Lecture Notes: Understanding the Capital Dividend Account
Introduction
Importance of understanding the Capital Dividend Account (CDA) for company balance sheets.
Relevance to funding buy-sell agreements using life insurance policies.
Life Insurance Policies and Corporate Ownership
Discussion on companies owning life insurance policies instead of individuals.
Importance of understanding life insurance proceeds when the policy is company-owned.
Accounting for Life Insurance Proceeds
Focus on life insurance proceeds accounting when the insured passes away.
Demonstration using a company’s balance sheet:
Left side: Assets of the company (bank account, inventory, real estate, etc.).
Right side: Liabilities and shareholders' equity (debts, loans, expenses).
Balance Sheet Principle: Assets must equal liabilities plus shareholders' equity.
Example: If a company borrows $10,000, it is recorded as cash on one side and a bank loan on the other.
Treatment of Life Insurance Proceeds
Corporate-owned life insurance: Death benefits paid to the company.
Example: $100,000 death benefit is credited to the company account.
Accounting treatment:
Assets increase by the amount of the death benefit.
Balance sheet must balance: Increase $100,000 on the assets side must be offset.
Special Treatment Under Income Tax Act
Insurance proceeds under the Income Tax Act:
Adjusted cost base credited to retained earnings.
Difference between death benefit and adjusted cost base goes to CDA.
Example: Death benefit $100,000, Adjusted cost base $88,000.
$8,000 to retained earnings.
$92,000 to Capital Dividend Account.
Benefits of Capital Dividend Account
Amounts credited to CDA can be distributed as tax-free dividends:
Example: $92,000 can be paid to shareholders tax-free.
Importance of CDA for buy-sell agreements funded by insurance.
Conclusion
Understanding CDA is crucial for accounting in corporate insurance policies.
CDA provides a tax-efficient way for companies to distribute insurance proceeds to shareholders.
Key Takeaway
The CDA allows life insurance proceeds to be distributed as tax-free dividends, making corporate-owned policies advantageous in certain buy-sell agreement funding situations.