium) – generally, the insured pays to a common fund
from which losses are paid. However, not all insurance contracts have explicit premiums
(e.g., insurance cover bundled with some credit card contracts).
c. Indemnification against loss – the insurer agrees to indemnify the insured or other
beneficiaries against loss or liability from specified events and circumstances (i.e.,
insured event) that may occur or be discovered during a specified period.
Significant insurance risk (Uncertain future event)
• Risk (uncertainty) is an essential element of an insurance contract. Risk is the possibility

of loss or injury when an uncertain future event occurs.
• Insurance risk – is “risk, other than financial risk, transferred from the holder of a
contract to the issuer.”
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• A contract that transfers only an insignificant insurance risk is not an insurance contract.
• A contract that exposes the issuer to financial risk is not an insurance contract, unless it
also exposes the issuer to significant insurance risk.
Examples of insurance contracts
a. Insurance against theft or damage.
b. Insurance against product liability, professional liability, civil liability or legal expenses.
c. Life insurance and prepaid funeral plans.
d. Life-contingent annuities and pensions.
e. Disability and medical cover.
f. Surety bonds, fidelity bonds, performance bonds and bid bonds.
g. Product warranties issued by another party for goods sold by a manufacturer, dealer or
retailer. Product warranties issued directly by a manufacturer, dealer or retailer are
outside the scope of PFRS 17.
h. Title insurance.
i. Travel insurance.
j. Insurance swaps and other contracts that require a payment depending on changes in
physical variables that is specific to a party to the contract. (PFRS 17.B26)
k. The following are examples of items that are not insurance contracts:
a. Contracts that do not transfer significant insurance risk to the issuer.
b. Self-insurance.
c. Gambling contracts
d. Derivatives that expose a party to financial risk but not insurance risk, including
weather derivatives.
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e. Credit-related guarantees (e.g., letter of credit, credit derivative default contract

or credit insurance contract) that require payments even if the holder has not
incurred a loss on the failure of the debtor to make payments when due. (PFRS
17.B27)
Types of insurance contracts
a. Direct insurance contract – an insurance contract where the insurer directly accepts
risk from the insured and assumes the sole obligation to compensate the insured in case
of a loss event.
b. Reinsurance contract – an insurance contract issued by one insurer (the reinsurer) to

compensate another insurer (the cedant) for losses on one or more contracts issued by
the cedant.
o Reinsurer – the party that has an obligation under a reinsurance contract to

compensate a cedant if an insured event occurs.
o Cedant – the policyholder under a reinsurance contract.
Legal principles of insurance
• The principal objective of every insurance contract is to provide financial protection to

the insured in case of occurrence of an uncertain future event. Neither the “insured” nor
the “insurer” shall misuse an insurance contract to unjustly enrich him at the expense of
the other.
Legal principles of insurance (Continuation)
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1. Principle of Insurable Interest –The insured has an insurable interest in the property if he is
benefited by the property’s existence and prejudiced by its destruction.
2. Principle of Utmost Good Faith – all insurance contracts must be negotiated with utmost
honesty and fairness because the contracting parties do not have the same access to relevant
information.
3. Principle of Indemnity – the insured is compensated for the loss he incurred and reverted
back to his previous financial condition before the occurrence of the loss event. The insured
neither profits nor incurs loss due to the occurrence of the loss event. This principle does not
apply to life insurance because the value of human life cannot be measured in monetary terms.
4. Principle of Contribution –This principle applies when the insured obtains insurance from
more than one insurer. In case of a loss event, the insured can only claim compensation for the
actual losses he incurred from either insurer or both insurers on a proportionate basis. There is
no “double” compensation for actual losses incurred by the insured. If any of the insurers,
compensates in full the insured, that insurer can claim from the other insurers their shares on
the losses incurred by the insured.
5. Principle of Subrogation – Subrogation means substituting one entity (e.g., the insurer) for
another entity’s (e.g., the insured) legal right to collect a debt or damages.
6. Principle of Loss Minimization – in cases of sudden loss events (e.g., fire), the insured
should try his best to minimize the loss of his insured property by taking all necessary steps to
control and reduce the losses and save what is left of the property (e.g., calling the fire
department in case of fire). This prevents the insured from neglecting the loss event just
because the property is insured.
7. Principle of Proximate Cause – when a loss is caused by more than one loss events, the
closest (proximate) cause, not the furthest cause, is taken into consideration when determining
the extent of the insurer’s liability. This principle does not apply to life insurance.
Separating components from an insurance contract
• An insurance contract may contain one or more non-insurance components (e.g.,

investment component and/or service component) that need to be separated and
accounted for under other Standards. For this purpose, an entity applies PFRS 9 to
separate an embedded derivative or a distinct investment component from a host
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insurance contract and applies PFRS 15 to allocate the cash flows to the separated
components.
Level of aggregation of insurance contracts
• Insurance contracts are combined into portfolios. A portfolio consists of insurance

contracts with similar risks and managed together (e.g., contracts within a product line).
Each portfolio is then further subdivided into the following groups:
a. a group of contracts that are onerous at initial recognition, if any;
b. a group of contracts that at initial recognition have no significant possibility of

becoming onerous subsequently, if any; and
c. A group of the remaining contracts in the portfolio, if any.
(PFRS 17.16)
Accounting Models
• PFRS 17 prescribes the following measurement models:
a. General model
b. Premium allocation approach
c. Modifications to the General model for:
i. Onerous contracts,
ii. Reinsurance contracts held, and
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iii. Investment contracts with discretionary participation features.
General model
Recognition
• A group of insurance contracts is recognized from the earliest of the following:
a. the beginning of the coverage period of the group of contracts;
b. the date when the first payment from a policyholder in the group becomes due;
and
c. For a group of onerous contracts, when the group becomes onerous.
(PFRS 17.25)
Initial Measurement
• A group of insurance contracts is initially measured at the total of
a. the fulfillment cash flows, and
b. the contractual service margin
Fulfillment cash flows
• Fulfillment cash flows comprise the following:
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a. Estimates of future cash flows, which include all future cash flows within the
boundary of each contract in the group. Estimates may be determined at a higher
level of aggregation and then allocated to individual groups of contracts.
b. Adjustment for time value of money and financial risks (if financial risks are not
included in the estimates of future cash flows).
c. Risk adjustment for non-financial risk.
Contractual service margin
• The contractual service margin is the unearned profit in a group of insurance contracts
that the entity recognizes as it provides services in the future.
Subsequent Measurement
• The carrying amount of a group of insurance contracts at the end of each reporting
period is the sum of:
a. the liability for remaining coverage comprising:
i. the fulfilment cash flows related to future service allocated to the group at
that date;
ii. the contractual service margin of the group at that date; and
b. The liability for incurred claims, comprising the fulfilment cash flows related to
past service allocated to the group at that date.
Onerous contracts
• An insurance contract is onerous if the total of its fulfillment cash flows, any previously
recognized acquisition cash flows and any cash flows arising from the contract at initial
recognition date is a net outflow. The net outflow is recognized as a loss in profit or
loss. This results to a carrying amount of the liability for the group equal to the fulfilment
cash flows and a zero contractual service margin.
• On subsequent measurement, any excess net outflow for a group of insurance contracts
that becomes onerous or more onerous is recognized in profit or loss.
Premium Allocation Approach
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• PFRS 17 allows a simplified measurement of a group of insurance contracts (called

‘premium allocation approach’) if at the group’s inception:
a. the entity reasonably expects that the simplification would result to an

approximation of the general model; or
b. The coverage period of each contract in the group is one year or less.
(PFRS 17.53)
• Initial measurement
• Under the premium allocation approach, the liability is initially measured at:
a. the premiums received at initial recognition, if any;
b. minus any insurance acquisition cash flows at that date, unless the entity
chooses to recognize the payments as an expense; and
c. Plus or minus any amount arising from the derecognition at that date of the asset
or liability recognized for insurance acquisition cash flows.
(PFRS 17.55)
• Subsequent measurement
• At the end of each subsequent reporting period, the carrying amount of the liability is the
carrying amount at the start of the reporting period:
a. plus the premiums received in the period;
b. minus insurance acquisition cash flows, unless the entity chooses to recognize
the payments as an expense;
c. plus any amounts relating to the amortization of insurance acquisition cash flows
recognized as an expense in the reporting period, unless the entity chooses to
recognize insurance acquisition cash flows as an expense;
d. plus any adjustment to a financing component;
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e. minus the amount recognized as insurance revenue for coverage provided in that
period; and
f. Minus any investment component paid or transferred to the liability for incurred
claims.
(PFRS 17.55)
Reinsurance contracts held
Initial measurement:
• Estimates of future cash flows include the risk of the reinsurer’s non-performance.
• The risk adjustment for non-financial risk is determined in such a way that it depicts the
transfer of risk from the holder of the reinsurance contract to the reinsurer.
• The contractual service margin is regarded as a net gain or loss on purchasing the
reinsurance, rather than an unearned profit.
Reinsurance contracts held – continuation
Subsequent measurement:
• Changes in the fulfilment cash flows resulting from changes in the reinsurer’s risk of non-
performance do not adjust the contractual service margin but rather recognized in profit
or loss.
Derecognition
• An insurance contract is derecognized when:
a. it is extinguished, i.e., when the obligation in the insurance contract expires or is

discharged or cancelled; or
b. The contract is modified and the modification meets any of the conditions for
derecognition.
Presentation
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Statement of financial position
• The carrying amounts of the following groups are presented separately in the statement
of financial position:
a. insurance contracts issued that are assets;
b. insurance contracts issued that are liabilities;
c. reinsurance contracts held that are assets; and
d. Reinsurance contracts held that are liabilities.
Statement(s) of financial performance
• The amounts recognized in the statement(s) of profit or loss and other comprehensive
income are disaggregated into to the following:
a. insurance service result, comprising insurance revenue and insurance service

expenses; and
b. Insurance finance income or expenses.
“Build-Operate-Transfer” (BOT) arrangements
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• Under a BOT arrangement, the construction of a new infrastructure or the development

or maintenance of an existing infrastructure is outsourced by the government (‘grantor’)
from private companies (called the ‘operators’) through competitive bidding or direct
negotiation.
The ‘operator’ awarded with the BOT contract is allowed to finance the construction,
development or maintenance of the infrastructure and commercially operate it for a fixed
period of time sufficient for him to earn back the capital he invested as well as collect profit.
After which, the ‘operator’ transfers the infrastructure to the government without further
compensation.
Other terms
Other terms for BOT arrangements are:
• “service concession arrangement,”
• “rehabilitate-operate-transfer,”
• “public-to-private service concession” and
• “Private-public partnership (PPP).
Features of BOT arrangements
a. The service to be provided by the operator under the BOT arrangement is of public
service nature and shall be provided to the public on behalf of the public sector entity or
government.
b. The grantor of the BOT contract is a public sector entity (i.e., government).
c. The operator is responsible for at least some of the management of the infrastructure
and related services and does not merely act as an agent on behalf of the grantor.
d. The contract sets the initial prices to be levied by the operator and regulates price
revisions over the period of the service arrangement.
e. The operator is obliged to hand over the infrastructure to the grantor in a specified
condition at the end of the period of the arrangement, for little or no incremental
consideration, irrespective of which party initially financed it.
IFRIC 12 Service Concession Arrangements
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• IFRIC 12 applies to Build-Operate-Transfer (BOT) contracts if:
a. The grantor (i.e., government) controls or regulates
i. what services the operator must provide with the infrastructure,
ii. to whom it must provide them, and
iii. at what price; and
b. The grantor controls, through ownership, beneficial entitlement or otherwise, any

significant residual interest in the infrastructure at the end of the term of the
arrangement.
• The outsourcing of the operation of a governmental unit’s internal services (e.g.,

employee cafeteria, building maintenance, and accounting or information technology
functions) is not a service concession arrangement within the scope of IFRIC 12 or SIC
29.
Accounting issues
• IFRIC 12 deals with the accounting for the following:
1. Treatment of the operator’s rights over the infrastructure;
2. Recognition and measurement of arrangement consideration;
3. Construction or upgrade services;
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4. Operation services;
5. Borrowing costs;
6. Subsequent accounting treatment of a financial asset and an intangible asset;

and
7. Items provided to the operator by the grantor.
Treatment of the operator’s rights over the infrastructure
• The infrastructure referred to in a BOT contract accounted for under IFRIC 12 shall not
be recognized as property, plant and equipment of the operator.
Recognition and measurement of arrangement consideration
• Under a BOT arrangement that is within the scope of IFRIC 12, the operator acts as a
service provider.
• Such services may be:
1. Construction or upgrade services – the operator constructs or upgrades

infrastructure used to provide a public service; and
2. Operation services – the operator operates and maintains that infrastructure for a
specified period of time.
• The operator shall recognize and measure revenue in accordance with PFRS 15
Revenue from Contracts with Customers for the services it performs.
Recognition and measurement of arrangement consideration
• Under a BOT arrangement that is within the scope of IFRIC 12, the operator acts as a
service provider.
• Such services may be:
1. Construction or upgrade services – the operator constructs or upgrades

infrastructure used to provide a public service; and
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2. Operation services – the operator operates and maintains that infrastructure for a
specified period of time.
• The operator shall recognize and measure revenue in accordance with PFRS 15
Revenue from Contracts with Customers for the services it performs.
Construction or upgrade services
• The consideration from construction or upgrade services may be rights to:
1. Financial asset,
2. Intangible asset, or
3. Partly financial asset and partly intangible asset
• The operator shall account for construction or upgrade services in accordance with
PFRS 15.
• After completion of the construction services, the asset recognized from the contract is
accounted for under PFRS 9 (for a financial asset) or PAS 38 (for an intangible asset) or
both (if the consideration is partly a financial asset and partly an intangible asset.
Financial asset
• A financial asset shall be recognized if the operator has an unconditional contractual

right to receive cash or another financial asset from the grantor, such as when the
grantor contractually guarantees to pay the operator
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1. Specified or determinable amounts or
2. The shortfall, if any, between amounts received from users of the public service
and specified or determinable amounts, even if payment is contingent on the
operator ensuring that the infrastructure meets specified quality or efficiency
requirements.
• The amount due from or at the direction of the grantor is accounted for in accordance
with PFRS 9 Financial Instruments as measured at:
1. Amortized cost; or
2. Fair value through other comprehensive income (FVOCI); or
3. Fair value through profit or loss (FVPL).
Intangible asset
• An intangible asset shall be recognized if the operator receives a right (a license) to

charge users of the public service.
• The operator shall account for the intangible asset (license) it has received from the
grantor using PAS 38 Intangible Assets.
Partly by a financial asset and an intangible asset
• If the consideration received or receivable is partly a financial asset and partly an

intangible asset, each component shall be accounted for separately and both
components be recognized initially in accordance with PFRS 15.
Operation services
• The operator shall account for operation services in accordance with PFRS 15.
Borrowing costs incurred by the operator
• The operator is allowed to capitalize borrowing costs, subject to the provisions of PAS
23 Borrowing Costs, if the consideration in a service concession arrangement is in the
form of an intangible asset.
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To know more information about – Chapter 10- Insurance contract
PLEASE CLICK THE LINK: https://www.youtube.com/watch?v=H5EGeaz9lbI
To know more information about – Chapter 10- Accounting issues
PLEASE CLICK THE LINK: https://www.youtube.com/watch?v=WKviFvefp4U
Reference:
TEXTBOOK-Millan, Accounting for Special Transactions (2018), Philippines: Bandolin

Enterprise
WEBSITE REFERENCES-http://www.iasplus.com/
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PROFE01-ACCOUNTING FOR SPECIAL TRANSACTIONS

State the scope and applicability of PFRS 17.

Define an insurance contract.

Describe the level of aggregation and measurement of insurance contracts.

Define a “build-operate-transfer” (BOT) arrangement that is within the scope of IFRIC

Account for BOT arrangements.

a. insurance and reinsurance contracts issued by an insurer;

b. reinsurance contracts held by an insurer; and

c. investment contracts with discretionary participation features issued by an

• Policyholder – “a party that has a right to compensation under an insurance contract if

Essential elements in the definition of an insurance contract

a. Transfer of significant insurance risk – there is a transfer of significant insurance risk

Significant insurance risk (Uncertain future event)

• Risk (uncertainty) is an essential element of an insurance contract. Risk is the possibility

Examples of insurance contracts

a. Insurance against theft or damage.

c. Life insurance and prepaid funeral plans.

d. Life-contingent annuities and pensions.

e. Disability and medical cover.

f. Surety bonds, fidelity bonds, performance bonds and bid bonds.

a. Contracts that do not transfer significant insurance risk to the issuer.

e. Credit-related guarantees (e.g., letter of credit, credit derivative default contract

Types of insurance contracts

b. Reinsurance contract – an insurance contract issued by one insurer (the reinsurer) to

o Reinsurer – the party that has an obligation under a reinsurance contract to

o Cedant – the policyholder under a reinsurance contract.

Legal principles of insurance

• The principal objective of every insurance contract is to provide financial protection to

Legal principles of insurance (Continuation)

Separating components from an insurance contract

• An insurance contract may contain one or more non-insurance components (e.g.,

Level of aggregation of insurance contracts

• Insurance contracts are combined into portfolios. A portfolio consists of insurance

a. a group of contracts that are onerous at initial recognition, if any;

b. a group of contracts that at initial recognition have no significant possibility of

c. A group of the remaining contracts in the portfolio, if any.

• PFRS 17 prescribes the following measurement models:

b. Premium allocation approach

c. Modifications to the General model for:

ii. Reinsurance contracts held, and

iii. Investment contracts with discretionary participation features.

• A group of insurance contracts is recognized from the earliest of the following:

a. the beginning of the coverage period of the group of contracts;

c. For a group of onerous contracts, when the group becomes onerous.

• A group of insurance contracts is initially measured at the total of

a. the fulfillment cash flows, and

b. the contractual service margin

Fulfillment cash flows

• Fulfillment cash flows comprise the following:

c. Risk adjustment for non-financial risk.

Contractual service margin

a. the liability for remaining coverage comprising:

Premium Allocation Approach

• PFRS 17 allows a simplified measurement of a group of insurance contracts (called

a. the entity reasonably expects that the simplification would result to an

a. the premiums received at initial recognition, if any;

a. plus the premiums received in the period;

d. plus any adjustment to a financing component;

Reinsurance contracts held

Reinsurance contracts held – continuation

• An insurance contract is derecognized when:

a. it is extinguished, i.e., when the obligation in the insurance contract expires or is