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How to Use RRG Charts in Trading

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The relative rotation graph (RRG) is a sophisticated tool in technical analysis to help investors decide which sectors, individual stocks, and other assets to pursue. Investors can use it to visually compare the performance and momentum of securities and asset classes against a benchmark. RRGs plot assets on a two-dimensional graph, with the x-axis representing the relative strength ratio and the y-axis for relative strength momentum. This format enables traders and investors to visually assess the relative strength and trendline of different securities, making it valuable for trading, rotation, and asset allocation strategies.

Key Takeaways

  • The relative rotation graph (RRG) is a chart used in technical analysis to test the performance and momentum of securities or asset classes against a benchmark.
  • RRGs provide a comprehensive view of the market, helping investors to spot trends, compare multiple securities simultaneously, and make more informed decisions when rebalancing portfolios.
  • RRGs should be used with other forms of analysis since they are a partial view of the market.
  • Several tools and resources are available to create and analyze RRGs, ranging from professional-grade software from Bloomberg and Optuma to more accessible platforms like StockCharts.com.

What is the Relative Rotation Graph?

RRGs are used to identify which stocks or sectors are underperforming and outperforming a market index or benchmark. The RRG has four quadrants: leading, weakening, lagging, and improving. Each quadrant is for different stages of an asset’s performance cycle, providing insights into the rotation of market leadership. This movement of securities through the quadrants helps to spotting trends and potential reversals and could provide investors with a strategic advantage in both short-term and long-term trading.

RRGs were created by Julius de Kempenaer in the early 1990s to visualize the relative performance of stocks and other securities against a benchmark and each other. De Kempenaer’s work has been valuable for helping investors make more informed decisions about trading, rotation, and asset allocation.

RRGs are an excellent visual way of analyzing market trends and relative performance. However, like all technical tools, they should be used with other techniques for a more comprehensive approach to trading and investing.

Understanding the Parts of the Relative Rotation Graph

The key elements of RRG and how they indicate relative strength and momentum are as follows:

  • Axes: The x-axis is the relative strength ratio. This axis measures the performance of a security relative to a benchmark (hence, the strength is “relative”). A value more than 100 indicates outperformance, while a value less than 100 indicates underperformance. The y-axis represents the momentum of the relative strength. This axis shows the rate of change in the relative performance. It is essentially the momentum of the relative strength ratio,
  • Top right quadrant: The top right quadrant in the RRG is the leading quadrant. Securities in this quadrant are outperforming the benchmark, and their momentum is positive. This indicates strong and improving performance.
  • Bottom right quadrant: The bottom right quadrant is the weakening quadrant. Here, securities are still outperforming the benchmark, but their momentum is decreasing. Being here suggests that while they are strong, they might be losing their edge.
  • Bottom left quadrant: This is the lagging quadrant. Securities in this area are underperforming the benchmark with negative momentum. It is a sign of weakness.

  • Top left quadrant: This is the improving quadrant. This quadrant contains securities that are underperforming the benchmark but show increasing momentum. Being here suggests the potential for a turnaround.
  • Data points and movement: Each security or asset is represented as a data point on the graph. The position of a data point within the graph indicates its relative strength and momentum. The movement of these data points is tracked over time, usually in a clockwise direction through the quadrants, which illustrates the evolution of their relative performance.

RRGs help investors spot trends and compare several securities at once. However, RRGs should be used with other forms of analysis since they provide a relative, not absolute, view.

How to Interpret Relative Rotation Graphs

Interpreting RRGs involve analyzing the patterns and movements of securities on this chart to identify market leaders, laggards, and potential rotation opportunities.


Weekly Relative Rotation Graph of Magnificent Seven Stocks as at 18th December 2023.

stockcharts.com


Movements and Patterns in RRGs

Securities in the RRG generally move clockwise through the four quadrants. This rotation reflects the natural ebb and flow of securities’ relative strength and momentum relative to a benchmark. In addition, the further a security is from the center, the stronger its relative strength or weakness is compared with the benchmark. A security far out in the leading or lagging quadrant has a strong trend, whether positive or negative.

The speed at which a security moves through the quadrants can indicate the stability of its trend. Rapid movements might suggest more volatile or less stable trends. Indeed, many RRGs show tails behind the data points, representing their historical path. Longer tails provide more context on historical performance and trend stability.

Identifying Market Leaders and Laggards

Securities in the leading quadrant are outperforming the benchmark with positive momentum and are considered market leaders. A security with a presence or movement deeper into this quadrant suggests a strong and stable outperformance. Meanwhile, securities in the lagging quadrant are underperforming and have negative momentum. These are the laggards of the market. A security that is continuously in or moving deeper into this quadrant has a strong downtrend relative to the benchmark.


Monthly US Sector Rotation as at December 1 2023.

stockcharts.com


Identifying Rotational Opportunities

A security moving from the improving quadrant into the leading quadrant can be an opportunity. This shift indicates a security is starting to outperform the benchmark with increasing momentum. Similarly, a security moving from the weakening to the lagging quadrant suggests that its previous outperformance is deteriorating, and it is now starting to underperform. This could signal a selling opportunity or a warning to avoid new investments.

Meanwhile, a move from lagging to improving suggests that a security is beginning to reverse its underperformance. This indicates an early stage of recovery, a potential buying opportunity for contrarian investors. Also, securities shifting from leading to weakening are still outperforming but are losing momentum. This could be a signal to take the profits or closely watch the situation to see if it continues losing steam.

Using Relative Rotation Graphs with Other Technical Tools

RRGs can be more effective when put together with other charts in the technical analyst’s toolkit. For example, once an RRG helps determine sectors or stocks that are showing relative strength, you can then review stocks in those sectors in greater depth. Candlestick patterns and volume analysis can give more details on the trading behavior for specific stocks, clueing you in about potential reversals in price trends. Indicators like moving averages, the relative strength index (RSI), and Bollinger Bands can also be used to assess the momentum and volatility of these stocks, helping you decide on entries and exits.

In addition, the RRG’s ability to depict sector rotation can provide great help for those using a top-down investment approach. When showing the sectors moving into the leading quadrant, you might allocate more to sectors poised for growth and reduce your exposure to those going into the lagging quadrant. This sector rotation strategy can be particularly useful during different phases of the economic cycle, as certain sectors tend to do better than others based on the economic conditions. This then points to how fundamental analysis can be used with RRG for a fuller picture of particular sectors and their prospects.

Benefits and Limitations of Relative Rotation Graphs

RRGs offer several advantages and limitations when used in trading, analysis, and portfolio management. Understanding these can help make better use of them for investing.

Benefits and Limitations of Relative Rotation Graphs

Benefits

  • Easy Visualization of Market Dynamics

  • Comparison Tool

  • Helps Identify Trends

  • Helps with Timely Decision Making

  • Complements Other Analysis

  • Helps with Deciding Asset Allocation

Limitations

  • Shows Relative, Not Absolute Rotation

  • Lagging Indicator

  • Requires a Benchmark

  • Not a Standalone Tool

  • Provides no Indication of Value

Benefits of Relative Rotation Graphs

Here are some benefits of RRGs:

  • Visualizing market dynamics: RRGs provide a clear, visual representation of the relative strength and momentum of various securities or sectors, making it easier to understand complex market moves.
  • Comparison tool: With RRGs, you can compare several securities simultaneously against a benchmark, which can be valuable for portfolio diversification and sector rotation strategies.
  • Identifying trends: RRGs help pick out leaders, laggards, and emerging trends by observing the movement of securities through different quadrants.
  • Timely decision-making: The dynamic nature of RRGs aids investors in making timely decisions by highlighting changes in momentum and strength before they become evident through price movements alone.
  • Complementing other analyses: RRGs can be used alongside other technical, fundamental, and quantitative analysis tools, providing a more holistic view of the market.
  • Sector and asset allocation: RRGs are particularly useful for sector analysis and distributing assets since they help identify industries or asset classes likely to outperform or underperform.

Limitations of Relative Rotation Graphs

Here are some limitations of RRGs:

  • Relative, not absolute, rotation: RRGs illustrate the performance relative to a benchmark, not the absolute performance. A security in the leading quadrant could still be losing value in a bear market.
  • Lagging indicator: RRGs inherently lag. They reflect past performance and trends, which may not always predict future movements.
  • Requires a benchmark: The effectiveness of RRGs depends on the choice of an appropriate benchmark, which can vary based on the assets.
  • Not a stand-alone tool: RRGs should not to be used in isolation. They do not deliver insights into company fundamentals, macroeconomic conditions, or market sentiment.
  • No indication of value: RRGs do not provide information about the value of securities. A stock might be moving into the leading quadrant but still be overpriced.

While RRGs are powerful for visualizing and analyzing market trends and relative performance, they are most effective when used as part of a broader, diversified approach to investment analysis and decision-making. Understanding their limitations is crucial to avoid overestimating their relevance.

Differences Between the Relative Rotation Graph and the Relative Strength Index

The Relative Rotation Graph vs. the Relative Strength Index

Relative Rotation Graph (RRG)

  • Scope: RRG is used to compare several securities against a benchmark.

  • Dimensions: RRG provides a two-dimensional view.

  • Interpretation: RRG is better for relative performance and identifying trends.

  • Usage: RRG is typically used for asset allocation and sector rotation.

Relative Strength Index (RSI)

  • Scope: The RSI is used for analyzing the price momentum of a single security.

  • Dimensions: The RSI is a one-dimensional oscillator.

  • Interpretation: The RSI illustrates momentum and potential price reversals.

  • Usage: RSI is commonly used to identify potential entries and exits.

The RRG and the relative strength index (RSI) are both used in technical analysis, but serve different purposes and provide different kinds of information. RRGs are used for comparing several securities against a benchmark, while the RSI is for analyzing the price momentum of a single security. In addition, RRGs offer a two-dimensional view (strength and momentum), while the RSI is a one-dimensional oscillator (it constructs high and low bands and provides a trend indicator).

RRG is best used for relative performance and identifying trends. Meanwhile, the RSI is best for ascertaining momentum and potential price reversals. Another set of differences is that RRG is often used for asset allocation and sector rotation, while the RSI commonly helps identify potential entries and exits.

As such, RRG is more for visualizing and comparing the relative strength and trends of multiple securities, and the RSI sets out the momentum of individual securities and can help identify when there are overbought or oversold conditions.

Resources for Creating Relative Rotation Graphs

Making your RRGs requires specialized tools and resources, as these graphs involve complex calculations and dynamic visuals. Here are some great tools to use:

  • RRG Research: Founded by Julius de Kempenaer, the creator of RRGs, the firm’s site provides tools and insights related to RRGs. The website offers educational resources, analysis, and access to RRGs.
  • Bloomberg Professional Services Software: The Bloomberg Professional Services software, a leading financial data and analytics platform, offers RRG charts as part of its services. It provides functions for creating and customizing RRGs, making it a popular choice among professional investors and analysts.
  • Refinitiv Eikon: This platform is another leading financial data and analytics provider that offers RRG charts as part of its services.
  • StockCharts.com: This online platform offers various chart tools, including RRGs. It has a user-friendly interface for creating RRGs, suitable for professionals and individual investors.
  • Optuma: Optuma is a professional-level technical analysis software that includes RRGs among its features. Known for its advanced analysis tools, Optuma caters to professional traders and analysts.

The tool you choose depends on your needs, skill level, and access to resources.

Which Technical Analysis Indicators Work Well with Relative Rotation Graphs?

Combining RRGs with other indicators can provide a more comprehensive view of the market and help refine investment strategies. Some indicators include moving averages, the RSI, the moving average convergence divergence, Bollinger Bands, support and resistance levels, and other chart patterns.

What Asset Groups Work Well with Relative Rotation Graphs?

RRGs are best used to analyze asset groups when relative performance is key. These can include equity sectors and industries, exchange-traded funds, indexes, benchmarks, fixed-income securities, commodities, and currencies. RRGs’ ability to compare several assets simultaneously makes them invaluable for a wide range of investment strategies from picking individual stocks to deciding on broad asset allocations. However, with all financial and investment tools, they should be used as part of a broader, diversified approach to market analysis and not relied upon in isolation.

Which Benchmarks Work Well with Relative Rotation Graphs?

The benchmark chosen is critical in interpreting RRGs, setting the standard against which the other securities or asset classes are measured. The benchmark to use depends on the type of assets being analyzed and the specific goals of the analysis. Some commonly used benchmarks include broad market, sector, fixed-income, commodity, regional, country-specific, currency, real estate, and thematic indexes.

How Can the Reliability of Relative Rotation Graphs Be Improved?

Increasing the reliability of RRGs involves choosing the right benchmarks, using quality data, understanding the tool’s limitations, and integrating it with other forms of analysis. Regular reviews, adaptation to changing market conditions, and ongoing education are essential for effectively using RRGs in trading and investments.

The Bottom Line

RRGs are vital for some types of technical analysis, offering a way to visualize the relative performance and momentum of different securities against a chosen benchmark. Its design, characterized by placing securities in four distinct quadrants—labeled leading, weakening, lagging, and improving—allows traders and investors to quickly grasp shifts in the market and identify assets gaining or losing strength against others. This makes RRGs particularly useful for strategies involving sector rotation, asset allocation, and portfolio diversification.

For traders, RRGs provide a strategic edge by enabling a clear understanding of various market segments’ relative trends and strengths. By integrating RRG analysis with other technical indicators and fundamental insights, traders can identify potential entry and exit points more effectively.

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2011 U.S. Debt Ceiling Crisis

Written by admin. Posted in #, Financial Terms Dictionary

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What Is the 2011 U.S. Debt Ceiling Crisis?

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed.

Key Takeaways

  • The 2011 U.S. Debt Ceiling Crisis was one of a series of recurrent debates over increasing the total size of the U.S. national debt.
  • In 2008, the federal budget deficit stood at $458.6 billon, which widened to $1.4 trillion the following year as the government spent heavily to boost the economy.
  • To resolve the crisis, Congress passed a law that increased the debt ceiling by $2.4 trillion.

Understanding the 2011 U.S. Debt Ceiling Crisis

The federal government has rarely achieved a balanced budget, and its budget deficit ballooned following the 2007-08 Financial Crisis. In the 2008 fiscal year, the deficit stood at $458.6 billon, widening to $1.4 trillion in 2009 as the government engaged in a massive fiscal policy response to the economic downturn.

Between 2008 and 2010, Congress raised the debt ceiling from $10.6 trillion to $14.3 trillion. In 2011, as the economy showed early signs of recovery and federal debt approached its limit once again, negotiations began in Congress to balance spending priorities against the ever-rising debt burden. 

Heated debate ensued, pitting proponents of spending and debt against fiscal conservatives. Pro-debt politicians argued that failing to raise the limit would require immediate cuts to spending already authorized by Congress, which could result in late, partial, or missed payments to Social Security and Medicare recipients, government employees, and government contractors.

Moreover, they asserted the Treasury could suspend interest payments on existing debt rather than withhold funds committed to federal programs. The prospect of cutting back on already promised spending was labeled a crisis by debt proponents.

On the other hand, the specter of a technical default on existing Treasury debt roiled financial markets. Fiscal conservatives argued that any debt limit increase should come with constraints on the growth of federal spending and debt accumulation.

Outcome of the 2011 U.S. Debt Ceiling Crisis

Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.

In the first phase, a $400 billion increase would occur immediately, followed by another $500 billion unless Congress disapproved it. The second phase allowed for an increase between $1.2 trillion and $1.5 trillion, subject to Congressional disapproval as well. In return, the act included $900 billion in slowdowns in planned spending increases over a 10-year period. It also established a special committee charged with finding at least $1.5 trillion in additional savings.

In effect, the legislation incrementally raised the debt ceiling from $14.3 trillion to $16.4 trillion by January 27, 2012.

Following the passage of the act, Standard & Poor’s took the radical step of downgrading the United States long-term credit rating from AAA to AA+, even though the U.S. did not default. The report says, “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” The credit rating agency cited the unimpressive size of deficit reduction plans relative to the likely future prospects for politically driven spending and debt accumulation.

Debt Approval Process Leading to the 2011 U.S. Debt Ceiling Crisis

The U.S. Constitution gives Congress the power to borrow money. Before 1917, this power was exercised by Congress authorizing the Treasury to borrow specified amounts of debt to fund limited expenses, such as war-time military spending, which would be repaid after the end of hostilities. This kept the national debt directly linked to authorized spending.

In 1917, Congress imposed a limit on federal debt as well as individual issuance limits. In 1939, Congress gave the Treasury more flexibility in how it managed the overall structure of federal debt, giving it an aggregate limit. However, by delegating debt management authority to the Treasury, Congress was able to break the direct connection between authorized spending and the debt that finances it. 

While allowing greater flexibility to raise spending, this practice also created a need for Congress to repeatedly raise the debt limit when spending threatens to overrun available credit. Due to occasional political resistance to the idea of continually expanding the federal debt, this process of raising the debt limit has at times engendered controversy, which occurred during the 2011 Debt Ceiling Crisis.

What could happen if Congress does not vote to raise the debt ceiling in 2023?

In a letter to the U.S. House of Representatives, U.S. Treasury Secretary Janet Yellen warned congressional leaders that the U.S. will reach its borrowing limit on Thursday, January 19. Yellen wrote that the Treasury will take “extraordinary measures” to avoid defaulting on its obligations, but she warned these measures might only be sufficient to cover obligations into June. Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihood of all Americans, and global financial stability, she warned. She also mentioned that the U.S. would risk facing another credit rating downgrade, similar to that of 2011.

Once the debt ceiling is reached, what spending will the Treasury cut?

In a letter to the U.S. House of Representatives, U.S. Treasury Secretary Janet Yellen warned congressional leaders that the Treasury will implement extraordinary measures to prevent the U.S. from defaulting on its obligations.

In January 2023, the Treasury will redeem existing and will suspend new investments of the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund. It will also suspend reinvestment of the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan.

Why did increasing the debt ceiling cause contentious debate in 2011?

Between 2008 and 2010, Congress raised the debt ceiling from $10.6 trillion to $14.3 trillion. In 2011, as the economy showed early signs of recovery and federal debt approached its limit again, negotiations began in Congress to decide spending priorities.  Heated debate ensued between pro-debt politicians and fiscal conservatives. Pro-debt politicians argued that failing to raise the limit could result in late, partial, or missed payments to Social Security and Medicare recipients, government employees, and government contractors. Fiscal conservatives argued that any debt limit increase should come with limits on federal spending and debt accumulation.

The Bottom Line

Following the 2007-08 Financial Crisis, in an effort to slow down the severe recession as well as the persistently high unemployment rate, the government increased federal spending. As a result, the federal debt reached its limit on multiple occasions from 2008 to 2011 which led to a series of increases of the debt limit. In 2011, the Treasury asked for its borrowing capacity to be extended.

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed. Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.

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A-B Trust: Definition, How It Works, Tax Benefits

Written by admin. Posted in A, Financial Terms Dictionary

Definition, How It Works, Tax Benefits

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What Is an A-B Trust?

An A-B trust is a joint trust created by a married couple for the purpose of minimizing estate taxes. It is formed with each spouse placing assets in the trust and naming as the final beneficiary any suitable person except the other spouse. The trust gets its name from the fact that it splits into two separate entities when one spouse dies. Trust A is the survivor’s trust and trust B is the decedent’s trust.

Key Takeaways

  • An A-B trust is a joint trust created by a married couple; upon one spouse’s death, the trust splits into a survivor portion (the A trust) and a bypass portion (the decedent’s trust, or B trust).
  • Via the split, the A-B trust effectively minimizes estate taxes and defers them until after the death of the surviving spouse.
  • The surviving spouse has limited control over the decedent’s trust but the terms of the decedent’s trust can be set to allow the surviving spouse to access the assets, and even draw income from them.
  • A-B trusts are no longer widely used as the estate tax exemption, which is now indexed to inflation, is sufficient for most estates.

Understanding an A-B Trust

Estate taxes can bite deeply into a deceased person’s assets. For example, consider a married couple that has an estate worth $20 million by the time one of the spouses dies. The surviving spouse is left with the whole $20 million, which is not taxed due to the unlimited marital deduction for assets flowing from a deceased spouse to a surviving spouse.

But then, the other spouse dies, leaving the money to their children. The taxable portion of the estate (the amount that exceeds the 2022 exemption threshold of $12.06 million will be $7.94 million). This means that $7.94 million will be taxed at 40%, leaving only $4.76 million for the beneficiaries. The exemption for 2023 is $12.92 million.

To circumvent the estate from being subject to such steep taxes, many married couples set up a trust under their last will and testaments called an A-B trust. In the example above, if the couple instead had an A-B trust, the death of the first spouse would not trigger any estate taxes as a result of the lifetime exclusion; however, a sum of money equal to the current exemption amount will be transferred into an irrevocable trust called the bypass trust or B trust.

This trust is also known as the decedent’s trust. The remaining amount, $7.94 million, will be transferred to a survivor’s trust, or A trust, which the surviving spouse will have complete control over. The estate tax on the A trust is deferred until after the death of the surviving spouse.

Benefits of an A-B Trust

The A trust contains the surviving spouse’s property interests, but they have limited control over the assets in the deceased spouse’s trust; however, this limited control over the B trust will still enable the surviving spouse to live in the couple’s house and draw income from the trust, provided these terms are stipulated in the trust.

While the surviving spouse can access the bypass trust, if necessary, the assets in this trust will bypass their taxable estate after they die. After the surviving spouse dies, only the assets in the A trust are subject to estate taxes. If the estate tax exemption for this spouse is also $12.06 million for 2022 (the exemption threshold for 2023 is $12.92 million) and the value of assets in the survivor’s trust is still valued at $7.94 million, none of it will be subject to estate tax.

The federal tax exemption is transferable between married couples through a designation referred to as the portability of the estate tax exemption. If one spouse dies, the unused portion of their estate tax exemption can be transferred and added to the estate tax exemption of the surviving spouse. Upon the death of the surviving spouse, the property in the decedent’s trust passes tax-free to the beneficiaries named in this trust.

This is because the B trust uses up the estate tax exemption of the spouse that died first, hence, any funds left in the decedent’s trust will be passed tax-free. As the decedent’s trust is not considered part of the surviving spouse’s estate for purposes of the estate tax, double taxation is avoided.

Net Worth and A-B Trusts

If the deceased spouse’s estate falls under the amount of their tax exemption, then it may not be necessary to establish a survivor’s trust. The unused portion of the late spouse’s federal tax exemption can be transferred to the surviving spouse’s tax exemption by filling out IRS Form 706.

While A-B trusts are a great way to minimize estate taxes, they are not used much today. They were popular in the decades around the turn of the 21st century when the estate tax—which hadn’t been adjusted for years—could be triggered on estates as small as $1 million or $2 million. Nowadays, each individual has a combined lifetime federal gift tax and estate tax exemption of $12.06 million in 2022, rising to $12.92 million in 2023.

So only people with estates valued over $12.06 million will opt for an A-B trust in 2022. With the portability provision, a surviving spouse can include the tax exemption of their late spouse, allowing up to $24.12 million as of 2022 and $25.84 million in 2023, which can be transferred tax-free to beneficiaries.

What Are the Benefits of an A-B Trust?

The benefits of an A-B trust include death tax exemptions, built-in trust protection, and the portability of exemption. Disadvantages include maintenance costs, complex structure, and the possibility of large capital gains taxes after both parties die.

Why Is an A-B Trust Obsolete?

A-B trusts aren’t completely obsolete but they are not as common as they once were due to changes in estate tax law, primarily the fact that a couple now has extremely high estate tax exemptions. A-B trusts are primarily used to reduce estate taxes between married couples.

What Is Another Name for an A-B Trust?

A-B trusts are also known as bypass trusts or credit shelter trusts. The goal of these trusts is to reduce estate taxes between married couples.

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Accounting Information System (AIS): Definition and Benefits

Written by admin. Posted in A, Financial Terms Dictionary

Accounting Information System (AIS): Definition and Benefits

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What is an Accounting Information System (AIS)?

An accounting information system (AIS) involves the collection, storage, and processing of financial and accounting data used by internal users to report information to investors, creditors, and tax authorities. It is generally a computer-based method for tracking accounting activity in conjunction with information technology resources. An AIS combines traditional accounting practices, such as the use of Generally Accepted Accounting Principles (GAAP), with modern information technology resources.

How an Accounting Information Systems (AIS) is Used

An accounting information system contains various elements important in the accounting cycle. Although the information contained in a system varies among industries and business sizes, a typical AIS includes data relating to revenue, expenses, customer information, employee information, and tax information. Specific data includes sales orders and analysis reports, purchase requisitions, invoices, check registers, inventory, payroll, ledger, trial balance, and financial statement information.

An accounting information system must have a database structure to store information. This database structure is typically programmed with query language that allows for table and data manipulation. An AIS has numerous fields to input data as well as to edit previously stored data. In addition, accounting information systems are often highly secured platforms with preventative measures taken against viruses, hackers, and other external sources attempting to collect information. Cybersecurity is increasingly important as more and more companies store their data electronically.

The various outputs of an accounting information system exemplify the versatility of its data manipulation capabilities. An AIS produces reports including accounts receivable aging reports based on customer information, depreciation schedules for fixed assets, and trial balances for financial reporting. Customer lists, taxation calculations, and inventory levels may also be reproduced. However, correspondences, memos, or presentations are not included in the AIS because these items are not directly related to a company’s financial reporting or bookkeeping.

Benefits of Accounting Information Systems

Interdepartmental Interfacing

An accounting information system strives to interface across multiple departments. Within the system, the sales department can upload the sales budget. This information is used by the inventory management team to conduct inventory counts and purchase materials. Upon the purchase of inventory, the system can notify the accounts payable department of the new invoice. An AIS can also share information about a new order so that the manufacturing, shipping, and customer service departments are aware of the sale.

Internal Controls

An integral part of accounting information systems relates to internal controls. Policies and procedures can be placed within the system to ensure that sensitive customer, vendor, and business information is maintained within a company. Through the use of physical access approvals, login requirements, access logs, authorizations, and segregation of duties, users can be limited to only the relevant information necessary to perform their business function.

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