Posts Tagged ‘Accounting’

Absorption Rate: What Is the Absorption Rate in Real Estate? How to Measure

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What Is the Absorption Rate in Real Estate? How to Measure

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What Is Absorption Rate?

Absorption rate most commonly refers to a metric used in the real estate market to evaluate the rate at which available homes are sold in a specific market during a given time period. It is calculated by dividing the number of homes sold in the allotted time period by the total number of available homes. This equation can also be reversed to identify the amount of time it would take for the supply to be sold.

Absorption rate is also a key part of the accounting industry. In this context, absorption rate refers to the way in which businesses calculate their overhead costs.

Key Takeaways

  • The absorption rate is commonly used in the real estate market to determine how many homes are sold in a market at a particular time.
  • The equation can also be used to figure out how long it would take to sell the supply of homes on the market.
  • Realtors, appraisers, and lending institutions use absorption rates to understand market conditions and adjust terms accordingly.
  • An absorption rate above 20% typically signals a seller’s market and an absorption rate below 15% is an indicator of a buyer’s market.
  • Absorption rates are also used to determine and allocate overhead costs in accounting.

Understanding Absorption Rate

Absorption rate provides insight into how quickly or slowly houses are selling in the real estate market. Absorption rate does not take into account additional homes that enter the market at various times. While an absorption rate calculation can be projected, it’s most commonly used based on current available data and actual inventory.

A high absorption rate may indicate that the supply of available homes will shrink rapidly. A homeowner is typically able to sell their property faster during periods of high absorption. However, the time period associated with an absorption rate calculation is important to consider.

Traditionally, an absorption rate above 20% signaled a seller’s market in which homes are sold quickly. An absorption rate below 15% is an indicator of a buyer’s market in which homes are not being sold as fast.

Real estate professionals, such as brokers, use the absorption rate in pricing homes. During periods of higher absorption rates, homes are often priced higher.

Influence in the Real Estate Market

In market conditions with low absorption rates, a real estate agent may be forced to reduce a listing price to entice a sale. Alternatively, the agent can increase the price without sacrificing demand for the home if the market has a high absorption rate. The absorption rate is also important for buyers and sellers to follow as they make decisions on the timing of purchases and sales.

The absorption rate is also a signal for developers to start building new homes, though developers often use long lead times to forecast periods of higher absorption. During market conditions with a high absorption rate, demand may be high enough to warrant the further development of properties. Meanwhile, periods with lower absorption rates indicate a cooling period for construction.

Appraisers use the absorption rate to determine the value of a property. Some procedures require an addendum showing that absorption rates were considered in appraisal calculations. In general, appraisers are responsible for analyzing market conditions and maintaining an awareness of the absorption rates for all types of appraisal values.

Most appraisers include this data metric in the neighborhood section of the appraisal forms. The current valuation of a home would be reduced during periods of decreased absorption rates and increased when absorption rates are high.

Lenders and banking institutions will also consider market conditions when evaluating loan and credit terms. During periods of low absorption, banks may feel tempted to entice clients to borrow money with more favorable loan terms. Alternatively, lenders can be more selective during high absorption periods as they are more likely to have a broader portfolio of prospective borrowers.

Example of the Absorption Rate

Suppose a city has 1,000 homes currently on the market to be sold. If buyers purchase 100 homes per month, the absorption rate is 10% (100 homes sold per month divided by 1,000 homes available for sale). This also indicates that the supply of homes will be exhausted in 10 months (1,000 homes divided by 100 homes sold/month).

Want to know if it’s time to sell your home? Look up the number of homes sold in your area from the MLS website and use the formula above to determine how long it will take to sell your property.

Absorption Rate in Accounting

Absorption rate is also used in an entirely different manner in accounting.

In accounting, absorption rate (or the rate of absorption) is the rate at which companies calculate and allocate their overhead expenses. These are the costs associated with providing goods and services to their customers, though these expenses aren’t directly traceable to end products. As such, it’s also often called an overhead absorption rate.

Companies often have to use estimates to determine their overhead costs. That’s because they don’t know what the actual costs are until they come in. In order to determine their overhead, companies divide the total budgeted overhead costs divided by the total budgeted production base. This requires an adjustment at the end of the accounting period to make up for any difference between the predicted and actual costs.

Alternatively, a company may know its actual overhead costs but not know how to trace those costs to final products or services. To overcome this hurdle, companies use estimated cost drivers to guess what non-financial measures cause changes in financial measures.

This can be problematic, especially when companies use very conservative estimates to predict their costs. Doing so may throw off their balance sheets because the actual costs may be higher at the end of the reporting period or if costs fluctuate. However, this practice has the benefit of making sure all costs including estimated amounts and estimated allocations are included when evaluating their products.

What Does Absorption Rate Mean?

Absorption rate is most often associated with real estate and the rate at which houses are being bought. Absorption rate (and absorption costing) are also used in cost accounting to assign overhead costs.

What Does a High Absorption Rate Mean?

A high absorption rate means a higher proportion of houses are being purchased. Otherwise, a low absorption rate means a lower proportion of houses are being purchased. This information is used by relators, financial institutions, and appraisers as the rate at which houses are being bought drives a home’s value and price.

What Is the Formula for Absorption Rate in Real Estate?

To find out the absorption rate in real estate, divide the total number of homes sold in a specific period of time by the total number of homes available in that market.

What Is a 6-Month Absorption Rate?

Absorption rates indicate how long it takes to sell homes in a given market. A six-month absorption rate indicates a balanced market, so buyers and sellers equally benefit during this environment.

How Do You Calculate a Monthly Absorption Rate?

In order to determine a monthly absorption rate, take the total number of homes sold in the market and divide that by 12. Then, divide this monthly average number of homes sold by the total number of homes available for sale.

The Bottom Line

The absorption rate is a very important metric used in the real estate and accounting.

Realtors use it to determine how many homes are sold in a particular area at any given time. These professionals can also use the rate to determine the kind of market they are facing, whether that’s a buyer’s, seller’s, or a balanced market. This rate is also important for the construction industry, as it indicates when developers should start buying.

Equally important, absorption rate is used in the accounting field—notably for companies to estimate their overhead. Absorption costing entails estimating overhead costs, determining overhead cost drivers, and having products absorb these untraceable costs.

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Amalgamation: Definition, Types, How to Use, Pros and Cons

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Amalgamation: Definition, Types, How to Use, Pros and Cons

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What Is an Amalgamation?

An amalgamation is a combination of two or more companies into a new entity. Amalgamation is distinct from a merger because neither company involved survives as a legal entity. Instead, a completely new entity is formed to house the combined assets and liabilities of both companies.

The term amalgamation has generally fallen out of popular use in the United States, being replaced with the terms merger or consolidation even when a new entity is formed. But it is still commonly used in countries such as India.

Key Takeaways

  • Amalgamation is the combination of two or more companies into a brand new entity by combining the assets and liabilities of both entities into one.
  • This differs from a traditional merger in that neither of the two companies involved survives as an entity.
  • The transferor company is absorbed into the stronger, transferee company, leading to an entity with a stronger customer base and more assets.
  • Amalgamation can help increase cash resources, eliminate competition, and save companies on taxes.
  • But it can lead to a monopoly if too much competition is cut out, scale down the workforce, and increase the new entity’s debt load.

Understanding Amalgamations

Amalgamation typically happens between two or more companies engaged in the same line of business or those that share some similarity in operations. Companies may combine to diversify their activities or to expand their range of services.

Since two or more companies are merging together, an amalgamation results in the formation of a larger entity. The transferor company—the weaker company—is absorbed into the stronger transferee company, thus forming an entirely different company. This leads to a stronger and larger customer base, and also means the newly formed entity has more assets.

Amalgamations generally take place between larger and smaller entities, where the larger one takes over smaller firms.

The Pros and Cons of Amalgamations

Amalgamation is a way to acquire cash resources, eliminate competition, save on taxes, or influence the economies of large-scale operations. Amalgamation may also increase shareholder value, reduce risk by diversification, improve managerial effectiveness, and help achieve company growth and financial gain.

On the other hand, if too much competition is cut out, amalgamation may lead to a monopoly, which can be troublesome for consumers and the marketplace. It may also lead to the reduction of the new company’s workforce as some jobs are duplicated and therefore make some employees obsolete. It also increases debt: by merging the two companies together, the new entity assumes the liabilities of both.

Pros

  • Can improve competitiveness

  • Can reduce taxes

  • Increases economies of scale

  • Potential to increase shareholder value

  • Diversifies the firm

Amalgamation Procedure

The terms of amalgamation are finalized by the board of directors of each company. The plan is prepared and submitted for approval. For instance, the High Court and Securities and Exchange Board of India (SEBI) must approve the shareholders of the new company when a plan is submitted.

The new company officially becomes an entity and issues shares to shareholders of the transferor company. The transferor company is liquidated, and all assets and liabilities are taken over by the transferee company.

In accounting, amalgamations may also be referred to as consolidations.

Example of Amalgamation

In late 2021, it was announced that media companies Time Warner and Discovery, Inc. would combine in a deal worth an estimated $43 billion. Owned by AT&T, Time Warner (which the telecom company acquired in 2018) would be spun off and then amalgamated with Discovery. The new entity, known as Warner Bros. Discovery, Inc., is expected to close at some point in late 2022 and will be headed by Discovery CEO David Zaslav.

Types of Amalgamation

One type of amalgamation—similar to a merger—pools both companies’ assets and liabilities, and the shareholders’ interests together. All assets of the transferor company become that of the transferee company.

The business of the transferor company is carried on after the amalgamation. No adjustments are made to book values. Shareholders of the transferor company holding a minimum of 90% face value of equity shares become shareholders of the transferee company.

The second type of amalgamation is similar to a purchase. One company is acquired by another, and shareholders of the transferor company do not have a proportionate share in the equity of the combined company. If the purchase consideration exceeds the net asset value (NAV), the excess amount is recorded as goodwill. If not, it is recorded as capital reserves.

What Are the Objectives of an Amalgamation?

An amalgamation is similar to a merger in that it combines two firms, but here a brand new entity is formed as a result. The objective is thus to establish a unique entity that rests on the business combination in order to achieve greater competitiveness and economies of scale.

What Are the Methods of Accounting for Amalgamation?

There are two primary ways to account for an amalgamation. In the pooling of interests method, the transferee company takes on the balance sheet of the transferor—valued at the date of amalgamation. In the purchase method, assets are treated as acquired by the transferee where discrepancies are accounted for as goodwill or a capital surplus.

What Is an Amalgamation Reserve?

The amalgamation reserve is the amount of cash left over by the new entity after the amalgamation is completed. If this amount is negative, it will be booked as goodwill.

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Accounting Theory: What Is Accounting Theory in Financial Reporting?

Written by admin. Posted in A, Financial Terms Dictionary

What Is Accounting Theory in Financial Reporting?

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What Is Accounting Theory?

Accounting theory is a set of assumptions, frameworks, and methodologies used in the study and application of financial reporting principles. The study of accounting theory involves a review of both the historical foundations of accounting practices, as well as the way in which accounting practices are changed and added to the regulatory framework that governs financial statements and financial reporting.

Key Takeaways

  • Accounting theory provides a guide for effective accounting and financial reporting.
  • Accounting theory involves the assumptions and methodologies used in financial reporting, requiring a review of accounting practices and the regulatory framework.  
  • The Financial Accounting Standards Board (FASB) issues generally accepted accounting principles (GAAP) which aim to improve comparability and consistency in accounting information.
  • Accounting theory is a continuously evolving subject, and it must adapt to new ways of doing business, new technological standards, and gaps that are discovered in reporting mechanisms.

Understanding Accounting Theory

All theories of accounting are bound by the conceptual framework of accounting. This framework is provided by the Financial Accounting Standards Board (FASB), an independent entity that works to outline and establish the key objectives of financial reporting by businesses, both public and private. Further, accounting theory can be thought of as the logical reasoning that helps evaluate and guide accounting practices. Accounting theory, as regulatory standards evolve, also helps develop new accounting practices and procedures.

Accounting theory is more qualitative than quantitative, in that it is a guide for effective accounting and financial reporting.

The most important aspect of accounting theory is usefulness. In the corporate finance world, this means that all financial statements should provide important information that can be used by financial statement readers to make informed business decisions. This also means that accounting theory is intentionally flexible so that it can produce effective financial information, even when the legal environment changes.

In addition to usefulness, accounting theory states that all accounting information should be relevant, reliable, comparable, and consistent. What this essentially means is that all financial statements need to be accurate and adhere to U.S. generally accepted accounting principles (GAAP). Adherence to GAAP allows the preparation of financial statements to be both consistent to a company’s past financials and comparable to the financials of other companies.

Finally, accounting theory requires that all accounting and financial professionals operate under four assumptions. The first assumption states that a business is a separate entity from its owners or creditors. The second affirms the belief that a company will continue to exist and not go bankrupt. The third assumes that all financial statements are prepared with dollar amounts and not with other numbers like units of production. Finally, all financial statements must be prepared on a monthly or annual basis.

Special Considerations

Accounting as a discipline has existed since the 15th century. Since then, both businesses and economies have greatly evolved. Accounting theory is a continuously evolving subject, and it must adapt to new ways of doing business, new technological standards, and gaps that are discovered in reporting mechanisms.

For example, organizations such as the International Accounting Standards Board help create and revise practical applications of accounting theory through modifications to their International Financial Reporting Standards (IFRS). Professionals such as Certified Public Accountants (CPAs) help companies navigate new and established accounting standards.

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