What Is Aggregation?

Aggregation in the futures markets is a process that combines of all futures positions owned or controlled by a single trader or group of traders into one aggregate position. Aggregation in a financial planning sense, however, is a time-saving accounting method that consolidates an individual’s financial data from various institutions.

Aggregation is increasingly popular with advisors when servicing clients’ accounts, as they are able to discuss the accounts with the client in a cleaner, more easily understood way before they break down the account into its respective categories.

How Aggregation Works

Financial advisors use account-aggregation technology to gather position and transaction information from investors’ retail accounts held at other financial institutions. Aggregators provide investors and their advisors with a centralized view of the investor’s complete financial situation, including daily updates.

Financial planners handle both managed and non-managed accounts. Managed accounts contain assets under the advisor’s control that are held by the advisor’s custodian. The planners utilize portfolio management and reporting software to capture a client’s data through a direct link from the custodian. It is important for the planner to have all the accounts because aggregating them without the complete collection would paint an inaccurate picture of that client’s finances.

Additionally, non-managed accounts contain assets that are not under the advisor’s management but are nevertheless important to the client’s financial plan. Examples include 401(k) accounts, personal checking or savings accounts, pensions, and credit card accounts.

The advisor’s concern with managed accounts is lack of accessibility when the client does not provide log-in information. Advisors cannot offer an all-encompassing approach to financial planning and asset management without daily updates on non-managed accounts.

Importance of Account Aggregation

Account aggregation services solve the issue by providing a convenient method for obtaining current position and transaction information about accounts held at most retail banks or brokerages. Because investors’ privacy is protected, disclosing their personal-access information for each non-managed account is unnecessary.

Financial planners use aggregate account software for analyzing a client’s total assets, liabilities, and net worth; income and expenses; and trends in assets, liability, net worth, and transaction values. The advisor also assesses various risks in a client’s portfolio before making investment decisions.

Effects of Account Aggregation

Many aggregation services offer direct data connections between brokerage firms and financial institutions, rather than using banks’ consumer-facing websites. Clients give financial institutions their consent by providing personal information for the aggregate services.

What Is an Allowance for Doubtful Accounts?

An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate.

Understanding the Allowance for Doubtful Accounts

Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables.

Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.

How to Estimate the Allowance for Doubtful Accounts

Two primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected.

Percentage of Sales Method

The sales method applies a flat percentage to the total dollar amount of sales for the period. For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense.

If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400.

Accounts Receivable Aging Method

The second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount.

For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding. Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible.

Therefore, the company will report an allowance of $1,900 (($70,000 * 1%) + ($30,000 * 4%)). If the next accounting period results in an estimated allowance of $2,500 based on outstanding accounts receivable, only $600 ($2,500 – $1,900) will be the adjusting entry amount.

Risk Classification Method

Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt. Then, it aggregates all receivables in each grouping, calculates each group by the percentage, and records an allowance equal to the aggregate of all products.

Historical Percentage Method

If a company has a history of recording or tracking bad debt, it can use the historical percentage of bad debt if it feels that historical measurement relates to its current debt. For example, a company may know that its 10-year average of bad debt is 2.4%. Therefore, it can assign this fixed percentage to its total accounts receivable balance since more often than not, it will approximately be close to this amount. The company must be aware of outliers or special circumstances that may have unfairly impacted that 2.4% calculation.

Pareto Analysis Method

A Pareto analysis is a risk measurement approach that states that a majority of activity is often concentrated among a small amount of accounts. In many different aspects of business, a rough estimation is that 80% of account receivable balances are made up of a small concentration (i.e. 20%) of vendors. This 80%/20% ratio is used throughout business.

Though the Pareto Analysis can not be used on its own, it can be used to weigh accounts receivable estimates differently. For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism.

Specific Identification Method

Assume a company has 100 clients and believes there are 11 accounts that may go uncollected. Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount. Companies often have a specific method of identifying the companies that it wants to include and the companies it wants to exclude.

How to Account for the Allowance for Doubtful Accounts

Establishing the Allowance

The first step in accounting for the allowance for doubtful accounts is to establish the allowance. This is done by using one of the estimation methods above to predict what proportion of accounts receivable will go uncollected. For this example, let’s say a company predicts it will incur $500,000 of uncollected accounts receivable.

To create the allowance, the company must debit a loss. Most often, companies use an account called ‘Bad Debt Expense’. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’. Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.

• DR Bad Debt Expense $500,000
• CR Allowance for Doubtful Accounts $500,000

Adjusting the Allowance

Let’s say six months passes. The company now has a better idea of which account receivables will be collected and which will be lost. For example, say the company now thinks that a total of $600,000 of receivables will be lost. This means its allowance of $500,000 is $100,000 short. The company must record an additional expense for this amount to also increase the allowance’s credit balance.

• DR Bad Debt Expense $100,000
• CR Allowance for Doubtful Accounts $100,000

Writing Off Account

Now, let’s say a specific customer that owes a company $50,000 officially files for bankruptcy. This client’s account had previously been included in the estimate for the allowance. Because the company has a very low priority claim without collateral to the debt, the company decides it is unlikely it will every receive any of this $50,000. To properly reflect this change, the company must reduce its accounts receivable balance by this amount. On the other hand, once the receivable is removed from the books, there is no need to record an associated allowance for this account.

• DR Allowance for Doubtful Accounts $50,000
• CR Accounts Receivable $50,000

Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance. Also, note that when writing off the specific account, no income statement accounts are used. This is because the expense was already taken when creating or adjusting the allowance.

Recovering an Account

By miracle, it turns out the company ended up being rewarded a portion of their outstanding receivable balance they’d written off as part of the bankruptcy proceedings. Of the $50,000 balance that was written off, the company is notified that they will receive $35,000.

The company can recover the account by reversing the entry above to reinstate the accounts receivable balance and the corresponding allowance for doubtful account balance. Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the “Adjusting the Allowance” section above.

• DR Accounts Receivable $35,000
• CR Allowance for Doubtful Accounts $35,000
• DR Cash $35,000
• CR Accounts Receivable $35,000

The Bottom Line

The allowance for doubtful accounts is a general ledger account that is used to estimate the amount of accounts receivable that will not be collected. A company uses this account to record how many accounts receivable it thinks will be lost. The balance may be estimated using several different methods, and management should periodically evaluate the balance of the allowance account to ensure the appropriate bad debt expense and net accounts receivables are being recorded.

What Is the Alternative Minimum Tax?

An alternative minimum tax (AMT) places a floor on the percentage of taxes that a filer must pay to the government, no matter how many deductions or credits the filer may claim.

The United States currently has an alternative minimum tax for taxpayers who earn above certain income thresholds.

The AMT recalculates income tax after adding certain tax preference items back into adjusted gross income. It uses a separate set of rules to calculate taxable income after allowed deductions. Preferential deductions are added back into the taxpayer’s income to calculate their alternative minimum taxable income (AMTI), and then the AMT exemption is subtracted to determine the final taxable figure.

How the Alternative Minimum Tax Works

The difference between a taxpayer’s alternative minimum taxable income and his AMT exemption is taxed using the relevant rate schedule. This yields the tentative minimum tax (TMT).

If the tentative minimum tax is higher than the taxpayer’s regular tax liability for the year, then they pay the regular tax and the amount by which the tentative minimum tax exceeds the regular tax. In other words, the taxpayer pays the full tentative minimum tax.

There are two alternative minimum tax rates, 26% and 28%. For 2022, the 28% rate applies to excess alternative minimum taxable income of $206,100 or more for all taxpayers ($103,050 for married couples filing separate returns). For 2023, the 28% rate applies to excess alternative minimum taxable income of $220,700 or more for all taxpayers ($110,350 for married couples filing separate returns). The 26% rate applies to incomes up to those levels.

A taxpayer who has a high income and uses large tax breaks may owe a smaller percentage under the standard rules. If so, the taxpayer is obliged to recalculate the taxes owed under the alternative minimum tax system, which eliminates some of those tax breaks.

The taxpayer will owe whichever amount is higher.

AMT Exemption Amounts

For tax year 2022, the AMT exemption for single filers is $75,900. For married joint filers, the figure is $118,100. For tax year 2023, the figures are $81,300 for single filers and $126,500 for married joint filers.

Taxpayers have to complete Form 6251 to see whether they might owe AMT. First, they subtract the exemption amount from their income. If their AMT is less than the exemption, they do not have to pay AMT.

It’s important to note, though, that taxpayers with AMTI over a certain threshold do not qualify for the AMT exemption. For tax year 2022, the phase-out begins at $539,900 for single filers and $1,079,800 for couples filing jointly. For tax year 2023, the phase-out begins at $578,150 for single filers and $1,156,300.

Purpose of AMT

AMT is designed to prevent taxpayers from escaping their fair share of tax liability through tax breaks. However, in the past, the structure was not indexed to inflation or tax cuts. This can cause bracket creep, a condition in which middle-income taxpayers could be subject to this tax instead of just the wealthy taxpayers for whom AMT was invented. In 2012, however, Congress passed a law indexing the AMT exemption amount to inflation.

Calculating AMT

To determine if they owe AMT, individuals can use tax software that automatically does the calculation, or they can fill out IRS Form 6251. This form takes medical expenses, home mortgage interest, and several other miscellaneous deductions into account to help tax filers determine if their deductions are beyond an overall limit set by the IRS.

The form also requests information on certain types of income such as tax refunds, investment interest, and interest from private activity bonds, as well as numbers corresponding with capital gains or losses related to the disposition of property.

The IRS has specific formulas in place to determine which portion of this income and deductions the tax filers need to note on Form 6251. It uses another set of formulas to determine how these numbers lead to AMTI.

The Bottom Line

The Alternative Minimum Tax is an additional or parallel tax system in the U.S. that is designed to ensure that high-income individuals pay their fair share of taxes. Prior to the AMT, certain taxpayers paid little in the way of taxes, due to preferential treatment of certain income and expenses, or tax breaks.

What Is the Annual Equivalent Rate (AER)?

The annual equivalent rate (AER) is the interest rate for a savings account or investment product that has more than one compounding period. AER is calculated under the assumption that any interest paid is included in the principal payment’s balance and the next interest payment will be based on the slightly higher account balance.

The AER method means that interest can be compounded several times in a year, depending on the number of times that interest payments are made.

AER is also known as the effective annual interest rate or the annual percentage yield (APY).

The AER is the actual interest rate that an investor will earn for an investment, a loan, or another product, based on compounding. The AER reveals to investors what they can expect to return from an investment (the ROI)—the actual return of the investment based on compounding, which is more than the stated, or nominal, interest rate.

Assuming that interest is calculated—or compounded—more than once a year, the AER will be higher than the stated interest rate. The more compounding periods, the greater the difference between the two will be.

Formula for the AER


$\begin{aligned} &\text{Annual equivalent rate}=\left(1 + \frac{r}{n}\right)^n-1\\ &\textbf{where:}\\ &n=\text{The number of compounding periods (times per year interest is paid)}\\ &r = \text{The stated interest rate}\\ \end{aligned}$​Annual equivalent rate=(1+nr​)n−1where:n=The number of compounding periods (times per year interest is paid)r=The stated interest rate​

How to Calculate the AER

To calculate AER:

1. Divide the stated interest rate by the number of times a year that interest is paid (compounded) and add one.
2. Raise the result to the number of times a year that interest is paid (compounded)
3. Subtract one from the subsequent result.

The AER is displayed as a percentage (%).

Example of AER

Let’s look at AER in both savings accounts and bonds.

For a Savings Account

Assume an investor wishes to sell all the securities in their investment portfolio and place all the proceeds in a savings account. The investor is deciding between placing the proceeds in Bank A, Bank B, or Bank C, depending on the highest rate offered. Bank A has a quoted interest rate of 3.7% that pays interest on an annual basis. Bank B has a quoted interest rate of 3.65% that pays interest quarterly, and Bank C has a quoted interest rate of 3.7% that pays interest semi-annually.

Therefore, Bank A would have an annual equivalent rate of 3.7%, or (1 + (0.037 / 1))¹ – 1. Bank B has an AER of 3.7% = (1 + (0.0365 / 4))⁴ – 1, which is equivalent to that of Bank A even though Bank B is compounded quarterly. It would thus make no difference to the investor if they placed their cash in Bank A or Bank B.

On the other hand, Bank C has the same interest rate as Bank A, but Bank C pays interest semi-annually. Consequently, Bank C has an AER of 3.73%, which is more attractive than the other two banks’ AER. The calculation is (1 + (0.037 / 2))² – 1 = 3.73%.

With a Bond

Let’s now consider a bond issued by General Electric. As of March 2019, General Electric offers a noncallable semiannual coupon with a 4% coupon rate expiring Dec. 15, 2023. The nominal, or stated rate, of the bond, is 8%—or the 4% coupon rate times two annual coupons. However, the annual equivalent rate is higher, given the fact that interest is paid twice a year. The AER of the bond is calculated as (1+ (0.04 / 2 ))² – 1 = 8.16%.

Annual Equivalent Rate vs. Stated Interest

While the stated interest rate doesn’t account for compounding, the AER does. The stated rate will generally be lower than AER if there’s more than one compounding period. AER is used to determine which banks offer better rates and which investments might be attractive.

Advantages and Disadvantages of the AER

The primary advantage of AER is that it is the real rate of interest because it accounts for the effects of compounding. In addition, it is an important tool for investors because it helps them evaluate bonds, loans, or accounts to understand their real return on investment (ROI).

Unfortunately, when investors are evaluating different investment options, the AER is usually not stated. Investors must do the work of calculating the figure themselves. It’s also important to keep in mind that AER doesn’t include any fees that might be tied to purchasing or selling the investment. Also, compounding itself has limitations, with the maximum possible rate being continuous compounding.

Special Considerations

AER is one of the various ways to calculate interest on interest, which is called compounding. Compounding refers to earning or paying interest on previous interest, which is added to the principal sum of a deposit or loan. Compounding allows investors to boost their returns because they can accrue additional profit based on the interest they’ve already earned.

One of Warren Buffett’s famous quotes is, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.” Albert Einstein reportedly referred to compound interest as mankind’s greatest invention. 

When you are borrowing money (in the form of loans), you want to minimize the effects of compounding. On the other hand, all investors want to maximize compounding on their investments. Many financial institutions will quote interest rates that use compounding principles to their advantage. As a consumer, it is important to understand AER so you can determine the interest rate you are really getting.