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how long does it take to study for aams | once you receive access to the online material you have 120 days to pass your final exam how long it takes depends on your study habits and knowledge retention the bottom linean aams is a financial advisor certified by the college of financial planning to advise clients about personal finances asset management and investments it is a challenging course of study for those unfamiliar with investing and assets but it is also a stepping stone for achieving the highly coveted certified financial planner designation | |
what does accredited in business valuation mean | accredited in business valuation abv is a professional designation awarded to a certified public accountant cpa who specializes in calculating businesses value the abv certification is overseen by the american institute of certified public accountants aicpa it requires candidates to complete an application process pass an exam meet the minimum business experience and education requirements and pay a credential fee as of 2021 the annual fee for the abv credential was 380 1 maintaining the abv credential also requires those who hold the certification to meet minimum work experience standards and lifelong learning successful applicants earn the right to use the abv designation with their names improving job opportunities professional reputation and pay | |
how accredited in business valuation works | the accredited in business valuation credential is awarded to cpas who demonstrate considerable knowledge skill and business valuation experience the study program to become an abv covers the basic business valuation process professional standards qualitative and quantitative analysis valuation analysis and other related topics such as financial reporting and litigation individuals with the abv designation may work for business valuation firms consulting firms and other businesses that regularly deal with business value accredited in business valuation requirementscandidates seeking abv accreditation must have a valid and unrevoked cpa license or certificate issued by the appropriate state authority they must also pass the abv examination with some exceptions for example this requirement is waived in the case of am accredited member of the asa and asa accredited senior appraiser credential holders of the american society of appraisers cfa certified financial actuary holders and cbv chartered business valuator credential holders of the canadian institute of chartered business valuators every three years abv professionals must complete 60 hours of continuing professional education they must also pay an annual fee of several hundred dollars business experience and education requirements for candidatesabv candidates must have obtained a minimum of 150 hours of bv experience within the five years preceding the credential application date candidates may also apply a maximum of 15 experience hours by completing the hands on business valuation case study track at the aicpa forensic and valuation services conference abv candidates must complete 75 hours of valuation related continuing professional development cpd all hours must be obtained within the 5 year period preceding the date of the abv application accredited in business valuation examthe abv exam is conducted by computer and consists of two parts both parts must be passed in 12 months based on passing the first part to receive abv credit applicants are given three hours and 15 minutes to complete each section of the test including a 15 minute break the exam consists of 90 multiple choice questions per module and much of the exam are discrete multiple choice questions 78 in total a dozen questions are case studies with accompanying multiple choice answers these questions are meant to test a candidate s analytical aptitude and apply valuation theory and methodology | |
what is an accredited investor | an accredited investor is an individual or a business that is allowed to buy and sell securities that are not registered with financial authorities such as shares in new businesses that have not yet gone public accredited investors get this designation by satisfying at least one requirement regarding income net worth asset size governance status or professional experience in the u s the term is used by the securities and exchange commission sec under regulation d to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings accredited investors include high net worth individuals banks insurance companies brokers and trusts investopedia katie kerpelduties of an accredited investoraccredited investors have privileged access to pre ipo companies venture capital companies hedge funds angel investments and various deals involving complex and higher risk investments and instruments a company that is seeking to raise a round of funding may decide to directly approach accredited investors an example might be a young technology company that has a product in the late development stages and needs more money to launch the product on the market it is not a public company but hopes to launch an initial public offering ipo in the near future such a company might decide to offer securities to accredited investors directly this type of share offering is referred to as a private placement for accredited investors there is a high potential for risk or reward the sec wants to ensure that they are financially stable experienced and knowledgeable about their risky ventures 21requirements for accredited investorsthe regulations for accredited investors vary among jurisdictions in the u s the definition of an accredited investor is put forth by the sec in rule 501 of regulation d 3to be an accredited investor a person must have an annual income exceeding 200 000 300 000 for joint income for the last two years with the expectation of earning the same or a higher income in the current year the income test cannot be satisfied by showing one year of an individual s income and the next two years of joint income with a spouse 3an accredited investor should have a net worth exceeding 1 million either individually or jointly with a spouse this amount cannot include a primary residence the sec also considers applicants to be accredited investors if they are general partners executive officers or directors of a company that is issuing unregistered securities 3an entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding 5 million also if an entity consists of equity owners who are accredited investors the entity itself is an accredited investor 3 however an organization cannot be formed with the sole purpose of purchasing specific securities a person can qualify as an accredited investor by demonstrating sufficient education or job experience in the financial industry 3recent changes to the accredited investor definitionthe u s congress modified the definition of an accredited investor in 2020 to include registered brokers and investment advisors 4according to the sec s press release the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge experience or certifications in addition to the existing tests for income or net worth the amendments also expand the list of entities that may qualify as accredited investors including by allowing any entity that meets an investments test to qualify 5among other categories the sec now defines accredited investors to include the following individuals who have certain professional certifications designations or credentials individuals who are knowledgeable employees of a private fund and sec and state registered investment advisors 5 | |
how to become an accredited investor | people who want to be accredited investors don t apply to the sec for the designation rather it is the responsibility of the company offering a private placement to make sure that all of those approached are accredited investors individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities the issuer may ask the applicant to fill out a questionnaire and provide financial documents the required documentation may include account information financial statements and a balance sheet it may extend to tax returns w 2 forms salary slips and even letters from cpas tax attorneys investment brokers or advisors the company may check the applicant s credit report as part of the assessment most participants in private placements do not have to go through this process people with certain financial accreditations managers of hedge funds and partners in private equity firms are among those who don t have to prove their credentials to buy unregistered securities example of an accredited investorfor example suppose there is an individual whose income was 150 000 for the last three years they reported a primary residence value of 1 million with a mortgage of 200 000 a car worth 100 000 with an outstanding loan of 50 000 a 401 k account with 500 000 and a savings account with 450 000 while this individual fails the income test they are an accredited investor according to the test on net worth which cannot include the value of an individual s primary residence net worth is calculated as assets minus liabilities 1this person s net worth is exactly 1 million this involves a calculation of their assets other than their primary residence of 1 050 000 100 000 500 000 450 000 less a car loan equaling 50 000 since they meet the net worth requirement they qualify to be an accredited investor who qualifies to be an accredited investor the sec defines an accredited investor as either 6 | |
are there any other ways of becoming an accredited investor | under certain circumstances an accredited investor designation may be assigned to a firm s directors executive officers or general partners if that firm is the issuer of the securities being offered or sold 3 in some instances a financial professional holding a finra series 7 65 or 82 can act as an accredited investor there are a few less common qualifications such as managing a trust with more than 5 million in assets 1 | |
what privileges do accredited investors receive that others don t | under federal securities laws only those who are accredited investors may participate in certain securities offerings these may include shares in private placements structured products and private equity or hedge funds among others 1 | |
why do you need to be accredited to invest in complex financial products | accredited investors hear pitches for investments that are not regulated by the government and are not subject to the same disclosure rules that public companies are required to follow the regulators want to be certain that participants in these highly risky and complex investments can fend for themselves and judge the risks in the absence of government protection the bottom linethe accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand on the flip side it gives people who already have substantial financial assets a major advantage over those with more modest assets | |
what is accretion | accretion is the gradual and incremental growth of assets and earnings due to business expansion a company s internal growth or a merger or acquisition in finance accretion is also the accumulation of the additional income an investor expects to receive after purchasing a bond at a discount and holding it until maturity the most well known applications of financial accretion include zero coupon bonds or cumulative preferred stock understanding accretionin corporate finance accretion is the creation of value through organic growth or through a transaction for example when new assets are acquired at a discount or for a cost that is below their perceived current market value cmv acccretion can also occur by acquiring assets that are anticipated to grow in value after the transaction in securities markets purchasing bonds below their face or par value is considered buying at a discount whereas purchasing above the face value is known as buying at a premium in finance accretion adjusts the cost basis from the purchase amount discount to the anticipated redemption amount at maturity for example if a bond is purchased for an amount totaling 80 of the face amount the accretion is 20 as interest rates increase the value of existing bonds declines which means that bonds trading in the market decline in price to reflect the interest rate increase since all bonds mature at the face amount the investor recognizes additional income on a bond purchased at a discount and that income is recognized using accretion the rate of accretion is determined by dividing the discount by the number of years in the term in the case of zero coupon bonds the interest acquired is not compounding while the bond s value increases based on the agreed upon interest rate it must be held for the agreed upon term before it can be cashed out assume that an investor purchased a 1 000 bond for 860 and the bond matures in 10 years between the bond s purchase and maturity dates the investor needs to recognize additional income of 140 when the bond is purchased the 140 is posted to a discount on the bond account over the next 10 years a portion of the 140 is reclassified into the bond income account each year and the entire 140 is posted to income by the maturity date the earnings per share eps ratio is defined as earnings available to common shareholders divided by average common shares outstanding and accretion refers to an increase in a firm s eps due to an acquisition the accreted value of a security may not have any relationship to its market value examples of accretionfor example assume that a firm generates 2 000 000 in available earnings for common shareholders and that 1 000 000 shares are outstanding the eps ratio is 2 the company issues 200 000 shares to purchase a company that generates 600 000 in earnings for common shareholders the new eps for the combined companies is computed by dividing its 2 600 000 earnings by 1 200 000 outstanding shares or 2 17 investment professionals refer to the additional earnings as accretion due to the purchase as another example if a person purchases a bond with a value of 1 000 for the discounted price of 750 with the understanding it will be held for 10 years the deal is considered accretive the bond pays out the initial investment plus interest depending on the type of bond purchase interest may be paid out at regular intervals such as annually or in a lump sum upon maturity if the bond purchase is a zero coupon bond there is no interest accrual instead it is purchased at a discount such as the initial 750 investment for a bond with a face value of 1 000 the bond pays the original face value also known as the accreted value of 1 000 in a lump sum upon maturity a primary example within corporate finance is the acquisition of one company by another first assume the earnings per share of corporation x is listed as 100 and earnings per share of corporation y is listed as 50 when corporation x acquires corporation y corporations x s earnings per share increase to 150 this deal is 50 accretive due to the increase in value the accretion of a discount is the increase in the value of a discounted instrument as time passes and the maturity date looms closer however sometimes long term debt instruments like car loans become short term instruments when the obligation is expected to be fully repaid within one year if a person takes out a five year car loan the debt becomes a short term instrument after the fourth year | |
what is accretion of discount | accretion of discount is the increase in the value of a discounted instrument as time passes and the maturity date looms closer the value of the instrument will accrete grow at the interest rate implied by the discounted issuance price the value at maturity and the term to maturity | |
how accretion of discount works | a bond can be purchased at par at a premium or at a discount regardless of the purchase price of the bond however all bonds mature at par value the par value is the amount of money that a bond investor will be repaid at maturity a bond that is purchased at a premium has a value above par as the bond gets closer to maturity the value of the bond declines until it is at par on the maturity date the decrease in value over time is referred to as the amortization of premium a bond that is issued at a discount has a value that is less than the par value as the bond approaches its redemption date it will increase in value until it converges with the par value at maturity this increase in value over time is referred to as an accretion of discount for example a three year bond with a face value of 1 000 is issued at 975 between issuance and maturity the value of the bond will increase until it reaches its full par value of 1 000 which is the amount that will be paid to the bondholder at maturity special considerationsaccretion can be accounted for using a straight line method whereby the increase is evenly spread throughout the term using this method of portfolio accounting accretion of discount can be said to be a straight line accumulation of capital gains on a discount bond in anticipation of receipt of par at maturity accretion can also be accounted for using a constant yield whereby the increase is closest to maturity the constant yield method is the method required by the internal revenue service irs for calculating the adjusted cost basis from the purchase amount to the expected redemption amount this method spreads out the gain over the remaining life of the bond instead of recognizing the gain in the year of the bond s redemption calculating accretionto calculate the amount of accretion use the formula the first step in the constant yield method is determining the yield to maturity ytm which is the yield that will be earned on a bond held until it matures the yield to maturity depends on how frequently the yield is compounded the irs allows the taxpayer some flexibility in determining which accrual period to use for computing yield for example a bond with a 100 par value and a coupon rate of 2 is issued for 75 with a 10 year maturity date let s assume it is compounded annually for the sake of simplicity the ytm can therefore be calculated as coupon interest on the bond is 2 x 100 par value 2 therefore the purchase price of 75 represents the bond s basis at issuance however in subsequent periods the basis becomes the purchase price plus accrued interest for example after year 2 the accrual can be calculated as using this example one can see that a discount bond has a positive accrual in other words the basis accretes increasing over time from 0 19 0 20 and so on periods 3 to 10 can be calculated in a similar manner using the former period s accrual to calculate the current period s basis | |
what is accretive | in both finance and in general lexicon the term accretive is the adjective form of the word accretion which refers to gradual or incremental growth for example an acquisition deal may be deemed accretive for the absorbing company if that deal contributes to an increase in earnings per share by definition in corporate finance accretive acquisitions of assets or businesses must ultimately add more value to a company than the expenditures associated with the acquisition this can be due to the fact that the newly acquired assets in question are purchased at a discount to their perceived current market value or if the assets are expected to grow as a direct result of the transaction key takeaways the term accretive is an adjective that refers to business deals that result in gradual or incremental growth in value for a company in corporate finance accretive acquisitions of assets must add more value to a company than the costs of acquiring the target entity accretive deals can occur if acquired assets are purchased at a discount to their perceived current market value in general finance accretive investments refer to any security that is purchased at a discount breaking down accretivein general finance accretion refers to the change in the price of a bond or security in fixed income investments the word accretive may be used to describe the increase in value attributable to interest accrued but not paid for example discounted bonds earn interest through accretion until they reach maturity in such cases acquired bonds are acquired at a discount when compared to the current face value of the bond also known as the par as the bond matures the value increases based on the interest rate that was in effect at the time of issuance determining the rate of accretionthe rate of accretion is determined by dividing the discount by the number of years in the term in the case of zero coupon bonds the interest acquired is not compounded while the value of the bond increases based on the agreed upon interest rate it must be held for the agreed upon term before it can be cashed out examples of accretionif a person purchases a bond with a value of 1 000 for the discounted price of 750 with the understanding that it will be held for 10 years the deal is considered accretive because the bond pays out the initial investment plus interest depending on the type of bond purchased interest may be paid out at regular intervals annually semi annually etc or it may be paid in lump sum upon maturity with zero coupon bonds there is no interest accrual instead it is purchased at a discount such as the initial 750 investment for a bond with a face value of 1 000 the bond pays the original face value also known as the accreted value of 1 000 in a lump sum upon maturity in corporate finance acquisition deals are often accretive first let s assume that the earnings per share of corporation x is listed as 100 and earnings per share of corporation y is listed as 50 when corporation x acquires corporation y corporations x s earnings per share increase to 150 rendering this a 50 accretive deal important the antonym to accretive is dilutive which describes any deal which causes a corporation s earnings per share value to drop | |
what is accrual accounting | accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred in other words the revenue earned and expenses incurred are entered into the company s journal regardless of when money exchanges hands accrual accounting is usually compared to cash basis of accounting which records revenue when the goods and services are actually paid for learn more about accrual accounting and how it differs from the other popular accounting method cash accounting investopedia jessica olah | |
how accrual accounting works | the general concept of accrual accounting is that accounting journal entries are made when a good or service is provided rather than when payment is made or received entries are also made for debts and payments due this method allows the current and future cash inflows or outflows to be combined to give a more accurate picture of a company s current and long term finances accrual accounting follows the matching principle which states that revenues and expenses should be recorded in the same period accrual accounting is encouraged by international financial reporting standards ifrs and generally accepted accounting principles gaap as a result it has become the standard accounting practice for most companies except for very small businesses and individuals larger companies are required to use the accrual method of accounting if their average gross receipt of revenues is more than 25 million over the previous three years if a company does not meet the average revenue requirement it can choose to use cash basis or accrual as its accounting method 12accrual accounting is always required for companies that carry inventory or make sales on credit regardless of the company size or revenue 3benefits of accrual accountingthe accrual method does provide a more accurate picture of the company s current condition but its relative complexity makes it more expensive to implement this method arose from the increasing complexity of business transactions and a desire for more accurate financial information selling on credit and projects that provide revenue streams over a long period affect a company s financial condition at the time of a transaction therefore it makes sense that such events should also be reflected in the financial statements during the same reporting period that these transactions occur under accrual accounting firms have immediate feedback on their expected cash inflows and outflows making it easier for businesses to manage their current resources and plan for the future accrual accounting provides a more accurate picture of a company s financial position however many small businesses use cash accounting because it is less confusing accrual accounting vs cash accountingaccrual accounting can be contrasted with cash accounting which recognizes transactions only when there is an exchange of cash additionally cash basis and accrual differ in the way and time transactions are entered cash accounting uses transactions when payments are made for example consider a consulting company that provides a 5 000 service to a client on oct 30 the client received the bill for services rendered and made a cash payment on nov 25 under the cash basis method the consultant would record an owed amount of 5 000 by the client on oct 30 and enter 5 000 in revenue when it is paid on nov 25 and record it as paid in contrast accrual accounting uses a technique called double entry accounting when the consulting company provided the service it would enter a debit of 5 000 in accounts receivable debits increase an asset account when the payment is made on nov 25 the consultant credits credits decrease an asset account the accounts receivable by 5 000 and credits the service revenues account a revenue account credits increase a revenue account with 5 000 the received capital can then be moved to other accounts such as free cash if needed the company uses the same double entry method to enter which account the capital came from and is moved to | |
how do you explain accrual to non accountants | accrual accounting uses the double entry accounting method where payments or reciepts are recorded in two accounts at the time the transaction is initiated not when they are made | |
what is the difference between cash accounting and accrual accounting | cash accounting records payments and receipts when they are received accrual records payments and receipts when services or good are provided or debt is incurred | |
what is accrual journal entry | the accounting journal is the first entry in the accounting process where transactions are recorded as they occur an accrual or journal entry is made when a transaction occurs | |
what are the 3 accounting methods | the three accounting methods are cash basis of accounting accrual basis of accounting and a hybrid of the two called modified cash basis of accounting the bottom lineaccrual accounting is an accounting method in which payments and expenses are credited and debited when earned or incurred accrual accounting differs from cash basis accounting where expenses are recorded when payment is made and revenues are recorded when cash is received accrual accounting uses double entry accounting where there are generally two accounts used when entering a transaction this method is more accurate than cash basis accounting because it tracks the movement of capital through a company and helps it prepare its financial statements | |
what are accruals | accruals are revenues earned or expenses incurred that impact a company s net income on the income statement but cash related to the transaction hasn t yet changed hands accruals also affect the balance sheet because they involve non cash assets and liabilities the revenue from a service would be recorded as an accrual in a company s financial statements if the company has performed a service for a customer but hasn t yet received payment this ensures that the company s financial statements accurately reflect its true financial position even if it hasn t yet received payment for all the services it s provided accrual accounts include accounts payable accounts receivable accrued tax liabilities and accrued interest earned or payable among many others understanding accrualsan accrual is a record of revenue or expenses that have been earned or incurred but haven t yet been recorded in the company s financial statements this can include things like unpaid invoices for services provided or expenses that have been incurred but not yet paid accruals are important because they help to ensure that a company s financial statements accurately reflect its true financial position even if it hasn t yet received payment for all the services it has provided or paid all its bills revenue is recognized when it s earned in accrual based accounting regardless of when the payment is received the revenue received from a service would be recorded in december when it was earned if a company provided a service to a customer in december but didn t receive payment until january of the following year 1expenses are recorded when they re incurred regardless of when they re paid an expense would be recorded in december if a company incurs expenses in december for a service that will be received in january revenue derived from that service would be recorded in december when it was earned accruals and deferrals are the basis of the accrual method of accounting the preferred method by generally accepted accounting principles gaap an accountant makes adjustments for revenue that s been earned but not yet recorded in the general ledger and expenses that have been incurred but are also not yet recorded 1the accruals are made via adjusting journal entries at the end of each accounting period so the reported financial statements can be inclusive of these amounts the use of accrual accounts greatly improves the quality of information on financial statements accountants only recorded cash transactions before the use of accruals unfortunately cash transactions don t give information about other important business activities such as revenue based on credit extended to customers or a company s future liabilities a company can measure what it owes in the short term and also what cash revenue it expects to receive by recording accruals it also allows a company to record assets that don t have a cash value such as goodwill the offset to an accrued expense is an accrued liability account in double entry bookkeeping this appears on the balance sheet the offset to accrued revenue is an accrued asset account and this also appears on the balance sheet an adjusting journal entry for an accrual will therefore impact both the balance sheet and the income statement accrual accounting is the preferred method according to generally accepted accounting principles gaap it s widely considered to provide a more accurate and comprehensive view of a company s financial position and performance than the cash basis of accounting which only records transactions when cash is exchanged 2the company must make journal entries to record accruals on the balance sheet to reflect the revenues and expenses that have been earned or incurred but not yet recorded a company would make a journal entry to record the revenue from that service as an accrual if it s provided a service to a customer but hasn t yet received payment this would involve debiting the accounts receivable account and crediting the revenue account on the income statement the company would make a journal entry to record the expenses as an accrual if it has incurred expenses but has not yet paid them this would involve debiting the expenses account on the income statement and crediting the accounts payable account example of accrualslet s look at an example of a revenue accrual for a utility company an example of an accrued expense for accounts payable could be the cost of electricity that the utility company has used to power its operations but hasn t yet paid for the utility company would make a journal entry to record the cost of the electricity as an accrued expense in this case this would involve debiting the expense account and crediting the accounts payable account the effect of this journal entry would be to increase the utility company s expenses on the income statement and to increase its accounts payable on the balance sheet another example of an expense accrual involves employee bonuses that were earned in 2023 but won t be paid until 2024 the 2023 financial statements must reflect the bonus expenses earned by employees in 2023 as well as the bonus liability the company plans to pay out an adjusting journal entry therefore records this accrual with a debit to an expense account and a credit to a liability account before issuing the 2023 financial statements the liability account will be decreased through a debit and the cash account will be reduced through a credit when the payment is made in the new year the utility company generated electricity that customers received in december but it doesn t bill the electric customers until the following month when the meters have been read the company must complete an adjusting journal entry to report the revenue that was earned in december to have the proper revenue figure for the year on the utility s financial statements it will also be reflected in the receivables account as of december 31 because the utility company has fulfilled its obligations to its customers in earning the revenue at that point the adjusting journal entry for december would include a debit to accounts receivable and a credit to a revenue account the company would record a credit to decrease accounts receivable and a debit to increase cash the following month when the cash is received another expense accrual occurs for interest a company with a bond will accrue interest expense on its monthly financial statements even though interest on bonds is typically paid semi annually the interest expense recorded in an adjusting journal entry will be the amount that s accrued as of the financial statement date a corresponding interest liability will be recorded on the balance sheet | |
what is the purpose of accruals | the purpose of accruals is to ensure that a company s financial statements accurately reflect its true financial position this is important because financial statements are used by a wide range of stakeholders to evaluate the financial health and performance of a company including investors creditors and regulators a company s financial statements would only reflect the cash inflows and outflows without accruals rather than the true state of its revenues expenses assets and liabilities accruals provide a more accurate picture of a company s financial position by recognizing revenues and expenses when they re earned or incurred rather than only when payment is received or made | |
what are the types of accruals | some types of accruals include accrued revenues these refer to the recognition of revenues that have been earned but not yet recorded in the company s financial statements the revenue received for a service would be recorded as an accrual in december when it was earned if a company provides a service to a customer in december but doesn t receive payment until january of the following year accrued expenses refer to the recognition of expenses that have been incurred but not yet recorded in the company s financial statements the expenses would be recorded as an accrual in december when they were incurred if a company incurs expenses in december for a service that will be received in january 3accrued interest refers to interest that s been earned on an investment or a loan but hasn t yet been paid it would be recorded as an accrual on the company s financial statements if the firm has a savings account that earns interest and the interest has been earned but not yet paid | |
is an accrual a credit or a debit | it depends on the type of accrual and the effect it has on the company s financial statements the journal entry would involve a credit to the revenue account and a debit to the accounts receivable account for accrued revenues this has the effect of increasing the company s revenue and accounts receivable on its financial statements the journal entry would involve a debit to the expense account and a credit to the accounts payable account for accrued expenses this has the effect of increasing the company s expenses and accounts payable on its financial statements | |
what is the journal entry for accruals | the rules for recording accruals are generally the same as the rules for recording other transactions in double entry accounting the specific journal entries will depend on the individual circumstances of each transaction the bottom lineaccruals impact a company s bottom line even though cash has not yet changed hands the accrual method of accounting is the preferred method according to gaap and involves making adjustments for revenue that have been earned but are not yet recorded and expenses that have been incurred but are not yet recorded this is accomplished by adjusting journal entries at the end of the accounting period accruals are important because they help to ensure that a company s financial statements accurately reflect its actual financial condition | |
what is accrue | to accrue means to accumulate over time most commonly used when referring to the interest income or expenses of an individual or business interest in a savings account for example accrues over time such that the total amount in that account grows the term accrue is often related to accrual accounting which has become the standard accounting practice for most companies | |
when something financial accrues it essentially builds up to be paid or received in a future period both assets and liabilities can accrue over time the term accrue when related to finance is synonymous with an accrual under the accounting method outlined by generally accepted accounting principles gaap and international financial reporting standards ifrs | an accrual is an accounting adjustment used to track and record revenues that have been earned but not received or expenses that have been incurred but not paid think of accrued entries as the opposite of unearned entries with accrued entries the corresponding financial event has already taken place but payment has not been made or received accepted and mandatory accruals are decided by the financial accounting standards board fasb which controls interpretations of gaap 1 accruals can include accounts payable accounts receivable goodwill future tax liability and future interest expense special considerationsthe accrual accounting procedure measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur giving a better picture of the company s financial health and causing asset or liability adjustments to build up over time this is in contrast to the cash method of accounting where revenues and expenses are recorded when the funds are actually paid or received leaving out revenue based on credit and future liabilities cash based accounting does not require adjustments while some very small or new businesses use cash accounting companies normally prefer the accrual accounting method accrual accounting gives a far better picture of a company s financial situation than cost accounting because it records not only the company s current finances but also future transactions if a company sold 100 worth of product on credit in january for example it would want to record that 100 in january under the accrual accounting method rather than wait until the cash is actually received which may take months or may even become a bad debt types of accruesall accruals fall into one of two categories either revenue or expense accrual revenue accruals represent income or assets including non cash based ones yet to be received these accruals occur when a good or service has been sold by a company but the payment for it has not been made by the customer companies with large amounts of credit card transactions usually have high levels of accounts receivable and high levels of accrued revenue assume that company abc hires consulting firm xyz to help on a project that is estimated to take three months to complete the fee for this job is 150 000 to be paid upon completion while abc owes xyz 50 000 after each monthly milestone the total fee accrues over the duration of the project instead of being paid in installments whenever a business recognizes an expense before it is actually paid it can make an accrual entry in its general ledger the expense may also be listed as accrued in the balance sheet and charged against income in the income statement common types of accrued expense include interest taxes and other payments sometimes need to be put into accrued entries whenever unpaid obligations should be recognized in the financial statements otherwise the operating expenses for a certain period might be understated which would result in net income being overstated salaries are accrued whenever a workweek does not neatly correspond with monthly financial reports and payroll for example a payroll date may fall on jan 28 if employees have to work on january 29 30 or 31 those workdays still count toward the january operating expenses current payroll has not yet accounted for those salary expenses so an accrued salary account is used there are different rationales for accruing specific expenses the general purpose of an accrual account is to match expenses with the accounting period during which they were incurred accrued expenses are also effective in predicting the amount of expenses the company can expect to see in the future | |
what are accrued expenses | accrued expenses also known as accrued liabilities are those expenses recognized on the books before they have been paid the expenses are recorded in the accounting period in which they are incurred accrual accounting is the preferred accounting method of generally accepted accounting principles gaap understanding accrued expensessince accrued expenses represent a company s obligation to make future cash payments they are shown on a company s balance sheet as current liabilities an accrued expense can be an estimate and differ from the supplier s invoice which will arrive at a later date following the accrual method of accounting expenses are recognized when they are incurred not necessarily when they are paid an example of an accrued expense is when a company purchases supplies from a vendor but has not yet received an invoice for the purchase other forms of accrued expenses include interest payments on loans warranties on products or services received and taxes all of which have been incurred or obtained but for which no invoices have been received nor payments made employee commissions wages and bonuses are accrued in the period when they occur although the actual payment is made in the following period | |
when a company accrues accumulates expenses its portion of unpaid bills also accumulates this increases both its expenses and liabilities | accrual vs cash basis accountingaccrual accounting differs from cash basis accounting which records financial events and transactions only when cash is exchanged often resulting in the overstatement and understatement of income and account balances although the accrual method of accounting is labor intensive because it requires extensive journaling it is a more accurate measure of a company s transactions and events for each period this more complete picture helps users of financial statements to better understand a company s present financial health and predict its future financial position accrued expenses vs prepaid expensesaccrued expenses are the opposite of prepaid expenses prepaid expenses are payments made in advance for goods and services that are expected to be provided or used in the future while accrued expenses represent liabilities prepaid expenses are recognized as assets on the balance sheet this is because the company is expected to receive future economic benefit from the prepayment on the other hand an accrued expense is an event where a company has acquired an obligation to pay an amount to someone else but has not yet done so for example there is a lawsuit that the company is expected to lose so the company records the expense and a liability for the expected payment even though it has not been paid yet therefore it is literally the opposite of a prepayment an accrual is the recognition of something that has already happened in which cash is yet to be settled advantages and disadvantages of accrued expensesaccrued expenses theoretically make a company s financial statements more accurate while the cash method is more simple accrued expenses strive to include activities that may not have fully been incurred but will still happen consider an example where a company enters into a contract to incur consulting services if the company receives an invoice for 5 000 accounting theory states that the company should technically recognize this transaction because it is contractually obligated to pay for the service accrued expenses also may make it easier for companies to plan and strategize accrued expenses often yield more consistent financial results as companies can include recurring transactions in their financial reports that may not yet have been paid in addition accrued expenses may be a financial reporting requirement depending on the company and its u s securities and exchange commission sec filing requirements because of additional work of accruing expenses this method of accounting is more time consuming and demanding for staff to prepare there is a greater chance of misstatements especially if auto reversing journal entries are not used in addition a company runs the risk of accidentally accruing an expense that they may have already paid lastly the accrual method of accounting blurs cash flow and cash usage as it includes non cash transactions that have not yet impacted bank accounts for a large company the general ledger will be flooded with transactions that report items with no bearing on the company s bank statement nor impact to the current amount of cash on hand potentially makes financial statements more aligned to actual business operationsoften makes month over month financial statements more consistentmay yield more useful information for management to make decisions plansadheres to external financial reporting requirementsoften requires more time and resources to prepare compared to the cash method of accountingusually results in greater risk of misstatement accruals not reversing or accidental duplication may complicate some reporting by blurring cash usage and capital needsspecial considerationsa critical component to accrued expenses is reversing entries journal entries that back out a transaction in a subsequent period accrued expenses are not meant to be permanent they are meant to be temporary records that take the place of a true transaction in the short term every accrued expense must have a reversing entry without the reversing entry a company risks duplicating transactions by recording both the actual invoice when it gets paid as well as the accrued expense many accounting software systems can auto generate reversing entries when prompted accrued expenses are prevalent during the end of an accounting period a company often attempts to book as many actual invoices as it can during an accounting period before closing its accounts payable ap ledger then supporting accounting staff analyze what transactions invoices might not have been recorded by the ap team and book accrued expenses for companies that are responsible for external reporting accrued expenses play a big part in wrapping up month end quarter end or fiscal year end processes a company usually does not book accrued expenses during the month instead accrued expenses are booked during the close period example of accrued expensesa company pays its employees salaries on the first day of the following month for services received in the prior month so employees who worked all of november will be paid in december if on dec 31 the company s income statement recognizes only the salary payments that have been made the accrued expenses from the employees services for december will be omitted because the company actually incurred 12 months worth of salary expenses an adjusting journal entry is recorded at the end of the accounting period for the last month s expense the adjusting entry will be dated dec 31 and will have a debit to the salary expenses account on the income statement and a credit to the salaries payable account on the balance sheet | |
how are accrued expenses accounted for | an accrued expense also known as an accrued liability is an accounting term that refers to an expense that is recognized on the books before it is paid the expense is recorded in the accounting period in which it is incurred since accrued expenses represent a company s obligation to make future cash payments they are shown on a company s balance sheet as current liabilities | |
what are some examples of accrued expenses | an example of an accrued expense is when a company purchases supplies from a vendor but has not yet received an invoice for the purchase other forms of accrued expenses include interest payments on loans warranties on products or services received and taxes all of which have been incurred or obtained but for which no invoices have been received nor payments made employee commissions wages and bonuses are accrued in the period when they occur although the actual payment is made in the following period | |
how does accrual accounting differ from cash basis accounting | accrual accounting measures a company s performance and position by recognizing economic events regardless of when cash transactions occur whereas cash accounting only records transactions when payment occurs accrual accounting presents a more accurate measure of a company s transactions and events for each period cash basis accounting often results in the overstatement and understatement of income and account balances | |
what is a prepaid expense | a prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future prepaid expenses are initially recorded as assets but their value is expensed over time onto the income statement unlike conventional expenses the business will receive something of value from the prepaid expense over the course of several accounting periods | |
what is the journal entry for accrued expenses | accrued expenses are recognized by debiting the appropriate expense account and crediting an accrued liability account a second journal entry must then be prepared in the following period to reverse the entry for example a company wants to accrue a 10 000 utility invoice to have the expense hit in june the company s june journal entry will be a debit to utility expense and a credit to accrued payables then the company theoretically pays the invoice in july at which point they debit the accrued payables account to remove the liability now paid and credit cash to reflect the cash outflow the bottom linecompanies using the accrual method of accounting recognize accrued expenses costs that have not yet been paid for but have already been incurred accrued expenses make a set of financial statements more consistent by recording charges in specific periods though it takes more resources to perform this type of accounting while the cash method of accounting recognizes items when they are paid the accrual method recognizes accrued expenses based on when service is performed or received | |
what is accrued income | accrued income is the money a company has earned in the ordinary course of business but has yet to be received and for which the invoice is yet to be billed to the customer mutual funds or other pooled assets that accumulate income over a period of time but only pay shareholders once a year are by definition accruing their income individual companies can also generate income without actually receiving it which is the basis of the accrual accounting system understanding accrued incomemost companies use accrual accounting it is an alternative to the cash accounting method and is necessary for companies that sell products or provide services to customers on credit under the u s generally accepted accounting principles gaap accrual accounting is based on the revenue recognition principle this principle seeks to match revenues to the period in which they were earned rather than the period in which cash is received in other words just because money has not yet been received it does not mean that revenue has not been earned the matching principle also requires that revenue be recognized in the same period as the expenses that were incurred in earning that revenue also referred to as accrued revenue accrued income is often used in the service industry or in cases in which customers are charged an hourly rate for work that has been completed but will be billed in a future accounting period accrued income is listed in the asset section of the balance sheet because it represents a future benefit to the company in the form of a future cash payout revenue recognitionin 2014 the financial accounting standards board which establishes regulations for u s businesses and non profits introduced accounting standards code topic 606 revenue from contracts with customers to provide an industry neutral revenue recognition model to increase financial statement comparability across companies and industries 1the fasb also issued the following amendments to asu no 2014 09 to provide clarification on the guidance asu no 2015 14 revenue from contracts with customers topic 606 deferral of the effective date asu no 2016 08 revenue from contracts with customers topic 606 principal versus agent considerations reporting revenue gross versus net asu no 2016 10 revenue from contracts with customers topic 606 identifying performance obligations and licensing asu no 2016 12 revenue from contracts with customers topic 606 narrow scope improvements and practical expedients2examples of accrued incomeassume company a picks up trash for local communities and bills its customers 300 at the end of every six month cycle even though company a does not receive payment for six months the company still records a 50 debit to accrued income and a 50 credit to revenue each month the bill has not been sent out but the work has been performed and therefore expenses have already been incurred and revenue earned | |
when cash is received for the service at the end of six months a 300 credit in the amount of the full payment is made to accrued income and a 300 debit is made to cash the balance in accrued income returns to zero for that customer | accrued income also applies to individuals and their paychecks the income that a worker earns usually accrues over a period of time for example many salaried employees are paid by their company every two weeks they do not get paid at the end of each workday at the end of the pay cycle the employee is paid and the accrued amount returns to zero if they leave the company they still have pay that has been earned but has not yet been disbursed | |
is accrued income an expense or a liability | accrued income is recorded as an asset on a company s balance sheet while accrued expenses are recorded as liabilities | |
what is an example of accrued revenue | if a company performed a service in may and charged 1 000 for it but was not paid till august it would record that sale in may accrued and recognize it when it was received in august | |
is accrued income a debit or a credit | accrued income will be recorded as a credit to an income account and as a debit to accounts receivable on the balance sheet after the service has been provided but before payment has been received the bottom lineaccrued income is a method of recording income under the accrual method of accounting income is recorded as it is incurred rather than when it is received this stands in contrast to the cash accounting method which only records income and other figures such as sales when cash is in hand | |
what is accrued interest | in accounting accrued interest refers to the amount of interest that has been incurred as of a specific date on a loan or other financial obligation but has not yet been paid out accrued interest can either be in the form of accrued interest revenue for the lender or accrued interest expense for the borrower the term accrued interest also refers to the amount of bond interest that has accumulated since the last time a bond interest payment was made investopedia julie bangunderstanding accrued interestaccrued interest is calculated as of the last day of the accounting period for example assume interest is payable on the 20th of each month and the accounting period is the end of each calendar month the month of april will require an accrual of 10 days of interest from the 21st to the 30th it is posted as part of the adjusting journal entries at month end accrued interest is reported on the income statement as a revenue or expense depending on whether the company is lending or borrowing in addition the portion of revenue or expense yet to be paid or collected is reported on the balance sheet as an asset or liability because accrued interest is expected to be received or paid within one year it is often classified as a current asset or current liability accrued interest is a result of accrual accounting which requires that accounting transactions be recognized and recorded when they occur regardless of whether payment has been received or expended at that time the ultimate goal when accruing interest is to ensure that the transaction is accurately recorded in the right period accrual accounting differs from cash accounting which recognizes an event when cash or other forms of consideration trade hands the revenue recognition principle and matching principle are both important aspects of accrual accounting and both are relevant in the concept of accrued interest the revenue recognition principle states that revenue should be recognized in the period in which it was earned rather than when payment is received the matching principle states that expenses should be recorded in the same accounting period as the related revenues to illustrate how these principles impact accrued interest consider a business that takes out a loan to purchase a company vehicle the company owes the bank interest on the vehicle on the first day of the following month the company has use of the vehicle for the entire prior month and is therefore able to use the vehicle to conduct business and generate revenue at the end of each month the business will need to record interest that it expects to pay out on the following day in addition the bank will be recording accrued interest income for the same one month period because it anticipates the borrower will be paying it the following day accrued interest example accountingconsider the following example let us assume there is a 20 000 loan receivable with an interest rate of 7 5 on which payment has been received for the period through the 20th day of the month in this scenario to record the extra amount of interest revenue that was earned from the 21st to the 30th of the month the calculation would be as follows the amount of accrued interest for the party who is receiving payment is a credit to the interest revenue account and a debit to the interest receivable account the receivable is consequently rolled onto the balance sheet and classified as a short term asset the same amount is also classified as revenue on the income statement the accrued interest for the party who owes the payment is a credit to the accrued liabilities account and a debit to the interest expense account the liability is rolled onto the balance sheet as a short term liability while the interest expense is presented on the income statement both cases are posted as reversing entries meaning that they are subsequently reversed on the first day of the following month this ensures that when the cash transaction occurs in the following month the net effect is only the portion of the revenue or expense that was earned or incurred in the current period stays in the current period using the example above 123 29 7 5 x 30 365 x 20 000 is received by the lending company on the 20th day of the second month of that 41 10 related to the prior month and was booked as an adjusting journal entry at the prior month end to recognize the revenue in the month it was earned because the adjusting journal entry reverses in the second month the net effect is that 82 19 123 29 41 10 of the payment is recognized in the second month that is equivalent to the 20 days worth of interest in the second month accrued interest example bondsaccrued interest is an important consideration when purchasing or selling a bond bonds offer the owner compensation for the money they have lent in the form of regular interest payments these interest payments also referred to as coupons are generally paid semiannually when a bond is quoted without the addition of accrued interest it is known as a flat or clean bond quote if a bond is bought or sold at a time other than those two dates each year the purchaser will have to tack onto the sales amount any interest accrued since the previous interest payment the new owner will receive a full 1 2 year interest payment at the next payment date therefore the previous owner must be paid the interest that accrued prior to the sale let s assume you are interested in buying a bond with a face value of 1 000 and a 5 semiannual coupon the interest payment is made twice a year on june 1 and december 1 and you plan to buy the bond on september 30 how much accrued interest would you have to pay bond markets use a number of slightly differing day count conventions to calculate the exact amount of accrued interest since most u s corporate and municipal bonds use the 30 360 convention which assumes that each month has 30 days regardless of the actual number of days in a particular month we will use that day count convention in this example step 1 calculate the exact number of days between the date of the last coupon payment june 1 and your purchase date september 30 in this example the number of days based on the 30 360 convention is 120 days step 2 calculate accrued interest by multiplying the day count by the daily interest rate and face value of the bond thus accrued interest 120 x 5 360 1 000 16 67step 3 add the accrued interest to the face value of the bond to get your purchase price purchase price of bond 1 000 16 67 1 016 67on the next coupon payment date december 1 you will receive 25 in interest but since you paid 16 67 in accrued interest when you purchased the bond the net interest received by you is 8 33 25 16 67 which is precisely the amount of interest you should have received for the 60 days that you owned the bond until the next coupon payment september 30 to december 1 | |
what is accrued liability | the term accrued liability refers to an expense incurred but not yet paid for by a business these are costs for goods and services already delivered to a company for which it must pay in the future a company can accrue liabilities for any number of obligations which are recorded on the company s balance sheet they are normally listed on the balance sheet as current liabilities and are adjusted at the end of an accounting period crea taylor investopediaunderstanding accrued liabilitiesan accrued liability is a financial obligation that a company incurs during a given accounting period although the goods and services may already be delivered the company has not yet paid for them in that period they are also not recorded in the company s general ledger 1 although the cash flow has yet to occur the company must still pay for the benefit received accrued liabilities which are also called accrued expenses only exist when using an accrual method of accounting 2 the concept of an accrued liability relates to timing and the matching principle under accrual accounting all expenses are to be recorded in financial statements in the period in which they are incurred which may differ from the period in which they are paid the expenses are recorded in the same period when related revenues are reported to provide financial statement users with accurate information regarding the costs required to generate revenue the cash basis or cash method is an alternative way to record expenses but it doesn t accrue liabilities accrued liabilities are entered into the financial records during one period and are typically reversed in the next when paid this allows for the actual expense to be recorded at the accurate dollar amount when payment is made in full accrued liabilities only exist when using an accrual method of accounting types of accrued liabilitiesthere are two types of accrued liabilities that companies must account for we ve listed some of the most important details about each below 2this kind of accrued liability is also referred to as a recurring liability as such these expenses normally occur as part of a company s day to day operations for instance accrued interest payable to a creditor for a financial obligation such as a loan is considered a routine or recurring liability the company may be charged interest but won t pay for it until the next accounting period 2non routine accrued liabilities are expenses that don t occur regularly this is why they re also called infrequent accrued liabilities they aren t part of a company s normal operating activities a non routine liability may therefore be an unexpected expense that a company may be billed for but won t have to pay until the next accounting period 2journal entry for an accrued liabilityaccounting for an accrued liability requires a journal entry an accountant usually marks a debit and a credit to their expense accounts and accrued liability accounts respectively 3this is then reversed when the next accounting period begins and the payment is made the accounting department debits the accrued liability account and credits the expense account which reverses out the original transaction 2 | |
when do accrued liabilities occur | accrued liabilities arise for a number of reasons or when events occur during the normal course of business for instance at the end of a calendar year employee salaries and benefits must be recorded in the appropriate year regardless of when the pay period ends and when paychecks are distributed for example a two week pay period may extend from dec 25 to jan 7 although they aren t distributed until january there is still one full week of expenses for december the salaries benefits and taxes incurred from dec 25 to dec 31 are deemed accrued liabilities these expenses are debited to reflect an increase in the expenses meanwhile various liabilities will be credited to report the increase in obligations at the end of the year payroll taxes including social security medicare and federal unemployment taxes are liabilities that can be accrued periodically in preparation for payment before the taxes are due accrued liability vs accounts payable ap accrued liabilities and accounts payable ap are both types of liabilities that companies need to pay but there is a difference between the two accrued liabilities are for expenses that have not yet been billed either because they are a regular expense that doesn t require a bill e g payroll or because the company hasn t yet received a bill from the vendor e g a utility bill as such accounts payable or payables are generally short term obligations and must be paid within a certain amount of time creditors send invoices or bills which are documented by the receiving company s ap department the department then issues the payment for the total amount by the due date 4 paying off these expenses during the specified time helps companies avoid default examples of accrued liabilitiesas noted above companies can accrue liabilities for many different reasons as such there are many different kinds of expenses that fall under this category the following are some of the most common examples | |
why does a company accrue liabilities | a company can accrue liabilities for any number of obligations they are recorded on the company s balance sheet and are normally listed on the balance sheet as current liabilities and they re adjusted at the end of an accounting period | |
how do accrued liabilities work for a company | an accrued liability is a financial obligation that a company incurs during a given accounting period for goods and services already delivered the company has not yet paid for them in that period and they are not recorded in the company s general ledger the cash flow has yet to occur but the company must still pay for the benefit received | |
how many types of accrued liabilities are there | companies must account for two types of accrued liabilities the bottom lineaccrued liability is an expense that a business has incurred but not yet paid for these are goods and services already delivered to a company costs for which it must pay in the future | |
what is accrued revenue | accrued revenue is revenue that has been earned by providing a good or service but for which no cash has been received accrued revenues are recorded as receivables on the balance sheet to reflect the amount of money that customers owe the business for the goods or services they purchased accrued revenue may be contrasted with realized or recognized revenue and compared with accrued expenses investopedia zoe hansenunderstanding accrued revenueaccrued revenue is the product of accrual accounting and the revenue recognition and matching principles the revenue recognition principle requires that revenue transactions be recorded in the same accounting period in which they are earned rather than when the cash payment for the product or service is received the matching principle is an accounting concept that seeks to tie revenue generated in an accounting period to the expenses incurred to generate that revenue under generally accepted accounting principles gaap accrued revenue is recognized when the performing party satisfies a performance obligation for example revenue is recognized when a sales transaction is made and the customer takes possession of a good regardless of whether the customer paid cash or credit at that time accrued revenue often appears in the financial statements of businesses in the service industry because revenue recognition would otherwise be delayed until the work or service was finished which might last several months in contrast to manufacturing where invoices are issued as soon as products are shipped without using accrued revenue revenues and profit would be reported in a lumpy fashion giving a murky and not useful impression of the business s true value for example a construction company will work on one project for many months it needs to recognize a portion of the revenue for the contract in each month as services are rendered rather than waiting until the end of the contract to recognize the full revenue in 2014 the financial accounting standards board and the international accounting standards board introduced a joint accounting standards code topic 606 revenue from contracts with customers 1 this was to provide an industry neutral revenue recognition model to increase financial statement comparability across companies and industries public companies had to apply the new revenue recognition rules for annual reporting periods beginning after december 15 2017 2recording accrued revenueaccrued revenue is recorded in the financial statements by way of an adjusting journal entry the accountant debits an asset account for accrued revenue which is reversed with the amount of revenue collected crediting accrued revenue accrued revenue covers items that would not otherwise appear in the general ledger at the end of the period when one company records accrued revenues the other company will record the transaction as an accrued expense which is a liability on the balance sheet | |
when a customer makes a payment for the goods or services received the accountant makes a journal entry for the amount of cash received by debiting the cash account on the balance sheet and then crediting the same amount to the accrued revenue account or accounts receivable account | examples of accrued revenueaccrued revenue is often recorded by companies engaged in long term projects like construction or large engineering projects similar to the example of the construction company above companies in the aerospace and defense sectors might accrue revenue as each piece of military hardware is delivered even if they only bill the u s government once a year landlords may book accrued revenue if they record a tenant s rent payment at the first of the month but receive the rent at the end of the month | |
what is accumulated depreciation | accumulated depreciation is a method of accounting for the annual reduction of an asset s value up to a single point in its usable life this type of depreciation can be calculated using one of six methods the straight line declining balance double declining balance sum of the years digits units of production and half year recognition | |
when you purchase an asset for your business it has a market value as that asset ages or is used it loses some of that value this is called depreciation the opposite of appreciation which is an increase in value | businesses can expense this value reduction over the item s lifetime some assets which accumulate depreciation are the figure for accumulated depreciation can be located on a company s balance sheet below the line for related capitalized assets investopedia mira norianmethods to calculate accumulated depreciationthere are six accepted methods for calculating depreciation that are allowable under generally accepted accounting principles gaap a company may select from the following the most common method is the straight line method of accounting a company deducts the asset s salvage value from the purchase price to find a depreciable base then this base is accumulated evenly over the anticipated useful life of the asset the straight line method formula is imagine that company abc buys a building for 250 000 the building is expected to be useful for 20 years with a value of 10 000 at the end of the 20th year the depreciable base for the building is 250 000 10 000 240 000 divided over 20 years the company would recognize 12 000 in accumulated depreciation annually with the declining balance method depreciation is recorded as a percentage of the asset s current book value because the same percentage is used every year while the current book value decreases the amount of depreciation decreases each year even though the total accumulated depreciation will increase the amount of accumulated depreciation per year will decrease let s say that company abc buys a company vehicle for 10 000 with no salvage value at the end of its life the company decided it would depreciate 20 of the book value each year here s how that calculation would look | |
what is accumulated other comprehensive income | accumulated other comprehensive income oci includes all unrealized gains and losses reported in the equity section of the balance sheet that are netted below retained earnings other comprehensive income can consist of gains and losses on certain types of investments pension plans and hedging transactions it is excluded from net income because the gains and losses have not yet been realized investors reviewing a company s balance sheet can use the accumulated oci account as a barometer for upcoming threats or windfalls to net income other comprehensive income vs realized incomean investment must have a buy transaction and a sell transaction to realize a gain or loss if for example an investor buys ibm common stock at 20 per share and later sells the shares at 50 the owner has a realized gain per share of 30 realized gains and losses are reported on the income statement an unrealized gain or loss means that no sell transaction has occurred other comprehensive income reports unrealized gains and losses for certain investments based on the fair value of the security as of the balance sheet date if for example the stock was purchased at 20 per share and the fair market value is now 35 per share the unrealized gain is 15 per share companies can designate investments as available for sale held to maturity or trading securities unrealized gains and losses are reported in oci for some of these securities so the financial statement reader is aware of the potential for a realized gain or loss on the income statement down the road types of accumulated other comprehensive incomeunrealized gains and losses relating to a company s pension plan are commonly presented in accumulated other comprehensive income oci companies have several types of obligations for funding a pension plan a defined benefit plan for example requires the employer to plan for specific payments to retirees in future years if the assets invested in the plan are not sufficient the company s pension plan liability increases a firm s liability for pension plans increases when the investment portfolio recognizes losses retirement plan expenses and unrealized losses may be reported in oci once the gain or loss is realized the amount is reclassified from oci to net income oci also includes unrealized gains or losses related to investments for example a large unrealized loss from bond holdings today could spell trouble if the bonds are nearing maturity in addition to investment and pension plan gains and losses oci includes hedging transactions a company performs to limit losses this includes foreign currency exchange hedges that aim to reduce the risk of currency fluctuations a multinational company that must deal with different currencies may require a company to hedge against currency fluctuations and the unrealized gains and losses for those holdings are posted to oci | |
what is the accumulation phase | accumulation phase has two meanings for investors and those saving for retirement it refers to the period when an individual is working and planning and ultimately building up the value of their investment through savings the accumulation phase is then followed by the distribution phase in which retirees begin accessing and using their funds | |
how the accumulation phase works | the accumulation phase is also a specific period when an annuity investor is in the early stages of building up the cash value of the annuity this building phase is followed by the annuitization phase where payments are paid out to the annuitant the accumulation phase essentially begins when a person starts saving money for retirement and ends when they begin taking distributions for many people this starts when they begin their working life and ends when they retire from the work world it is possible to start saving for retirement even before beginning the work phase of one s life such as when someone is a student but it is not common typically joining the workforce coincides with the start of the accumulation phase importance of the accumulation phasethe sooner an individual begins the accumulation phase the better because the long term financial difference between beginning to save in one s 20s vs in their 30s is substantial postponing consumption by saving during an accumulation period will most often increase the amount of consumption one will be able to have later the earlier the accumulation period is in your life the more advantages you will have such as compounding interest and protection from business cycles in terms of annuities when a person invests money in an annuity to provide income for retirement they are at the accumulation period of the annuity s life span the more invested during the accumulation phase the more will be received during the annuitization phase real world examplesthere are many income streams that an individual can build up during the accumulation phase starting from when they first enter the workforce or in some cases sooner here are a few of the more popular options | |
what is the accumulation distribution indicator a d | the accumulation distribution indicator a d is a cumulative indicator that uses volume and price to assess whether a stock is being accumulated or distributed the a d measure seeks to identify divergences between the stock price and the volume flow this provides insight into how strong a trend is if the price is rising but the indicator is falling then it suggests that buying or accumulation volume may not be enough to support the price rise and a price decline could be forthcoming the accumulation distribution indicator a d formulamfm close low high close high low where mfm money flow multiplier close closing price low low price for the period high high price for the period begin aligned text mfm frac text close text low text high text close text high text low textbf where text mfm text money flow multiplier text close text closing price text low text low price for the period text high text high price for the period end aligned mfm high low close low high close where mfm money flow multiplierclose closing pricelow low price for the periodhigh high price for the period money flow volume mfm period volume begin aligned text money flow volume text mfm times text period volume end aligned money flow volume mfm period volume a d previous a d cmfv where cmfv current period money flow volume begin aligned text a d text previous a d text cmfv textbf where text cmfv text current period money flow volume end aligned a d previous a d cmfvwhere cmfv current period money flow volume | |
what does the accumulation distribution indicator a d tell you | the a d line helps to show how supply and demand factors are influencing price a d can move in the same direction as price changes or in the opposite direction the multiplier in the calculation provides a gauge for how strong the buying or selling was during a particular period it does this by determining whether the price closed in the upper or lower portion of its range this is then multiplied by the volume therefore when a stock closes near the high of the period s range and has high volume it will result in a large a d jump alternatively if the price finishes near the high of the range but volume is low or if the volume is high but the price finishes more toward the middle of the range then the a d will not move up as much the same concepts apply when the price closes in the lower portion of the period s price range both volume and where the price closes within the period s range determine how much the a d will decline image by sabrina jiang investopedia 2021the a d line can help assess price trends and potentially spot forthcoming reversals if a security s price is in a downtrend while the a d line is in an uptrend then the indicator shows there may be buying pressure and the security s price may reverse to the upside conversely if a security s price is in an uptrend while the a d line is in a downtrend then the indicator shows there may be selling pressure or higher distribution this warns that the price may be due for a decline in both cases the steepness of the a d line provides insight into the trend a strongly rising a d line confirms a strongly rising price similarly if the price is falling and the a d is also falling then there is still plenty of distribution and prices are likely to continue to decline 1the accumulation distribution indicator a d vs on balance volume obv both of these technical indicators use price and volume albeit somewhat differently on balance volume obv looks at whether the current closing price is higher or lower than the prior close if the close is higher then the period s volume is added if the close is lower then the period s volume is subtracted the a d indicator doesn t factor in the prior close and uses a multiplier based on where the price closed within the period s range therefore the indicators use different calculations and may provide different information limitations of using the accumulation distribution indicator a d the a d indicator does not factor in price changes from one period to the next and focuses only on where the price closes within the current period s range this creates some anomalies assume a stock gaps down 20 on huge volume the price oscillates throughout the day and finishes in the upper portion of its daily range but is still down 18 from the prior close such a move would actually cause the a d to rise even though the stock lost a significant amount of value it finished in the upper portion of its daily range therefore the indicator will increase likely dramatically due to the large volume traders need to monitor the price chart and mark any potential anomalies like these as they could affect how the indicator is interpreted also one of the main uses of the indicator is to monitor for divergences 1 divergences can last a long time and are poor timing signals when divergence appears between the indicator and price it doesn t mean a reversal is imminent it may take a long time for the price to reverse or it may not reverse at all the a d is just one tool that can be used to assess strength or weakness within a trend but it is not without its faults use the a d indicator in conjunction with other forms of analysis such as price action analysis chart patterns or fundamental analysis to get a more complete picture of what is moving the price of a stock | |
what is the acid test ratio | the acid test ratio commonly known as the quick ratio uses data from a firm s balance sheet to indicate whether it has the means to cover its short term liabilities generally a ratio of 1 0 or more indicates a company can pay its short term obligations while a ratio of less than 1 0 indicates it might struggle to pay them investopedia joules garciaunderstanding the acid test ratioin certain situations analysts prefer to use the acid test ratio rather than the current ratio also known as the working capital ratio because the acid test method ignores assets such as inventory which may be difficult to liquidate quickly the acid test ratio is thus a more conservative metric companies with an acid test ratio of less than 1 0 do not have enough liquid assets to pay their current liabilities and should be treated cautiously if the acid test ratio is much lower than the current ratio a company s current assets are highly dependent on inventory however this is not a bad sign in all cases as some business models are inherently dependent on inventory retail stores for example may have very low acid test ratios without necessarily being in danger the acceptable range for an acid test ratio will vary among different industries and you ll find that comparisons are most meaningful when analyzing peer companies in the same industry as each other for most industries the acid test ratio should exceed 1 0 on the other hand a high ratio is not always good it could indicate that cash has accumulated and is idle rather than being reinvested returned to shareholders or otherwise put to productive use some tech companies generate massive cash flows and accordingly have acid test ratios as high as 7 or 8 while this is certainly better than the alternative these companies have drawn criticism from activist investors who would prefer that shareholders receive a portion of the profits calculating the acid test ratiothe numerator of the acid test ratio can be defined in various ways but the primary consideration should be gaining a realistic view of the company s liquid assets cash and cash equivalents should definitely be included as should short term investments such as marketable securities accounts receivable are generally included but this is not appropriate for every industry in the construction industry for example accounts receivable may take much more time to recover than is standard practice in other industries so including it could make a firm s financial position seem much more secure than it is in reality the formula is acid test cash marketable securities a r current liabilities where a r accounts receivable begin aligned text acid test frac text cash text marketable securities text a r text current liabilities textbf where text a r text accounts receivable end aligned acid test current liabilitiescash marketable securities a r where a r accounts receivable another way to calculate the numerator is to take all current assets and subtract illiquid assets most importantly inventory should be subtracted keeping in mind that this will negatively skew the picture for retail businesses because of the amount of inventory they carry other elements that appear as assets on a balance sheet should be subtracted if they cannot be used to cover liabilities in the short term such as advances to suppliers prepayments and deferred tax assets the ratio s denominator should include all current liabilities debts and obligations due within one year it is important to note that time is not factored into the acid test ratio if a company s accounts payable are nearly due but its receivables won t come in for months it could be on much shakier ground than its ratio would indicate the opposite can also be true the term acid test is rumored to have originated from testing precious metals like gold with acid to make sure it was real acid test ratio examplea company s acid test ratio can be calculated using its balance sheet below is an abbreviated version of apple inc s aapl balance sheet as of jan 27 2022 showing the components of the company s current assets and current liabilities all figures in millions of dollars 1to obtain the company s liquid current assets add to get current liabilities add then divide current liquid assets by current liabilities to calculate the acid test ratio the calculation would look like this not everyone calculates this ratio the same there is no single hard and fast method for determining a company s acid test ratio some analysts might include other balance sheet line items not included in this example and others might remove the ones used here so it is important to understand how data providers arrive at their conclusions before using the metrics given to you | |
what s the difference between current and acid test ratios | both the current ratio also known as the working capital ratio and the acid test ratio measure a company s short term ability to generate enough cash to pay off all debts should they become due at once however the acid test ratio is considered more conservative than the current ratio because its calculation ignores items such as inventory which may be difficult to liquidate quickly another key difference is that the acid test ratio includes only assets that can be converted to cash within 90 days or less while the current ratio includes those that can be converted to cash within one year | |
what does the acid test ratio tell you | the acid test or quick ratio shows if a company has or can get enough cash to pay its immediate liabilities such as short term debt for most industries the acid test ratio should exceed 1 0 if it s less than 1 0 then companies do not have enough liquid assets to pay their current liabilities and should be treated with caution if the acid test ratio is much lower than the current ratio it means that a company s current assets are highly dependent on inventory on the other hand a very high ratio could indicate that accumulated cash is sitting idle rather than being reinvested returned to shareholders or otherwise put to productive use | |
how do you calculate the acid test ratio | to calculate the acid test ratio of a company divide a company s current cash marketable securities and total accounts receivable by its current liabilities this information can be found on the company s balance sheet | |
what is an acquisition | an acquisition is a transaction in which one company purchases most or all of another company s shares to gain control of that company acquisitions are common in business and may occur with or without the target company s approval there s often a no shop clause during the process of approval most people commonly hear about the acquisitions of large well known companies but mergers and acquisitions m a occur more regularly between small to medium sized firms than between large companies sydney saporito investopediaunderstanding acquisitionsan acquisition is a financial transaction that occurs when one business acquires the majority or all of its target s shares the goal of an acquisition is to gain control of the target s operations including its assets production facilities resources market share customer base and other elements companies acquire other businesses for various reasons they might seek economies of scale diversification greater market share increased synergy cost reductions or new niche offerings they might simply want to cut out the competition acquisitions are usually friendly endeavors they occur when the target firm agrees to be acquired its board of directors approves of the deal friendly acquisitions often work toward the mutual benefit of both the acquiring and target companies both companies develop strategies to ensure that the acquiring company purchases the appropriate assets and they review the financial statements and other valuations for any obligations that may come with the assets the purchase proceeds when both parties agree to the terms and meet any legal stipulations purchasing more than 50 of a target firm s stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company s other shareholders special considerationsa company must evaluate whether its target company is a good candidate acquirers may have to consider some key steps before pondering whether they should go through with a deal reasons for acquisitionsbuying an existing company in another country could be the easiest way to enter a foreign market if a company wants to expand its operations to that country or a totally new market the purchased business will already have its own personnel a brand name and other intangible assets this could help to ensure that the acquiring company will start off in a new market with a solid base perhaps a company met with physical or logistical constraints or depleted its resources it s often sounder to acquire another firm than to expand its own when a company is encumbered in this way such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit companies may start making acquisitions to reduce excess capacity eliminate the competition and focus on the most productive providers when there s too much competition or supply federal watchdogs often keep an eye on deals that may affect the market acquisitions between two similar companies may harm consumers including higher prices and lower quality goods and services 1sometimes it can be more cost efficient for a company to purchase another company that has already implemented a new technology successfully than to spend the time and money to develop the new technology itself officers of companies have a fiduciary duty to perform thorough due diligence of target companies before making any acquisition acquisition vs takeover vs mergeracquisition and takeover mean almost the same thing but they have different nuances on wall street an acquisition generally describes a primarily amicable transaction in which both firms cooperate a takeover suggests that the target company resists or strongly opposes the purchase the term merger is used when the purchasing and target companies mutually combine to form a completely new entity but the exact use of these terms tends to overlap in practice because each acquisition takeover and merger is a unique case with its own peculiarities and reasons for undertaking the transaction unfriendly acquisitions are commonly known as hostile takeovers they occur when the target company doesn t consent to the acquisition hostile acquisitions don t have the same agreement from the target firm so the acquiring firm must actively purchase large stakes of the target company to gain a controlling interest this forces the acquisition it implies that the firms aren t equal in one or more significant ways even if a takeover isn t exactly hostile a merger is the mutual fusion of two companies into one new legal entity so it s a more than friendly acquisition this deal generally occurs between roughly equal companies in terms of their basic characteristics including their size customer base and scale of operations the merging companies strongly believe that their combined entity would be more valuable to all parties especially shareholders than either one could be alone example of acquisitionsaol was the most publicized online service of its time extolled as the company that brought the internet to america founded in 1985 it grew to become the united states largest internet provider by 2000 2 meanwhile the legendary media conglomerate time warner was being labeled an old media company given its range of tangible businesses like publishing and television and an enviable income statement the young upstart aol purchased the venerable giant time warner for 165 billion in 2000 in a masterful display of overweening confidence the deal dwarfed all records and became the biggest merger in history 3the vision was that the new entity aol time warner would become a dominant force in the news publishing music entertainment cable and internet industries aol became the largest technology company in america after the merger but the joint phase lasted less than a decade the expected successes of the merger failed to materialize as aol lost value and the dotcom bubble burst aol and time warner dissolved their union at t and time warner announced that at t would buy time warner for 85 4 billion in october 2016 morphing at t into a media heavy hitter at t completed the acquisition in june 2018 after a protracted court battle 5the at t time warner acquisition deal of 2018 was as historically significant as the aol time warner deal of 2000 the u s department of justice sought to end the deal saying the acquisition would hurt competition leading consumers to face higher fees and bills 6the government lost its appeal in court and dropped the lawsuit at t decided to spin off its media assets including time warner despite this 7 | |
what are the types of acquisition | a business combination like an acquisition or merger can often be categorized in one of four ways | |
what is the purpose of an acquisition | acquiring other companies can serve many purposes for the parent company it can allow the company to expand its product lines or offerings and it can cut down on costs by acquiring businesses that feed into its supply chain it can also acquire competitors to maintain market share and reduce competition | |
what is the difference between a merger and an acquisition | the parent company fully takes over the target company and integrates it into the parent entity in an acquisition the two companies combine in a merger but create a brand new entity such as with a new company name and an identity that combines aspects of both | |
what was the 1990s acquisitions frenzy | the 1990s will be remembered in corporate america as the decade of the internet bubble and the megadeal the late 1990s in particular spawned a series of multibillion dollar acquisitions not seen on wall street since the junk bond fests of the roaring 1980s from yahoo s 1999 5 7 billion purchase of broadcast com to athome corp s 7 5 billion purchase of excite companies were lapping up the growth now profitability later phenomenon 89 such acquisitions reached their zenith in the first few weeks of 2000 the bottom linefinancial transactions can range from simple buy and sell deals to acquisitions that take place when one company acquires most or all of another entity s shares to take over the target s operations other reasons for acquisitions can include entering a new market gaining market share or even cutting out the competition large scale acquisitions make big news but these deals are fairly common in the small sized to midsized business market | |
what is acquisition accounting | acquisition accounting is a set of formal guidelines describing how assets liabilities non controlling interest nci and goodwill of a purchased company must be reported by the buyer on its consolidated statement of financial position the fair market value fmv of the acquired company is allocated between the net tangible and intangible assets portion of the balance sheet of the buyer any resulting difference is regarded as goodwill acquisition accounting is also referred to as business combination accounting | |
how acquisition accounting works | international financial reporting standards ifrs and international accounting standards ias require all business combinations to be treated as acquisitions for accounting purposes meaning that one company must be identified as an acquirer and one company must be identified as an acquiree even if the transaction creates a new company the acquisition accounting approach requires everything to be measured at fmv the amount a third party would pay on the open market at the time of acquisition the date that the acquirer took control of the target company that includes the following fair value analysis is often conducted by a third party valuation specialist history of acquisition accountingacquisition accounting was introduced in 2008 by the major accounting authorities the financial accounting standards board fasb and the international accounting standards board iasb to replace the previous method known as purchase accounting acquisition accounting was preferred because it strengthened the concept of fair value it focuses on prevailing market values in a transaction and includes contingencies and non controlling interests which were not accounted for under the purchase method another difference between the two techniques is how bargain acquisitions are treated under the purchase method the difference between the acquired company s fair value and its purchase price was recorded as negative goodwill ngw on the balance sheet that was to be amortized over time in contrast with acquisition accounting ngw is immediately treated as a gain on the income statement complexities of acquisition accountingacquisition accounting improved the transparency of mergers and acquisitions m a but did not make the process of combining financial records easier each component of assets and liabilities of the acquired entity has to be adjusted for fair value in items ranging from inventory and contracts to hedging instruments and contingencies to name just a few the amount of work needed to adjust and integrate the books of the two companies is one main reason for the long period between agreement on a deal by the respective boards of directors and the actual deal closing | |
what is an acquisition cost | an acquisition cost also referred to as the cost of acquisition is the total cost that a company recognizes on its books for property or equipment after adjusting for discounts incentives closing costs and other necessary expenditures but before sales taxes an acquisition cost may also entail the amount needed to take over another firm or purchase an existing business unit from another company additionally an acquisition cost can describe the costs incurred by a business in relation to the efforts involved in acquiring a new customer understanding acquisition costsacquisition costs are the expenses incurred in procuring assets goods or services they re the cost necessary for business operations but they may come up with an upfront cost the significance of acquisition costs transcends mere financial transactions they serve as vital metrics for evaluating the efficiency and efficacy of procurement processes it can also act as a barrier to entry for specific goods and industries acquisition costs can also have influence over pricing strategies profit margins and overall competitiveness within the marketplace businesses must strike a delicate balance between minimizing acquisition costs to enhance profitability and ensuring that quality and value remain uncompromised for example it may be cheaper to procure certain goods however these may be lower quality or less unique and do not satisfy customer needs types of acquisition coststhe list below is not meant to be exhaustive instead use this list as a reference to potential types of acquisition costs acquisition costs can include an acquisition cost can be paid for well after something has been acquired the timing of an expense can be misleading so be cautious when analyzing total acquisition costs importance of acquisition coststracking acquisition costs is important for a few reasons first it facilitates financial planning and budgeting by providing insights into future expenses associated with acquiring assets or goods this optimization can help a company with its profitability and operational efficiency as it knows what it will need to spend for future acquisition costs monitoring acquisition costs is also important for profitability analysis by understanding the impact of acquisition costs on overall profitability businesses can assess the financial viability of projects for example a product may have a profit margin of 60 however it may cost the company five times as much in acquisition costs as any other product the company should do a profit analysis and review its long term plans to make sure the plan fits its portfolio especially from a profit recovery standpoint tracking acquisition costs supports strategic decision making processes such as mergers acquisitions and investments in the example above a company may find itself in a similar situation but regarding the acquisition of a competing company by understanding how its financial picture will shape up after the acquisition the acquiring company can better understand whether the buy is a good decision investopedia julie bangacquisition costs and taxesacquisition costs and taxes are somewhat interconnected taxes may directly impact acquisition costs through various channels including import duties sales taxes and value added taxes vat similarly sales taxes or vat imposed on the sale of assets can significantly inflate acquisition costs affecting the affordability and financial feasibility of acquiring assets for businesses one thing to keep in mind is irs treatment for acquisition costs as well depending on what the cost is a company may have a specific tax treatment of the cost for example when starting a business many different types of expenses should be capitalized these costs include a survey of potential markets advertisements salaries or travel there are also specific rules around recoverable acquisition start up costs when buying an active business 1acquisition costs and goodwillacquisition costs and goodwill are closely related components of accounting for business when a company acquires another business goodwill arises when the purchase price of an acquired business exceeds the fair value of its identifiable net assets assets less liabilities at the acquisition date goodwill represents the premium paid for the business over and above the fair value of its tangible and identifiable intangible assets goodwill is considered an intangible asset on the acquirer s balance sheet it s reviewed from time to time and can be written up or down it s important to note that goodwill can be recorded at the time of an acquisition but it isn t technically an expense like other forms of costs there s no invoice related to goodwill however it is the value that the acquirer must pay for based on the inherent value of a company the presence of goodwill reflects the value attributed to intangible factors such as brand reputation customer relationships skilled workforce and strategic positioning these can not be separately identifiable and measurable from the acquired business s net assets however they may be directly correlated to why a company is acquiring another so goodwill and acquisitions are very closely related example of acquisition costhome depot s announcement to acquire srs distribution inc marks a strategic move aimed at expanding its offering and capabilities for professional customers this acquisition aligns with the home depot s objective to better serve complex project purchase occasions through this acquisition the home depot anticipates an expansion of its total addressable market by approximately 50 billion 2from a financial perspective home depot plans to fund the acquisition through a combination of cash on hand and debt this shows a bit of confidence in the move as the company is paying for the acquisition costs by incurring debt the total transaction value acquisition cost is 18 25 billion 3 | |
how are acquisition costs differentiated from other types of costs | acquisition costs are distinct from other types of costs such as operating expenses or production costs while operating expenses represent ongoing costs incurred to maintain day to day operations acquisition costs specifically pertain to the initial acquisition of assets or goods | |
what are the main components of acquisition costs | the main components of acquisition costs typically include the purchase price of the asset any transportation or shipping costs associated with acquiring the asset installation or setup fees legal and administrative expenses and any additional costs necessary to bring the asset into use | |
how do acquisition costs impact financial statements | acquisition costs have a direct impact on a company s financial statements particularly the balance sheet and income statement on the balance sheet acquisition costs may be capitalized as assets increasing the value of the company s asset base this also means the cost of these goods will hit the income statement as an expense over time through the amortization process | |
what role do acquisition costs play in pricing strategies | acquisition costs play an important role in pricing strategies as they directly impact the cost structure of products or services a company may wish to recoup these acquisition costs quickly therefore they may price their goods higher companies with more patience may try to recover these costs over a longer period of time but may face more risk in doing so the bottom lineunderstanding acquisition costs is an important part of business accounting acquisition costs influence pricing strategies profitability analysis and decision making processes like mergers and acquisitions businesses must efficiently track analyze and optimize acquisition costs to make the most of their long term plans | |
what is an acquisition premium | an acquisition premium is a figure that s the difference between the estimated real value of a company and the actual price paid to acquire it an acquisition premium represents the increased cost of buying a target company during a merger and acquisition m a transaction there is no requirement that a company pay a premium for acquiring another company in fact depending on the situation it may even get a discount understanding acquisition premiumsin an m a scenario the company that pays to acquire another company is known as the acquirer and the company to be purchased or acquired is referred to as the target firm typically an acquiring company will pay an acquisition premium to close a deal and ward off competition an acquisition premium might be paid too if the acquirer believes that the synergy created from the acquisition will be greater than the total cost of acquiring the target company the size of the premium often depends on various factors such as competition within the industry the presence of other bidders and the motivations of the buyer and seller in cases where the target company s stock price falls dramatically its product becomes obsolete or if there are concerns about the future of its industry the acquiring company may withdraw its offer | |
when a company decides that it wants to acquire another firm it will first attempt to estimate the real value of the target company for example the enterprise value of macy s using data from its 2017 10 k report is estimated at 11 81 billion after the acquiring company determines the real value of its target it decides how much it is willing to pay on top of the real value so as to present an attractive deal to the target firm especially if there are other firms that are considering an acquisition | in the example above an acquirer may decide to pay a 20 premium to buy macy s thus the total cost it will propose would be 11 81 billion x 1 2 14 17 billion if this premium offer is accepted then the acquisition premium value will be 14 17 billion 11 81 billion 2 36 billion or in percentage form 20 you also may use a target company s share price to arrive at the acquisition premium for instance if macy s is currently trading at 26 per share and an acquirer is willing to pay 33 per share for the target company s outstanding shares then you may calculate the acquisition premium as 33 26 26 27 however not every company pays a premium for an acquisition intentionally using our price per share example let s assume that there was no premium offer on the table and the agreed upon acquisition cost was 26 per share if the value of the company drops to 16 before the acquisition becomes final the acquirer will find itself paying a premium of 26 16 16 62 5 acquisition premiums in financial accountingin financial accounting the acquisition premium is known as goodwill the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process the acquiring company records goodwill as a separate account on its balance sheet goodwill factors in intangible assets like the value of a target company s brand solid customer base good customer relations healthy employee relations and any patents or proprietary technology acquired from the target company an adverse event such as declining cash flows economic depression increased competitive environment and the like can lead to an impairment of goodwill which occurs when the market value of the target company s intangible assets drops below its acquisition cost any impairment results in a decrease in goodwill on the balance sheet and shows as a loss on the income statement an acquirer can purchase a target company for a discount that is for less than its fair value when this occurs negative goodwill also known as badwill is recognized | |
what is active management | the term active management means that an investor a professional money manager or a team of professionals is tracking the performance of an investment portfolio and making buy hold and sell decisions about the assets in it the goal of any investment manager is to outperform a designated benchmark while simultaneously accomplishing one or more additional goals such as managing risk limiting tax consequences or adhering to environmental social and governance esg standards for investing active managers may differ from other is how they accomplish some of these goals for example active managers may rely on investment analysis research and forecasts which can include quantitative tools as well as their own judgment and experience in making decisions on which assets to buy and sell their approach may be strictly algorithmic entirely discretionary or somewhere in between by contrast passive management sometimes known as indexing follows simple rules that try to track an index or other benchmark by replicating it those who advocate for passive management maintain that the best results are achieved by buying assets that mirror a particular market index or indexes their contention is that passive management removes the shortfalls of human biases and that this leads to better performance however studies comparing active and passive management have only served to keep the debate alive about the respective merits of either approach understanding active managementinvestors who believe in active management do not support the stronger forms of the efficient market hypothesis emh which argues that it is impossible to beat the market over the long run because all public information has already been incorporated into stock prices those who support these forms of the emh insist that stock pickers who spend their days buying and selling stocks to exploit their frequent fluctuations will over time likely do worse than investors who buy the components of the major indexes that are used to track the performance of the wider markets over time but this point of view narrows investing goals into a single dimension active managers would contend that if an investor is concerned with more than merely tracking or slightly beating a market index an active management approach might be better suited for the task active managers measure their own success by measuring how much their portfolios exceed or fall short of the performance of a comparable unmanaged index industry or market sector for example the fidelity blue chip growth fund uses the russell 1000 growth index as its benchmark over the five years that ended june 30 2020 the fidelity fund returned 17 35 while the russell 1000 growth index rose 15 89 thus in terms of active share the fidelity fund outperformed its benchmark by 1 46 for that five year period 1 active managers will also assess portfolio risk along with their success in achieving other portfolio goals this is an important distinction for investors in retirement years many of whom may have to manage risk over shorter time horizons strategies for active managementactive managers believe it is possible to profit from the stock market through any of a number of strategies that aim to identify stocks that are trading at a lower price than their value merits their strategies may include researching a mix of fundamental quantitative and technical indications to identify stock selections they may also employ asset allocation strategies aligned with their fund s goals many investment companies and fund sponsors believe it s possible to outperform the market and employ professional investment managers to manage the company s mutual funds they may see this as a way to adjust to ever changing market conditions and unprecedented innovations in the markets disadvantages of active managementactively managed funds generally have higher fees and are less tax efficient than passively managed funds the investor is paying for the sustained efforts of investment advisers who specialize in active investment and for the potential for higher returns than the markets as a whole there is no consensus on which strategy yields better results active or passive management an investor considering active management should take a hard look at the actual returns after fees of the manager advantages of active managementa fund manager s expertise experience and judgment are employed by investors in an actively managed fund an active manager who runs an automotive industry fund might have extensive experience in the field and might invest in a select group of auto related stocks that the manager concludes are undervalued active fund managers have more flexibility there is more freedom in the selection process than in an index fund which must match as closely as possible the selection and weighting of the investments in the index actively managed funds allow for benefits in tax management the flexibility in buying and selling allows managers to offset losers with winners managing riskactive fund managers can manage risks more nimbly a global banking exchange traded fund etf may be required to hold a specific number of british banks that fund is likely to have dropped significantly following the shock brexit vote in 2016 an actively managed global banking fund meanwhile might have reduced its exposure to british banks due to heightened levels of risk active managers can also mitigate risk by using various hedging strategies such as short selling and using derivatives active management performancethere is plenty of controversy surrounding the performance of active managers their success or failure depends largely on which of the contradictory statistics is quoted over 10 years ending in 2021 active managers who invested in domestic small growth stocks were most likely to beat the index a study showed that 88 of active managers in this category outperformed their benchmark index before fees were deducted 2 | |
what is an activist investor | an activist investor typically a specialized hedge fund buys a significant minority stake in a publicly traded company in order to change how it is run the activist investor s goals may be as modest as advising company management or as ambitious as forcing the sale of the company divestitures or restructuring or replacing the board of directors unlike private equity firms that buy and restructure companies in order to profit when they are resold activist investors seldom acquire full or majority stakes 1 instead they use public communications and private discussions to win over other shareholders and company insiders when such efforts fail an activist investor may pursue a proxy contest to elect new directors in order to force the company to meet their demands understanding activist investorsactivist investors are sometimes called shareholder activists a term also used to describe those lobbying companies to improve working conditions for the overseas employees of their contractors or backers of a dissident board slate elected to fight climate change 23however many activist investor campaigns seek only to maximize shareholder value and most of those are the work of hedge funds specializing in the unique mix of public pressure behind the scenes lobbying and business expertise required unlike the public pension funds and mutual funds that also engage in activism at times activist hedge funds may hold highly concentrated stakes and supplement them with additional leverage from derivatives like stock options to offset the considerable cost of such campaigns in contrast with institutional investors that sometimes turn to activism after owning a disappointing investment for years activist hedge funds typically buy a stake in an underperforming company shortly before calling for change and hope to profit from the resulting turnaround and price appreciation 4in contrast to institutional investors activist hedge funds are also more willing to use confrontational tactics from poison pen letters to management and unflattering public reports to proxy fights seeking to oust incumbent directors the rise of activist investors has been described as an effective market response to the agency problem which arises when agents in this case company managements have the opportunity and the means to enrich themselves at the expense of clients in this case shareholders a diffuse group with limited powers to safeguard its ownership interests 5 | |
how activist investors make their case | investor activists often announce their campaigns by filing a schedule 13d form with the u s securities and exchange commission sec which must be filed within 10 calendar days of acquiring 5 or more of a company s voting class shares qualified institutional investors and passive investors meaning those not trying to acquire or influence control of the company may instead file a simplified schedule 13g with less stringent disclosure requirements and thresholds 6 schedule 13d filers must disclose among other facts their reasons for acquiring the stake and any plans they may have for the company in terms of mergers and acquisitions asset disposals capitalization or dividends or other policies the initial 13d filing gives the activist investor a golden opportunity to publicize their case for change at the targeted company at the same time the filing curtails the activist s ability to alter their stake in and plans for the company out of the public eye any changes to the facts disclosed on a schedule 13d must be reported in an amended filing promptly under current sec rules 7activist investors may use amended schedule 13d filings to comment on a company s response to their proposals for example when netflix inc nflx adopted a poison pill after funds affiliated with carl icahn reported a stake of nearly 10 in the video streaming company the funds filed an amended disclosure calling the poison pill an example of poor corporate governance 8 activist investors may also write sharply worded letters to incumbent managers issue press releases arguing their case to other shareholders or privately lobby institutional investors to side with them 91011whichever tactics activist investors use must be persuasive since the only way to overcome opposition from entrenched company management short of a hostile takeover is to persuade a sufficient number of other shareholders to replace the board in a proxy fight or at least to be able to credibly threaten to do so the future of shareholder activismthere has been a claim that activism is dying lamented carl icahn in may 2022 contrasting the legendary investor s few holds barred approach seen in the past 12 some have feared the changes proposed to the schedule 13d disclosure requirements in 2022 constitute a pressing threat with elliott investment management stating publicly that the proposed rules will virtually shut down activism 13in february 2022 the sec had proposed shortening the initial schedule 13 filing deadline from 10 calendar days to 5 with amendments due within a day of a material change rather than promptly as currently the proposal if passed would effectively force 13d filers to specify holdings of derivatives such as options that confer an economic interest in the company without the shareholder rights associated with an outright stock position perhaps more controversially the proposed rules would no longer require investors to agree to act in concert and be designated a single group by the sec for schedule 13d reporting purposes 1415 rules have also been proposed to make it harder for activist shareholders to squash a company s environmental or other pro esg initiatives 16sec chair gary gensler argued the stepped up requirements proposed would address an information asymmetry between activist investors and other shareholders 14 critics countered the proposed rules would make activism unprofitable by making it more difficult and costly for activist investors to accumulate significant stakes while inhibiting communication among shareholders 17despite these proposed rule changes shareholder activism does not seem to be slowing down at least not yet for example activist investor nelson peltz reportedly made a profit of more than 150 million by acquiring shares of disney dis in november 2022 in a move that prompted a proxy fight against the returning ceo bob iger however this brief fight was called off after iger announced a restructuring plan that is expected to save the media giant 5 5 billion in costs and cut 7 000 employees peltz has expressed satisfaction with the company s direction and decision to make changes praising iger and his management team 18 in early 2023 valueact capital management a san francisco based activist hedge fund took a stake in streaming media company spotify technology sa spot with the goal of cutting costs and streamlining management 19 valueact has also disclosed a major position and board seat in salesforce crm which now has no less than five large activist investor shareholders on board with long positions resulting in early 2023 cost cutting measures that include layoffs of 10 of the company s employees 20 in all three of the these examples markets have reacted positively to the inclusion of activist shareholders seeing their share prices afterwards outperform | |
do activist investors ever settle with companies | yes because activist investing is not a zero sum game since activist investors and incumbent managers share an interest in the company s success they may sometimes agree to a mutually acceptable compromise such agreements typically grant the activist investor representation on the company board in exchange for a pledge to support management and the company s director nominees for a specified time the agreements may also specify steps management will take at activist investors behest while including standstill provisions preventing the activist from increasing their stake in the company or requiring them to maintain a specified minimum stake 2122 | |
is shareholder activism dying | while some fear recently proposed sec rule changes may put a damper on activist investing it has not yet seemed to slow down after taking a dip in 2020 and 2021 due to covid19 restrictions activist investors were seen back above 2019 levels in fact shareholder activism activity hit a record high in 2022 16 some predict this upward trend will continue through 2023 and beyond despite regulatory roadblocks that may be put in the way although only time will tell | |
do activist investors create value | activist investors have been effective at times in addressing the agency problem faced by shareholders whose interests don t always coincide with those of entrenched management teams they ve certainly created value for themselves and other shareholders activist investing can t easily be pigeonholed as good or bad however activist investors look out for themselves and realize the lion s share of the value they unlock their relatively short term focus on strategies likely to lift the share price such as return of capital to shareholders in the form of dividends or share buybacks can prevent companies from making needed long term investments 23 | |
which activist investor generates the largest share price gains at the outset | it is difficult to know for sure which activist investors have been the more successful dollar for dollar and what other factors may cause particular stocks to rise in addition to an activist taking on a stake but we can look to sec disclosures and public statements made by these investors elliott investment management for one claims that its investments receive an average rise of 8 in the shares of the target company on the day the firm made its stake public according to elliot its activist engagements have increased the market values of the targeted companies by an aggregate of more 30 billion 24who are the biggest activist investors the largest activist shareholders by assets under management aum as of q1 2023 are listed in the table below led by new york city based third point partners 25the bottom line | |
what is activity based budgeting abb | activity based budgeting abb is a system that records researches and analyzes activities that lead to costs for a company every activity in an organization that incurs a cost is scrutinized for potential ways to create efficiencies budgets are then developed based on these results activity based budgeting abb is more rigorous than traditional budgeting processes which tend to merely adjust previous budgets to account for inflation or business development | |
how activity based budgeting abb works | keeping costs to a minimum is a crucial part of business management when done effectively and not too excessively companies should be able to maintain and keep growing their revenues while squeezing out higher profits from them using activity based budgeting abb can help companies to reduce the activity levels required to generate sales eliminating unnecessary costs should boost profitability the activity based budgeting abb process is broken down into three steps activity based budgeting abb vs traditional budgeting processesactivity based budgeting abb is an alternative budgeting practice traditional methods are more simplistic adjusting prior period budgets to account for inflation or revenue growth rather than using past budgets to calculate how much a firm will spend in the current year activity based budgeting abb digs deeper activity based budgeting abb is not necessary for all companies for example established firms that experience minimal change typically find that applying a flat rate to data from the previous year to reflect business growth and inflation is sufficient in contrast newer companies without access to historical budgeting information cannot consider this an option activity based budgeting abb is also likely to be implemented by firms undergoing material changes such as those with new subsidiaries significant customers business locations or products in these types of cases historical information may no longer be a useful basis for future budgeting example of activity based budgetingcompany a anticipates receiving 50 000 sales orders in the upcoming year with each single order costing 2 to process therefore the activity based budget abb for the expenses relating to processing sales orders for the upcoming year is 100 000 50 000 2 this figure may be compared to a traditional approach to budgeting if last year s budget called for 80 000 of sales order processing expenses and sales were expected to grow 10 only 88 000 80 000 80 000 10 is budgeted advantages and disadvantages of activity based budgetingactivity based budgeting abb systems allow for more control over the budgeting process revenue and expense planning occurs at a precise level that provides useful details regarding projections abb allows for management to have increased control over the budgeting process and to align the budget with overall company goals unfortunately these benefits come at a cost activity based budgeting abb is more expensive to implement and maintain than traditional budgeting techniques and more time consuming as well moreover abb systems need additional assumptions and insight from management which can on occasion result in potential budgeting inaccuracies | |
what is activity based costing abc | activity based costing abc is a costing method that assigns overhead and indirect costs to related products and services this accounting method of costing recognizes the relationship between costs overhead activities and manufactured products assigning indirect costs to products less arbitrarily than traditional costing methods however some indirect costs such as management and office staff salaries are difficult to assign to a product abc is used to get a better grasp on costs allowing companies to form a more appropriate pricing strategy investopedia theresa chiechi | |
how activity based costing abc works | activity based costing abc is mostly used in the manufacturing industry since it enhances the reliability of cost data hence producing nearly true costs and better classifying the costs incurred by the company during its production process this costing system is used in target costing product costing product line profitability analysis customer profitability analysis and service pricing activity based costing is used to get a better grasp on costs allowing companies to form a more appropriate pricing strategy the formula for activity based costing is the cost pool total divided by cost driver which yields the cost driver rate the cost driver rate is used in activity based costing to calculate the amount of overhead and indirect costs related to a particular activity the abc calculation is as follows as an activity based costing example consider company abc that has a 50 000 per year electricity bill the number of labor hours has a direct impact on the electric bill for the year there were 2 500 labor hours worked which in this example is the cost driver calculating the cost driver rate is done by dividing the 50 000 a year electric bill by the 2 500 hours yielding a cost driver rate of 20 for product xyz the company uses electricity for 10 hours the overhead costs for the product are 200 or 20 times 10 activity based costing benefits the costing process by expanding the number of cost pools that can be used to analyze overhead costs and by making indirect costs traceable to certain activities requirements for activity based costing abc the abc system of cost accounting is based on activities which are any events units of work or tasks with a specific goal such as setting up machines for production designing products distributing finished goods or operating machines activities consume overhead resources and are considered cost objects under the abc system an activity can also be considered as any transaction or event that is a cost driver a cost driver also known as an activity driver is used to refer to an allocation base examples of cost drivers include machine setups maintenance requests consumed power purchase orders quality inspections or production orders there are two categories of activity measures transaction drivers which involve counting how many times an activity occurs and duration drivers which measure how long an activity takes to complete unlike traditional cost measurement systems that depend on volume count such as machine hours and or direct labor hours to allocate indirect or overhead costs to products the abc system classifies five broad levels of activity that are to a certain extent unrelated to how many units are produced these levels include batch level activity unit level activity customer level activity organization sustaining activity and product level activity benefits of activity based costing abc activity based costing abc enhances the costing process in three ways first it expands the number of cost pools that can be used to assemble overhead costs instead of accumulating all costs in one company wide pool it pools costs by activity second it creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures such as machine hours or direct labor costs finally abc alters the nature of several indirect costs making costs previously considered indirect such as depreciation utilities or salaries traceable to certain activities alternatively abc transfers overhead costs from high volume products to low volume products raising the unit cost of low volume products 1 | |
what is activity based management | activity based management abm is a system for determining the profitability of every aspect of a business so that its strengths can be enhanced and its weaknesses can either be improved or eliminated altogether activity based management abm which was first developed in the 1980s seeks to highlight the areas where a business is losing money so that those activities can be eliminated or improved to increase profitability abm analyzes the costs of employees equipment facilities distribution overhead and other factors in business to determine and allocate activity costs activity based management abm is a procedure used by businesses to analyze the profitability of every segment of their company enabling them to identify problem areas and areas of particular strength understanding activity based management abm activity based management can be applied to different types of companies including manufacturers service providers non profits schools and government agencies abm can provide cost information about any area of operations in a business in addition to improving profitability and the overall financial strength of a company the results of an abm analysis can help that company produce more accurate budgets and long term financial forecasts examples of activity based management abm abm can be used for example to analyze the profitability of a new product a company is offering by looking at marketing and production costs sales warranty claims and any costs or repair time needed for returned or exchanged products if a company is reliant on a research and development department abm can be used to look at the costs of operating the department the costs of testing out new products and whether the products developed there turned out to be profitable another example might be a company that has opened an office in a second location abm can help management assess the costs of the running that location including the staff facilities and overhead and then determine whether any subsequent profits are enough to make up for or justify those costs special considerationsa lot of the information gathered in activity based management is derived from information gathered from another management tool activity based costing abc whereas activity based management focuses on business processes and managerial activities driving organizational business goals activity based costing seeks to identify and reduce cost drivers by optimizing resources both abc and abm are management tools that help in managing operational activities to improve the performance of a business entity or an entire organization activity based costing can be considered an offshoot of activity based management by mapping business costs like supplies salaries and leasing activity to business processes products customers and distribution activity activity based costing helps improve overall managerial effectiveness and transparency | |
what is an activity cost driver | an activity cost driver is an action that triggers higher or lower variable costs for a business sometimes referred to as a causal factor it is associated with the managerial accounting concept of activity based costing abc keeping tabs on activity cost drivers is important as doing so can help boost efficiency and company profits | |
how activity cost drivers work | a cost driver affects the cost of specific business activities in abc an activity cost driver influences the costs of labor maintenance or other variable costs cost drivers are essential in abc a branch of managerial accounting that allocates the indirect costs or overheads of an activity multiple cost drivers may be associated with an activity for example direct labor hours are a driver of most activities in product manufacturing if the expenditure for labor is high this will increase the cost of producing all company products or services if the cost of warehousing is high this will also increase the expenses incurred for product manufacturing or providing services keeping tabs on cost drivers makes it easier to determine the actual cost of production and make more accurate financial projections more technical cost drivers are machine hours the number of engineering change orders the number of customer contacts the number of product returns the machine setups required for production or the number of inspections if a business owner can identify the cost drivers then the business owner can more accurately estimate the true cost of production for the business and then determine the per item and batch level costs | |
when a factory machine requires periodic maintenance the maintenance cost is allocated to the products produced by the machine for example the cost driver selected is machinery hours after every 1 000 machine hours there is a maintenance expense of 500 therefore every machine hour results in a 50 cent 500 1 000 maintenance cost allocated to the product being manufactured based on the cost driver of machine hours | using cost drivers simplifies the allocation of manufacturing overhead the correct allocation of manufacturing overhead is important to determine the true cost of a product internal management uses the cost of a product to determine the prices of the products they produce for this reason the selection of accurate cost drivers directly affects an entity s profitability and operations activity based costing abc is a more accurate way of allocating direct and indirect costs abc calculates the true cost of each product by identifying the amount of resources consumed by a business activity such as electricity or man hours special considerations subjectivity of cost driversmanagement selects cost drivers as the basis for manufacturing overhead allocation there are no industry standards stipulating or mandating cost driver selection company management selects cost drivers based on the variables of the expenses incurred during production | |
what are some examples of activity cost drivers | activity cost drivers include direct labor hours the cost of warehousing order frequency and product returns | |
what do you mean by cost driver | cost drivers are the activities that trigger business expenses | |
what is the activity based costing method | activity based costing abc is a method of assigning overhead and indirect costs such as salaries and utilities to products and services doing this helps to get a better grasp on costs allowing companies to form a more appropriate pricing strategy and churn out higher profits the bottom lineexamining activity cost drivers helps companies to reduce unnecessary expenses and get to grips with how much an order really costs the importance of accessing this knowledge shouldn t be understated the ultimate goal is to maximize profits and a key way to accomplish this is by being aware of all expenses and keeping them in check | |
what is an activity ratio | an activity ratio is a type of financial metric that indicates how efficiently a company is leveraging the assets on its balance sheet to generate revenues and cash commonly referred to as efficiency ratios activity ratios help analysts gauge how a company handles inventory management which is key to its operational fluidity and overall fiscal health xiaojie liu investopediaunderstanding activity ratiosactivity ratios are most useful when employed to compare two competing businesses within the same industry to determine how a particular company stacks up among its peers but activity ratios may also be used to track a company s fiscal progress over multiple recording periods to detect changes over time these numbers can be mapped to present a forward looking picture of a company s prospective performance activity ratios can be broken down into the following subcategories the accounts receivable turnover ratio determines an entity s ability to collect money from its customers total credit sales are divided by the average accounts receivable balance for a specific period a low ratio suggests a deficiency in the collection process the merchandise inventory turnover ratio measures how often the inventory balance is sold during an accounting period the cost of goods sold cogs is divided by the average inventory for a specific period higher calculations suggest that a company can move its inventory with relative ease the total assets turnover ratio measures how efficiently an entity uses its assets to tender a sale total sales are divided by total assets to decipher how proficiently a business uses its assets smaller ratios may indicate that a company is struggling to move its products a performance metric known as return on equity roe measures the revenues raised from shareholder equity roe is calculated by dividing net income by all outstanding stock shares in the market a metric called the asset turnover ratio measures the amount of revenue that a company generates per dollar of assets this figure which is simply calculated by dividing a company s sales by its total assets reveals how efficiently a company is using its assets to generate sales activity ratios vs profitability ratiosactivity ratios and profitability ratios are both fundamental analytical tools that help investors evaluate different facets of a company s fiscal strength profitability ratios depict a company s profit generation while activity ratios measure how well a company utilizes its resources to generate those profits profitability ratios may help analysts compare a company s profits with those of its industry competitors while also tracking the same company s progress across several different reporting periods | |
when are activity ratios most useful | activity ratios are most useful when they compare two competing businesses within the same industry to determine how a particular company stacks up among its peers | |
what are activity ratio subcategories | activity ratio subcategories described earlier in this article are | |
how does an activity ratio differ from a profitability ratio | an activity ratio measures how well a company utilizes its resources to generate those profits while a profitability ratio depicts a company s profit generation the bottom linean activity ratio commonly called an efficiency ratio indicates how efficiently a company is leveraging the assets on its balance sheet to generate revenues and cash it is a type of financial metric and it helps analysts gauge how a company handles inventory management | |
what are the actual deferral percentage adp actual contribution percentage acp tests | the actual deferral percentage adp and actual contribution percentage acp tests are two tests that companies must conduct to ensure that their 401 k plans don t unfairly benefit highly paid employees at the expense of others companies that offer 401 k plans must conduct the tests in order to retain the qualified status of their plans under irs rules and the employee retirement income security act erisa if the plan fails either test the employer must take corrective action in the 12 month period following the close of the plan year in which the oversight occurred failure to do so can result in the irs imposing pecuniary penalty fees plan disqualification and fiduciary liability on the part of the employer | |
how adp and acp tests work | the adp test compares the average salary deferral percentages of highly compensated employees hce to that of non highly compensated employees nhce an hce is any employee who owns more than 5 interest in the company at any time during the current or previous plan year or earned more than 130 000 during the 2020 tax year the adp test takes into account both pre tax deferrals and after tax roth deferrals but no catch up contributions which may be made only by employees age 50 and over to pass the test the adp of the hce may not exceed the adp of the nhce by more than two percentage points in addition the combined contributions of all hces may not be more than two times the percentage of nhce contributions the acp test uses a similar method as the adp test except that it uses matching contributions or employee after tax contributions correcting an adp acp test failure | |
when employers fail the adp acp tests they can remedy the failure by refunding excess contributions back to hces in the amount necessary to pass the test however these refunds will be liable for income tax for the hce individuals | some companies set buffer zones within their plan documents to steer plans away from potentially failing the adp acp test in the first place one option is setting a cap on contributions by hces another option is to place a contribution limit on hces at the point where the plan would fail an adp acp test setting plan buffer zones may require employers to conduct adp acp test projections typically in the middle of the plan year to determine if any restrictions need to be applied still some companies use a safe harbor 401 k plan to avoid the adp acp test entirely | |
what is a safe harbor plan | safe harbor 401 k plans allow sponsors to bypass adp acp and other non discrimination testing in exchange for providing eligible matching or nonelective contributions on behalf of their employees to qualify for safe harbor a company must provide a basic match such as a 100 match on the first 3 of deferred compensation and a 50 match on deferrals of 3 to 5 they may also provide each employee with a nonelective contribution of at least 3 of compensation regardless of how much the employee contributes or if they contribute at all | |
what is an actuarial gain or loss | actuarial gain or loss refers to an increase or a decrease in the projections used to value a corporation s defined benefit pension plan obligations the actuarial assumptions of a pension plan are directly affected by the discount rate used to calculate the present value of benefit payments and the expected rate of return on plan assets the financial accounting standards board fasb sfas no 158 requires the funding status of pension funds to be reported on the plan sponsor s balance sheet this means there are periodic updates to the pension obligations the fund performance and the financial health of the plan 1 depending on plan participation rates market performance and other factors the pension plan may experience an actuarial gain or loss in their projected benefit obligation while those accounting rules require pension assets and liabilities to be marked to market on an entity s balance sheet they allow actuarial gains and losses or changes to actuarial assumptions to be amortized through comprehensive income in shareholders equity rather than flowing directly through the income statement understanding actuarial gain or lossactuarial gains and losses are best understood in the context of overall pension accounting except where specifically noted this definition addresses pension accounting under u s generally accepted accounting principles gaap while u s gaap and international financial reporting standards ifrs prescribe similar principles measuring pension benefit obligations there are key differences in how the two standards report pension cost in the income statement particularly the treatment of actuarial gains and losses funded status represents the net asset or liability related to a company s defined benefit plans and equals the difference between the value of plan assets and the projected benefit obligation pbo for the plan valuing plan assets which are the investments set aside for funding the plan benefits requires judgment but does not involve the use of actuarial estimates however measuring the pbo requires the use of actuarial estimates and it is these actuarial estimates that give rise to actuarial gains and losses there are two primary types of assumptions economic assumptions that model how market forces affect the plan and demographic assumptions that model how participant behavior is expected to affect the benefits paid key economic assumptions include the interest rate used to discount future cash outflows expected rate of return on plan assets and expected salary increases key demographic assumptions include life expectancy anticipated service periods and expected retirement ages actuarial gains and losses create volatility in resultsfrom period to period a change in an actuarial assumption particularly the discount rate can cause a significant increase or decrease in the pbo if recorded through the income statement these adjustments potentially distort the comparability of financial results therefore under u s gaap these adjustments are recorded through other comprehensive income in shareholders equity and are amortized into the income statement over time under ifrs these adjustments are recorded through other comprehensive income but are not amortized into the income statement footnote disclosures contain useful information about actuarial assumptionsaccounting rules require detailed disclosures related to pension assets and liabilities including period to period activity in the accounts and the key assumptions used to measure funded status these disclosures allow financial statement users to understand how a company s pension plans affect financial position and results of operations relative to prior periods and other companies | |
what s an actuarial life table | an actuarial life table is a table or spreadsheet that shows the probability of a person at a certain age dying before their next birthday it s often used by life insurance companies to calculate the remaining life expectancy for people at different ages and stages and the probability of surviving a particular year of age because men and women have different mortality rates an actuarial life table is computed separately for men and women an actuarial life table is also called a mortality table life table or actuarial table | |
how an actuarial life table works | insurance companies utilize actuarial life tables to help price products and project future insured events mathematically and statistically based actuarial life tables assist life insurance companies by showing event probabilities such as death sickness and disability an actuarial life table can also include factors to differentiate variable risks such as smoking occupation socio economic status and even gambling and debt load computerized predictive modeling allows actuaries the ability to calculate for a wide variety of circumstances and probable outcomes actuarial scienceactuarial science uses primarily two types of life tables first the period life table is used to determine mortality rates for a specific time period of a certain population the other type of actuarial life table is called the cohort life table also referred to as a generation life table it is used to represent the overall mortality rates of a certain population s entire lifetime actuarial life tables for men and women are computed differently due to the discrepancy of life expectancies for each gender the population selection must be born during the same specific time interval a cohort life table is more commonly used because it attempts to predict any expected change in mortality rates of a population in the future a cohort table also analyzes observable mortality patterns over time both types of actuarial life tables are based on actual populations of the present and educated predictions of a population s near future other types of life tables may be based on historical records these types of life tables often undercount infants and understate infant mortality insurance companies use actuarial life tables to primarily make two types of predictions the probability of surviving any particular year of age and the remaining life expectancy for people of different ages other uses of actuarial life tablesactuarial life tables also play an important role in the sciences of biology and epidemiology in addition the social security administration in the united states uses actuarial life tables to examine the mortality rates of people who have social security in order to inform certain policy decisions or actions 1actuarial life tables are also important in product life cycle management and for pension calculations | |
how are actuarial tables used | typically they re used by life insurance companies to calculate the remaining life expectancy for people at different ages and stages and the probability of surviving a particular year of age |
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