What Is Accelerated Depreciation?

Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater depreciation expenses in the early years of the life of an asset. Accelerated depreciation methods, such as double-declining balance (DDB), means there will be higher depreciation expenses in the first few years and lower expenses as the asset ages. This is unlike the straight-line depreciation method, which spreads the cost evenly over the life of an asset.

Understanding Accelerated Depreciation

Accelerated depreciation methods tend to align the recognized rate of an asset’s depreciation with its actual use, although this isn’t technically required. This alignment tends to occur because an asset is most heavily used when it’s new, functional, and most efficient. 

Because this tends to occur at the beginning of the asset’s life, the rationale behind an accelerated method of depreciation is that it appropriately matches how the underlying asset is used. As an asset age, it is not used as heavily, since it is slowly phased out for newer assets.

Special Considerations

Using an accelerated depreciation method has financial reporting implications. Because depreciation is accelerated, expenses are higher in earlier periods compared to later periods. Companies may utilize this strategy for taxation purposes, as an accelerated depreciation method will result in a deferment of tax liabilities since income is lower in earlier periods.

Alternatively, public companies tend to shy away from accelerated depreciation methods, as net income is reduced in the short-term.

Types of Accelerated Depreciation Methods

Double-Declining Balance Method  

The double-declining balance (DDB) method is an accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable base—also known as the book value, for the remainder of the asset’s expected life.

For example, an asset with a useful life of five years would have a reciprocal value of 1/5 or 20%. Double the rate, or 40%, is applied to the asset’s current book value for depreciation. Although the rate remains constant, the dollar value will decrease over time because the rate is multiplied by a smaller depreciable base each period.

Sum of the Years’ Digits (SYD)

The sum-of-the-years’-digits (SYD) method also allows for accelerated depreciation. To start, combine all the digits of the expected life of the asset. For example, an asset with a five-year life would have a base of the sum-of-the-digits one through five, or 1 + 2 + 3 + 4 + 5 = 15. 

In the first depreciation year, 5/15 of the depreciable base would be depreciated. In the second year, only 4/15 of the depreciable base would be depreciated. This continues until year five depreciates the remaining 1/15 of the base.

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.

Understanding Accrued Interest

Accrued 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.

Accrual Accounting and Accrued Interest

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 – Accounting

Consider 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:

• (7.5% x (10 / 365)) x $20,000 = $41.10

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 – Bonds

Accrued 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.

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 = $16.67

Step 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 = $1,016.67

On 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 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) Formula

$\begin{aligned}&\text{MFM} = \frac {(\text{Close} – \text{Low} ) – ( \text{High} – \text{Close} ) } {\text{High} – \text{Low} } \\&\textbf{where:}\\&\text{MFM} = \text{Money Flow Multiplier} \\&\text{Close} = \text{Closing price} \\&\text{Low} = \text{Low price for the period} \\&\text{High} = \text{High price for the period} \\ \end{aligned}$​MFM=High−Low(Close−Low)−(High−Close)​where:MFM=Money Flow MultiplierClose=Closing priceLow=Low price for the periodHigh=High price for the period​

$\begin{aligned}&\text{Money Flow Volume} = \text{MFM} \times \text{Period Volume} \\ \end{aligned}$​Money Flow Volume=MFM×Period 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​

How to Calculate the A/D Line

1. Start by calculating the multiplier. Note the most recent period’s close, high, and low to calculate.
2. Use the multiplier and the current period’s volume to calculate the money flow volume.
3. Add the money flow volume to the last A/D value. For the first calculation, use money flow volume as the first value.
4. Repeat the process as each period ends, adding/subtracting the new money flow volume to/from the prior total. This is A/D.

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.

The A/D line is used to 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.

The 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. 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 a firm’s balance sheet data as an indicator of whether it has sufficient short-term assets to cover its short-term liabilities.

Understanding the Acid-Test Ratio

In 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 quickly liquidate. The acid test ratio is thus a more conservative metric.

Companies with an acid-test ratio of less than 1 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.

This is not a bad sign in all cases, however, 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. On the other hand, a very 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 Ratio

The numerator of the acid-test ratio can be defined in various ways, but the main 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:

$\begin{aligned} &\text{Acid Test} = \frac{ \text{Cash} + \text{Marketable Securities} + \text{A/R} }{ \text{Current Liabilities} } \\ &\textbf{where:} \\ &\text{A/R} = \text{Accounts receivable} \\ \end{aligned}$​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, which are debts and obligations that are 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, that company could be on much shakier ground than its ratio would indicate. The opposite can also be true.

Acid-Test Ratio Example

A 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):