Deferred Acquisition Costs include all expenses that vary with and are directly related to the acquisition of new and renewal contracts.These expenses are capitalized and amortized in proportion to Estimated Gross Margins (EGM)

EGMs =
 Premiums
 plus  investment income on benefit reserve
 less  Non deferred expenses (This includes maintenance expense and ultimate renewal commission)
less  change in net level premium reserve

less  Death,surrender and endowment benefits
less  policyholder dividends

Assumptions for Estimated Gross Margins
1) Assumptions must be best estimate
2) Assumptions are continually unlocked as US GAAP book says on page 133 under section 5.5
“The assumptions underlying the policyholder benefit liability are established by reference to the contract for which the liability is being established. As a result, these assumptions are established at issue of the contract and do not change unless, in the rare circumstance,there is a post-issue contract modification. on the other hand, the assumptons used in estimating future gross margins need to be reviewed periodically and updated to reflect current estimates”
3) DAC discount rate equals earned rate

If EGMs do not show a good pattern, then an alternative amortization basis should be used as paragraph 20 of SOP 95-1 says:

“If significant negative gross margins are expected in any period, then the present value of gross margins before annual dividends, estimated gross premiums, or the balance of insurance in force should be substituted as the base for computing amortization”

However, the US GAAP book for life insurers says at the end of page 132:
“Once an alternative amortization base has been selected and put into use, it should continue to be used over the life of the contracts for which it has been made.”

The DAC balance as at the valuation date can be derived by the following two methods:

1)Retrospective Method

Ending DAC balance (EOY DAC)
  = Opening DAC Balance (BOY DAC)
  + New DAC
  + DAC interest on BOY DAC and New DAC
  – DAC Amortization Charge (kDAC x AGM)

Mathematically,
DAC(t) =(DAC(t-1)+(DAE(t))*(1+i(t))-KDAC*AGM(t)

Where
•Opening DAC balance will equal the closing DAC balance from the previous reporting period.

•New DAC is the amount of new DAC created in the reporting period. This reflects the DAC created for new business written in the reporting period as well as the additional DAC created on in-force business. New DAC includes:

Commission DAC
Expense(Non Commission) DAC

•Interest on DAC - As DAC is an asset on the balance sheet of the company, it earns interest.

•DAC Amortization - This reflects the amount of DAC that is charged as an expense in the income statement in the current reporting period.
Mathematically,Amortization for period t = KDAC * Actual Gross Margins(t)
KDAC is the DAC amortization rate and equals
Present value of Deferrable Acquisition Expenses + Accumulated Value of DAC/Present value of Estimated Gross Margins(EGMs) + Accumulated value of Actual Gross Margins(AGMs)

KDAC is basically percentage of gross margins required to provide for deferred policy acquisition costs.The DAC is recoverable if the k-factor is less than 100%.If the K-factor is greater than 100%, a portion of the DAC or the total DAC has to be written off immediately, so that the new K-factor is equal 100%.

2)Prospective View of DAC

DAC balance
  = (DAC amortization rate
  x PV of future gross margins)
  -  PV of future deferred expenses

Formula(1) is preferred as this DAC-roll forward provides more insight.

For FAS 120 products the DAC-amortization is analog to FAS 97 products with the following two differences:
The EGPs are replaced by the Estimated Gross Margins(EGMs)
The earned rate is used as discount rate instead of the credited rate.