When a policyowner cash surrenders a universal life insurance policy, how is the transaction typically classified in accounting?

• A. As a deferred revenue item
• B. As an expense on the income statement
• C. As a reduction in liabilities and recognition of income for the surrender value received
• D. As an increase in assets and recognition of a capital gain

Answer: (C)

Verified step by step guidance

1. Understand the nature of the transaction: Cash surrender of a universal life insurance policy involves the policyowner receiving the surrender value, which is the cash value accumulated in the policy minus any applicable fees or charges.
2. Identify the accounting classification: The surrender value received by the policyowner is typically treated as a reduction in liabilities because the insurance company no longer has the obligation to provide coverage under the policy.
3. Recognize the income component: The surrender value received may also be recognized as income by the insurance company, as it represents the financial benefit realized from the termination of the policy.
4. Analyze why it is not classified as deferred revenue or a capital gain: Deferred revenue refers to income received in advance for services not yet performed, which does not apply here. A capital gain typically arises from the sale of an asset, which is not the case in this transaction.
5. Conclude the accounting treatment: The transaction is classified as a reduction in liabilities and recognition of income for the surrender value received, aligning with the correct answer provided in the problem.