What Is an Accredited Investor?

An accredited investor is an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities. They are entitled to this privileged access by satisfying at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.

In the U.S., the term accredited investor is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include high-net-worth individuals (HNWIs), banks, insurance companies, brokers, and trusts.

Understanding Accredited Investors

Accredited investors are legally authorized to purchase securities that are not registered with regulatory authorities like the SEC. Many companies decide to offer securities to this class of accredited investors directly. Because this decision allows companies exemption from registering securities with the SEC, it can save them a lot of money.

This type of share offering is referred to as a private placement. It has the potential to present these accredited investors with a great deal of risk. Therefore authorities need to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.

When companies decide to offer their shares to accredited investors, the role of regulatory authorities is limited to verifying or offering the necessary guidelines for setting benchmarks to determine who qualifies as an accredited investor. Regulatory authorities help determine if the applicant possesses the necessary financial means and knowledge to take the risks involved in investing in unregistered securities.

Accredited investors also have privileged access to venture capital, hedge funds, angel investments, and deals involving complex and higher-risk investments and instruments.

Requirements for Accredited Investors

The regulations for accredited investors vary from one jurisdiction to the other and are often defined by a local market regulator or a competent authority. In the U.S, the definition of an accredited investor is put forth by SEC in Rule 501 of Regulation D.

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.

A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. This amount cannot include a primary residence. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.

An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.

Recent Changes to the Accredited Investor Definition

Recently, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors.

On Aug. 26, 2020, the U.S. Securities and Exchange Commission amended the definition of an accredited investor. According to the SEC’s press release, “the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”

Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.

Purpose of Accredited Investor Requirements 

Any regulatory authority of a market is tasked with both promoting investment and safeguarding investors. On one hand, regulators have a vested interest in promoting investments in risky ventures and entrepreneurial activities because they have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may be focused on concept-only research and development activities without any marketable product, and may have a high chance of failure. If these ventures are successful, they offer a big return to their investors. However, they also have a high probability of failure.

On the other hand, regulators need to protect less-knowledgeable, individual investors who may not have the financial cushion to absorb high losses or understand the risks associated with their investments. Therefore, the provision of accredited investors allows access for both investors who are financially well-equipped, as well as investors who are knowledgeable and experienced.

There is no formal process for becoming an accredited investor. Rather, it is the responsibility of the sellers of such securities to take a number of different steps in order to verify the status of entities or individuals who wish to be treated as accredited investors. 

Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to respond to a questionnaire to determine if the applicant qualifies as an accredited investor. The questionnaire may require various attachments: account information, financial statements, and a balance sheet to verify the qualification. The list of attachments can extend to tax returns, W-2 forms, salary slips, and even letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Additionally, the issuers may also evaluate an individual’s credit report for additional assessment.

Example of an Accredited Investor

For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000. While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual’s primary residence. Net worth is calculated as assets minus liabilities.

This person’s net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.

The Bottom Line

The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand. But on the flip side, it gives people already starting off with large financial assets a major advantage over those with more modest assets.

What Is Accretion?

Accretion is the gradual and incremental growth of assets and earnings due to business expansion, a company’s internal growth, or a merger or acquisition. 

In finance, accretion is also the accumulation of the additional income an investor expects to receive after purchasing a bond at a discount and holding it until maturity. The most well-known applications of financial accretion include zero-coupon bonds or cumulative preferred stock.

Understanding Accretion

In corporate finance, accretion is the creation of value through organic growth or through a transaction. For example, when new assets are acquired at a discount or for a cost that is below their perceived current market value (CMV). Acccretion can also occur by acquiring assets that are anticipated to grow in value after the transaction.

In securities markets, purchasing bonds below their face or par value is considered buying at a discount, whereas purchasing above the face value is known as buying at a premium. In finance, accretion adjusts the cost basis from the purchase amount (discount) to the anticipated redemption amount at maturity. For example, if a bond is purchased for an amount totaling 80% of the face amount, the accretion is 20%.

Factoring in Bond Accounting

As interest rates increase, the value of existing bonds declines, which means that bonds trading in the market decline in price to reflect the interest rate increase. Since all bonds mature at the face amount, the investor recognizes additional income on a bond purchased at a discount, and that income is recognized using accretion.

Bond Accretion (Finance)

The rate of accretion is determined by dividing the discount by the number of years in the term. In the case of zero coupon bonds, the interest acquired is not compounding. While the bond’s value increases based on the agreed-upon interest rate, it must be held for the agreed-upon term before it can be cashed out.

Assume that an investor purchased a $1,000 bond for $860 and the bond matures in 10 years. Between the bond’s purchase and maturity dates, the investor needs to recognize additional income of $140. When the bond is purchased, the $140 is posted to a discount on the bond account. Over the next 10 years, a portion of the $140 is reclassified into the bond income account each year, and the entire $140 is posted to income by the maturity date.

Earnings Accretion (Accounting)

The earnings-per-share (EPS) ratio is defined as earnings available to common shareholders divided by average common shares outstanding, and accretion refers to an increase in a firm’s EPS due to an acquisition.

Examples of Accretion

For example, assume that a firm generates $2,000,000 in available earnings for common shareholders and that 1,000,000 shares are outstanding; the EPS ratio is $2. The company issues 200,000 shares to purchase a company that generates $600,000 in earnings for common shareholders. The new EPS for the combined companies is computed by dividing its $2,600,000 earnings by 1,200,000 outstanding shares, or $2.17. Investment professionals refer to the additional earnings as accretion due to the purchase.

As another example, if a person purchases a bond with a value of $1,000 for the discounted price of $750 with the understanding it will be held for 10 years, the deal is considered accretive. The bond pays out the initial investment plus interest. Depending on the type of bond purchase, interest may be paid out at regular intervals, such as annually, or in a lump sum upon maturity. If the bond purchase is a zero-coupon bond, there is no interest accrual.

Instead, it is purchased at a discount, such as the initial $750 investment for a bond with a face value of $1,000. The bond pays the original face value, also known as the accreted value, of $1,000 in a lump sum upon maturity.

A primary example within corporate finance is the acquisition of one company by another. First, assume the earnings per share of Corporation X is listed as $100, and earnings per share of Corporation Y is listed as $50. When Corporation X acquires Corporation Y, Corporations X’s earnings per share increase to $150. This deal is 50% accretive due to the increase in value.

However, sometimes, long-term debt instruments, like car loans, become short-term instruments when the obligation is expected to be fully repaid within one year. If a person takes out a five-year car loan, the debt becomes a short-term instrument after the fourth year.

What Is 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 an Accounting Method?

An accounting method refers to the rules a company follows in reporting revenues and expenses. The two primary methods of accounting are accrual accounting (generally used by companies) and cash accounting (generally used by individuals).

Cash accounting reports revenues and expenses as they are received and paid through cash inflows and outflows; accrual accounting reports them as they are earned and incurred through sales and purchases on credit and by using accounts receivable & accounts payable. Generally accepted accounting principles (GAAP) requires accrual accounting.

Understanding an Accounting Method

All businesses need to keep accounting records. Public companies are required to do so. Accounting allows a business to monitor every aspect of its finances, from revenues to costs to taxes and more. Without accurate accounting, a business would not know where it stood financially, most likely resulting in its demise.

Accounting is also needed to pay accurate taxes to the Internal Revenue Service (IRS). If the IRS ever conducts an audit on a company, it looks at a company’s accounting records and methods. Furthermore, the IRS requires taxpayers to choose an accounting method that accurately reflects their income and to be consistent in their choice of accounting method from year to year.

This is because switching between methods would potentially allow a company to manipulate revenue to minimize their tax burdens. As such, IRS approval is required to change methods. Companies may use a hybrid of the two methods, which is allowable under IRS rules if specified requirements are met.

Types of Accounting Methods

Cash Accounting

Cash accounting is an accounting method that is relatively simple and is commonly used by small businesses. In cash accounting, transactions are only recorded when cash is spent or received.

In cash accounting, a sale is recorded when the payment is received and an expense is recorded only when a bill is paid. The cash accounting method is, of course, the method most people use in managing their personal finances and it is appropriate for businesses up to a certain size.

If a business generates more than $25 million in average annual gross receipts for the preceding three years, however, it must use the accrual method, according to Internal Revenue Service rules.

Accrual Accounting

Accrual accounting is based on the matching principle, which is intended to match the timing of revenue and expense recognition. By matching revenues with expenses, the accrual method gives a more accurate picture of a company’s true financial condition.

Under the accrual method, transactions are recorded when they are incurred rather than awaiting payment. This means a purchase order is recorded as revenue even though the funds are not received immediately. The same goes for expenses in that they are recorded even though no payment has been made.

Example of an Accounting Method

The value of accrual accounting becomes more evident for large, complex businesses. A construction company, for example, may undertake a long-term project and may not receive complete cash payments until the project is complete.

Under cash accounting rules, the company would incur many expenses but would not recognize revenue until cash was received from the customer. So, the accounting book of the company would look weak until the revenue actually came in. If this company was looking for debt financing from a bank, for example, the cash accounting method makes it look like a poor bet because it is incurring expenses but no revenue.

Under accrual accounting, the construction company would recognize a percentage of revenue and expenses corresponding to the portion of the project that was complete. This is known as the percentage of completion method. How much actual cash coming into the company, however, would be evident in the cash flow statement. This method would show a prospective lender a much more complete and accurate picture of the company’s revenue pipeline.