Posts Tagged ‘Examples’

Accidental Death Benefit: What It Is, Examples of What It Covers

Written by admin. Posted in A, Financial Terms Dictionary

Accidental Death Benefit: What It Is, Examples of What It Covers

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What Is an Accidental Death Benefit?

Accidental death benefit is a payment due to the beneficiary of an accidental death insurance policy, which is often a clause or rider connected to a life insurance policy. The accidental death benefit (ADB) life insurance policy usually pays in addition to the standard benefit payable if the insured died of natural causes.

Depending on the policy’s issuer, an accidental death benefit may extend up to a year after the initial accident occurs, provided the accident led to the insured’s death.

Key Takeaways

  • An accidental death benefit is paid to the beneficiary of an accidental death insurance policy.
  • Accidental death benefit riders often end at a specific age, which is set by the insurance company.
  • Insurance companies often have strict perimeters of what constitutes an accidental death.
  • Accidental death benefits are optional riders, so they aren’t included in standard life insurance policies.
  • Certain jobs and workers in dangerous environments should consider an accidental death benefit rider.

Understanding Accidental Death Benefits

Accidental death benefits are riders or provisions that may be added to basic life insurance policies at the request of the insured party. Some people add accidental death benefit riders to their policies to protect their beneficiaries if an accident occurs. This is important as accidents are hard to predict and can lead to financial struggles if a sudden death occurs.

Accidental death benefits are important for people who work in or around potentially hazardous environments. Even those who drive more than average—either professionally or as a commuter—should consider accidental death benefit riders.

As an optional feature, the insured party must pay an additional fee on top of their regular premiums to purchase this benefit. Then, the accidental death benefit increases the payout to a policy’s beneficiary. So essentially the beneficiary receives the death benefit paid by the policy itself plus any additional accidental death benefit covered by the rider. These riders typically end once the insured person reaches a certain age, such as 60, 70, or 80.

What Is Considered Accidental Death?

Insurance companies define accidental death as an event that strictly occurs as a result of an accident. Deaths from car crashes, slips, choking, drowning, machinery, and any other situations that can’t be controlled are deemed accidental. In the case of a fatal accident, death usually must occur within a period specified in the policy.

Some policies’ accidental death benefits may also cover dismemberment—total or partial loss of limbs—burns, instances of paralysis, and other similar cases. These riders are called accidental death and dismemberment (AD&D) insurance.

Accidents typically exclude things like acts of war and death caused by illegal activities. Death from an illness is also excluded. Any hazardous hobbies that the insured regularly engages in—race car driving, bungee jumping, or other risky activities—are often excluded as well.

Types of Accidental Death Benefit Plans

Group Life Supplement

With a group life supplement, the accidental death benefit plan is included as part of a group life insurance contract, such as those offered by your employer. The benefit amount is usually the same as that of the group life benefit.

Voluntary

A voluntary accidental death benefit plan is offered to members of a group as a separate, elective benefit. Offered by your employer, premiums are your responsibility. You generally pay these premiums through regular payroll deductions. Employees are covered for accidents that occur while on the job. Policies pay out benefits for voluntary accident insurance even if the insured party isn’t at work.

Travel Accident

The accidental death benefit plan with travel accident insurance is provided through an employee benefit plan and provides supplemental accident protection to workers while they are traveling on company business. Unlike voluntary accident insurance, the employer usually pays the entire premium for this coverage.

Dependents

Some group accidental death benefit plans also provide coverage for dependents. If you have a spouse or partner, or children who depend on your salary to pay bills and other costs, it may be a good idea to enroll in an accidental death benefit.

This additional insurance could help them out by providing money to pay bills, pay off a mortgage, or provide money to your children for future events, like college. In addition, if you co-own a business, your business partner could be listed on your insurance policy to cover any outstanding debts, in the event of your death.

Example of Accidental Death Benefit

As a hypothetical example, assume you have a $500,000 life insurance policy with a $1 million accidental death benefit rider. If you die due to a heart attack—a natural cause—the insurance company will pay your beneficiary $500,000. If you die as a result of a car accident, your beneficiary will receive the $500,000 life insurance benefit plus the $1 million accidental death benefit for a total payout of $1.5 million.

What Is Considered Accidental Death for Insurance Purposes?

Insurance companies consider accidental death to be an event that causes your death as the result of an accident. For example, most car crashes, falls down the stairs, machinery, choking, and even drowning are circumstances beyond your control, and thus counted as accidental.

What Is Accidental Death and Dismemberment Insurance?

Accidental death and dismemberment insurance covers you in the case of accidental death, or if you lose a limb (or other significant injuries) in an accident that causes you to stop working. Besides being dismembered, the insurance may include, workplace injuries, injuries caused by a fire or flood, accidents with firearms, or a serious fall.

Are Accidental Death and Dismemberment Insurance and Accidental Death Benefit the Same Thing?

Both accidental death and dismemberment (AD&D) and accidental death benefit policies both pay a benefit. The main difference is that an AD&D policy will pay if the insured is dismembered or injured, whereas the ADB only pays a benefit if the insured dies.

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Advance Payment: What It Is, How It Works, Examples

Written by admin. Posted in A, Financial Terms Dictionary

Advance Payment: What It Is, How It Works, Examples

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What Is an Advance Payment?

Advance payment is a type of payment made ahead of its normal schedule such as paying for a good or service before you actually receive it. Advance payments are sometimes required by sellers as protection against nonpayment, or to cover the seller’s out-of-pocket costs for supplying the service or product.

There are many cases where advance payments are required. Consumers with bad credit may be required to pay companies in advance, and insurance companies generally require an advance payment in order to extend coverage to the insured party.

Key Takeaways

  • Advance payments are made before receiving a good or service.
  • In many cases, advance payments protect the seller against nonpayment in case the buyer doesn’t come and pay at the time of delivery.
  • Companies record advance payments as assets on their balance sheets.
  • A prepaid cell phone is an example of an advance payment.

Understanding Advance Payments

Advance payments are amounts paid before a good or service is actually received. The balance that is owed, if any, is paid once delivery is made. These types of payments are in contrast to deferred payments—or payments in arrears. In these cases, goods or services are delivered first, then paid for later. For example, an employee who is paid at the end of each month for that month’s work would be receiving a deferred payment.

Advance payments are recorded as assets on a company’s balance sheet. As these assets are used, they are expended and recorded on the income statement for the period in which they are incurred.

Advance payments are generally made in two situations. They can be applied to a sum of money provided before a contractually agreed-upon due date, or they may be required before the receipt of the requested goods or services.

Advance Payment Guarantees

An advance payment guarantee serves as a form of insurance, assuring the buyer that, should the seller fail to meet the agreed-upon obligation of goods or services, the advance payment amount will be refunded to the buyer. This protection allows the buyer to consider a contract void if the seller fails to perform, reaffirming the buyer’s rights to the initial funds paid.

Governments also issue advance payments to taxpayers like Social Security.

Special Considerations: Advance Payments to Suppliers

In the corporate world, companies often have to make advance payments to suppliers when their orders are large enough to be burdensome to the producer. This is especially true if the buyer decides to back out of the deal before delivery.

Advance payments can assist producers who do not have enough capital to buy the materials to fulfill a large order, as they can use part of the money to pay for the product they will be creating. It can also be used as an assurance that a certain amount of revenue will be brought in by producing the large order. If a corporation is required to make an advance payment, it is recorded as a prepaid expense on the balance sheet under the accrual accounting method.

Examples of Advance Payments

There are many examples of advance payments in the real world. Take prepaid cell phones, for example. Service providers require payment for cell services that will be used by the customer one month in advance. If the advance payment is not received, the service will not be provided. The same applies to payments for upcoming rent or utilities before they are contractually due.

Another example applies to eligible U.S. taxpayers who received advance payments through the Premium Tax Credit (PTC) offered as part of the Affordable Care Act (ACA). The financial assistance helps citizens, that meet household income requirements, pay for their health insurance. The money due to the taxpayer is paid to the insurance company in advance of the actual due date for the credit.

The American Rescue Plan, signed by President Biden on March 11, 2021, made some changes to the ACA Premium Tax Credit. All taxpayers with insurance bought on the Marketplace are now eligible for this credit in 2021 and 2022; previously, filers were ineligible if their income exceeded 400% of the federal poverty line.

Consumers with bad credit may also be required to provide creditors with advance payments before they can purchase goods or services.

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Annualized Rate of Return

Written by admin. Posted in A, Financial Terms Dictionary

Annualized Rate of Return

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What Is an Annualized Rate of Return?

An annualized rate of return is calculated as the equivalent annual return an investor receives over a given period. The Global Investment Performance Standards dictate that returns of portfolios or composites for periods of less than one year may not be annualized. This prevents “projected” performance in the remainder of the year from occurring.

Key Takeaways

  • The annualized rate of return is a process for determining investment returns on an annual basis. 
  • The rate of return looks at gains or losses on investments over varying periods of time, while the annualized rate looks at the returns on a yearly basis.
  • The annualized rate of return is expressed as a percentage and is consistent over the years that the investment has provided returns.
  • It differs from the annual performance of an investment, which can vary considerably from year-to-year.

Understanding Annualized Rate

Annualized returns are returns over a period scaled down to a 12-month period. This scaling process allows investors to objectively compare the returns of any assets over any period.

Calculation Using Annual Data

Calculating the annualized performance of an investment or index using yearly data uses the following data points:

P = principal, or initial investment

G = gains or losses

n = number of years

AP = annualized performance rate

The generalized formula, which is exponential to take into account compound interest over time, is:

AP = ((P + G) / P) ^ (1 / n) – 1

Annualized Rate of Return Examples

For example, assume an investor invested $50,000 into a mutual fund and, four years later, the investment is worth $75,000. This is a $25,000 gain in four years. Thus, the annualized performance is:

AP = (($50,000 + $25,000) / $50,000) ^ (1/4) – 1

In this example, the annualized performance is 10.67 percent.

A $25,000 gain on a $50,000 investment over four years is a 50 percent return. It is inaccurate to say the annualized return is 12.5 percent, or 50 percent divided by four because this does not take into effect compound interest. If reversing the 10.67 percent result to compound over four years, the result is exactly what is expected:

$75,000 = $50,000 x (1 + 10.67%) ^ 4

It is important not to confuse annualized performance with annual performance. The annualized performance is the rate at which an investment grows each year over the period to arrive at the final valuation. In this example, a 10.67 percent return each year for four years grows $50,000 to $75,000. But this says nothing about the actual annual returns over the four-year period. Returns of 4.5 percent, 13.1 percent, 18.95 percent and 6.7 percent grow $50,000 into approximately $75,000. Also, returns of 15 percent, -7.5 percent, 28 percent, and 10.2 percent provide the same result.

Using Days in the Calculation

Industry standards for most investments dictate the most precise form of annualized return calculation, which uses days instead of years. The formula is the same, except for the exponent:

AP = ((P + G) / P) ^ (365 / n) – 1

Assume from the previous example that the fund returned $25,000 over a 1,275-day period. The annualized return is then:

AP = (($50,000 + $25,000) / $50,000) ^ (365/1275) – 1

The annualized performance in this example is 12.31 percent.

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Amortization of Intangibles

Written by admin. Posted in A, Financial Terms Dictionary

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What Is the Amortization of Intangibles?

Amortization of intangibles, also simply known as amortization, is the process of expensing the cost of an intangible asset over the projected life of the asset for tax or accounting purposes. Intangible assets, such as patents and trademarks, are amortized into an expense account called amortization. Tangible assets are instead written off through depreciation. The amortization process for corporate accounting purposes may differ from the amount of amortization used for tax purposes.

Key Takeaways

  • Amortization of intangible assets is a process by which the cost of such an asset is incrementally expensed or written off over time.
  • Amortization applies to intangible (non-physical) assets, while depreciation applies to tangible (physical) assets.
  • Intangible assets may include various types of intellectual property—patents, goodwill, trademarks, etc.
  • Most intangibles are required to be amortized over a 15-year period for tax purposes.
  • For accounting purposes, there are six amortization methods—straight line, declining balance, annuity, bullet, balloon, and negative amortization.

Understanding the Amortization of Intangibles

For tax purposes, the cost basis of an intangible asset is amortized over a specific number of years, regardless of the actual useful life of the asset (as most intangibles don’t have a set useful life). The Internal Revenue Service (IRS) allows intangibles to be amortized over a 15-year period if it’s one of the ones included in Section 197.

Intangible assets are non-physical assets that can be assigned an economic value. Intellectual property (IP) is considered to be an intangible asset and is a broad term that encompasses most intangible assets. Most IP is covered under Section 197. Examples of these Section 197 intangible assets include patents, goodwill, trademarks, and trade and franchise names.

Not all IP is amortized over the 15-year period set by the IRS, however. There are certain exclusions, such as software acquired in a transaction that is readily available for purchase by the general public, subject to a nonexclusive license, and has not been substantially modified. In those cases and select others, the intangibles are amortized under Section 167.

Special Considerations

When a parent company purchases a subsidiary company and pays more than the fair market value (FMV) of the subsidiary’s net assets, the amount over fair market value is posted to goodwill (an intangible asset). IP is initially posted as an asset on the firm’s balance sheet when it is purchased.

IP can also be internally generated by a company’s own research and development (R&D) efforts. For instance, a company may win a patent for a newly developed process, which has some value. That value, in turn, increases the value of the company and so must be recorded appropriately.

In either case, the process of amortization allows the company to write off annually a part of the value of that intangible asset according to a defined schedule.

Amortization vs. Depreciation

Assets are used by businesses to generate revenue and produce income. Over a period of time, the costs related to the assets are moved into an expense account as the useful life of the asset dwindles. By expensing the cost of the asset over a period of time, the company is complying with GAAP, which requires the matching of revenue with the expense incurred to generate the revenue.

Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization. Depreciation generally includes a salvage value for the physical asset—the value that the asset can be sold for at the end of its useful life. Amortization doesn’t take into account a salvage value.

Intangible amortization is reported to the IRS using Form 4562.

Types of Amortization

For accounting (financial statement) purposes, a company can choose from six amortization methods: straight line, declining balance, annuity, bullet, balloon, and negative amortization. There are only four depreciation methods that can be used for accounting purposes: straight line, declining balance, sum-of-the-years’ digits, and units of production.

For tax purposes, there are two options for amortization of intangibles that the IRS allows. These are straight line and the income forecast method. The income forecast method can be used instead of the straight-line method if the asset is: motion picture films, videotapes, sound recordings, copyrights, books, or patents. For depreciation of physical assets, the IRS only allows the Modified Accelerated Cost Recovery System (MACRS).

Example of Amortization

Assume, for example, that a construction company buys a $32,000 truck to contractor work, and that the truck has a useful life of eight years. The annual depreciation expense on a straight-line basis is the $32,000 cost basis minus the expected salvage value—in this case, $4,000—divided by eight years. The annual deprecation for the truck would be $3,500 per year, or ($32,000 – $4,000) ÷ 8.

On the other hand, assume that a corporation pays $300,000 for a patent that allows the firm exclusive rights over the intellectual property for 30 years. The firm’s accounting department posts a $10,000 amortization expense each year for 30 years.

Both the truck and the patent are used to generate revenue and profit over a particular number of years. Since the truck is a physical asset, depreciation is used, and since the rights are intangible, amortization is used.

How Do You Define Amortization of Intangibles?

The term amortization of intangibles describes the process of expensing costs associated with intangible assets, such as patents and trademarks, over the course of their life. This is done for tax or accounting purposes. Simply referred to as amortization, these assets are expensed into an amortization account.

How Do You Compute Amortization of Intangibles?

There are several ways to calculate the amortization of intangibles. The most common way to do so is by using the straight line method, which involves expensing the asset over a period of time. Amortization is calculated by taking the difference between the cost of the asset and its anticipated salvage or book value and dividing that figure by the total number of years it will be used.

Where Do You Find Amortization of Intangibles on a Company’s Financial Statements?

Amortization of intangibles (or amortization for short) appears on a company’s profit and loss statement under the expenses category. This figure is also recorded on corporate balance sheets under the non-current assets section.

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