Substance over form

There has been some speculation as to whether - under the Financial Services Authority client account rules (non-statutory and statutory trusts accounts) - there is still a need to include insurance debtor and creditor balances within your balance sheet.

When considering this subject, the reference point for guidance is Reporting the substance of transactions (FRS5). This standard requires an entity's financial statements to report the substance of the transactions into which it has entered.

The principal determinant of the substance of a transaction is to identify whether it has given rise to new assets or liabilities for the entity and whether it has increased or decreased the entity's existing assets or liabilities. In determining the substance of a transaction, all its aspects and implications should be identified and greater weight given to those more likely to have a commercial effect. Once identified as an asset or liability it should be recognised in the balance sheet.

As the broker is the agent of the insured, he is not normally liable to pay premiums to the underwriters until collected. However, market practice is that the broker is usually responsible for collecting premiums and claims and, to reflect this, the normal accounting practice is for premium and claim debtors and creditors to be accounted for by the broker and disclosed in the balance sheet.

This reflects the commercial substance of the position, not the broker's legal position as agent or as trustee of the client monies. If a client fails to settle premiums, the broker cannot normally bring an action against the insured to recover the monies as he is not a party to the contract. Non-payment of premium, however, entitles the underwriter to bring an action against the insured.

Under FRS5, assets are "rights or other access to future economic benefits controlled by an entity as a result of past transactions or events". The amounts to be collected by the broker are properly considered to be assets because, having placed the business, the broker will normally enjoy the future economic benefits in the form of interest receivable on the cash collected between the date of its receipt and the date of its onwards payment.

Liabilities are "an entity's obligations to transfer economic benefits as a result of past transactions or events". Having recognised amounts to be collected as debtors, a corresponding liability needs to be accounted for in recognition of the fact that amounts to be collected will also have to be transferred to third parties.

Paragraph 30 of FRS5 states: "Disclosure of a transaction in the financial statements, whether or not it has resulted in assets or liabilities being recognised or ceasing to be recognised, should be sufficient to enable the user of the financial statements to understand its commercial effects." The accounting policies of an insurance broker usually state they are not liable for premiums or claims and debtors and creditors are not offset.

The introduction of new types of client accounts has not changed the nature of the transactions undertaken by the broker and, therefore, the same 'substance over form' issues still pertain.