What Is Acceptable Quality Level (AQL)?

The acceptable quality level (AQL) is a measure applied to products and defined in ISO 2859-1 as the “quality level that is the worst tolerable.” The AQL tells you how many defective components are considered acceptable during random sampling quality inspections. It is usually expressed as a percentage or ratio of the number of defects compared to the total quantity.

How Acceptable Quality Level (AQL) Works

Goods in a sample are tested at random, and if the number of defective items is below the predetermined amount, that product is said to meet the acceptable quality level (AQL). If the acceptable quality level (AQL) is not reached for a particular sampling of goods, manufacturers will review the various parameters in the production process to determine the areas causing the defects.

As an example, consider an AQL of 1% on a production run. This percentage means that no more than 1% of the batch can be defective. If a production run is composed of 1,000 products, only 10 products can be defective. If 11 products are defective, the entire batch is scrapped. This figure of 11 or more defective products is known as the rejectable quality level (RQL).

The AQL is an important statistic for companies seeking a Six Sigma level of quality control, which is a quality-control methodology developed in 1986 by Motorola, Inc. AQL is also known as the acceptable quality limit.

Industry Differences in AQL Standards

The AQL of a product can vary from industry to industry. For example, medical products are more likely to have more stringent AQL because defective products can result in health risks.

In contrast, a product with benign side-effects from a possible defect may have a less strict AQL, such as the remote control for a TV. Companies have to weigh the added cost associated with the stringent testing and potentially higher spoilage due to a lower defect acceptance with the potential cost of a product recall.

Customers would, of course, prefer zero-defect products or services; the ideal acceptable quality level. However, sellers and customers usually try to arrive at and set acceptable quality limits based on factors typically related to business, financial, and safety concerns.

Using AQL Tables

AQL tables (also sometimes called AQL charts) are designed to allow users to reference a standard for what qualifies as an acceptable number of defects in manufacturing. They allow a person to see how many defects would be allowed for a company to achieve a certain AQL. The tables are part of ISO 2859.

So for example, let’s say a company orders 30,000 hats from a clothing manufacturer that will be produced in one batch, and the buyer and producer have agreed on AQL 0.0 for critical defects, AQL 3.0 for major defects, and AQL 5.0 for minor defects. Referencing the AQL tables would allow the buyer and producer to determine how many hats would need to be inspected to ensure that the agreed upon AQL is being met during production.

AQL Defects

Instances of failure to meet customer quality requirements are termed as defects. In practice, there are three categories of defects:

1. Critical defects: Defects that, when accepted, could harm users. Such defects are unacceptable. Critical defects are defined as 0% AQL.
2. Major defects: Defects usually not acceptable by the end-users, as they are likely to result in failure. The AQL for major defects is 2.5%.
3. Minor defects: Defects not likely to reduce materially the usability of the product for its intended purpose but that differ from specified standards; some end users will still buy such products. The AQL for minor defects is 4%.

AQL in Practice

Acceptable quality level (AQL): AQL is typically considered to be the worst quality level that is still considered satisfactory. It is the maximum percent defective that can be considered satisfactory. The probability of accepting an AQL lot should be high. A probability of 0.95 translates to a risk of 0.05.

Rejectable quality level (RQL): This is considered an unsatisfactory quality level and is sometimes known as lot tolerance percent defective (LTPD). The consumer’s risk has been standardized in some tables as 0.1. The probability of accepting an RQL lot is low.

Indifference quality level (IQL): This quality level is somewhere between AQL and RQL. Different companies maintain different interpretations of each defect type. However, buyers and sellers agree on an AQL standard that is appropriate to the level of risk each party assumes. These standards are used as a reference during a pre-shipment inspection.

The Bottom Line

AQL can be a useful figure to help ensure that large orders for manufacturing are completed to a level of standard that a buyer demands. It also allows the seller to be efficient in their production while maintaining the standard set by the buyer. It is generally used in large-scale orders of production, and is helpful in keeping both buyer and seller happy while producing good quality products.

What Is Administrative Services Only (ASO)?

Administrative services only (ASO) refers to an agreement that companies use when they fund their employee benefit plan but hire an outside vendor to administer it. For example, an organization may hire an insurance company to evaluate and process claims under its employee health plan while maintaining the responsibility of paying the claims itself. An ASO arrangement contrasts with a company that purchases health insurance for its employees from an external provider.

Understanding Administrative Services Only (ASO)

Plan specifics for administrative services only (ASO) vary depending on the agreement a company establishes with insurance companies and third-party administrators (TPA). In ASO arrangements, the insurance company provides little to no insurance protection, which is in contrast to a fully insured plan sold to the employer.

As such, an ASO plan is a type of self-insured or self-funded plan. The employer takes full responsibility for claims made to the plan. For this reason, many employers using ASO plans also establish aggregate stop-loss policies in which the insurance company takes responsibility for paying claims that exceed a certain level—for example, $10,000 per insured person in exchange for a premium.

ASO insurance plans typically cover short-term disability, health, and dental benefits. Occasionally, they cover long-term disability for larger employers. ASO services are gaining popularity as many employers, particularly larger ones, explore the potential financial advantages that this type of plan can provide. An ASO may allow an employer to take greater control of benefit costs to meet the organization’s needs. However, ASO arrangements may not be suitable for all companies, and they come with certain risks. 

Traditional Administrator vs. Administrative Services Only (ASO)

A traditional administrator agreement is an arrangement whereby an insurance company fully administers claims. The insurance company is responsible for the services to maintain and manage plans, including making decisions on and covering the costs of claims.

Alternatively, under the ASO, the insurance company only provides administrative services for plans. The insurer serves as a third-party administrator to the employer, who assumes the duty to cover claim costs.

Under the traditional administrator agreement, premiums are fixed and reviewed annually. This arrangement makes it difficult for employers to know the impact of claims until premiums are assessed for the next year. With ASO arrangements, employers can, in real-time, keep track of fluctuating costs and plan accordingly.

Considering costs, when they exceed what was expected, premiums increase the following year with the traditional administrator. If costs are less than expected, the surplus remains with the insurance company. On the other hand, with an ASO agreement, the surplus is reinvested with the employer.

Advantages and Disadvantages of Administrative Services Only (ASO)

The costs for fully insured plans depend on an insurer’s evaluation of anticipated claims for a given year. For an ASO, however, annual funding levels are based on actual paid claims. If there are fewer claims than anticipated, then employers keep the surplus and reinvest the reserves. The surplus can translate into employers offering additional benefits, many of which would not be ordinarily covered by conventional health plans.

The total costs for an ASO are typically lower than those for a traditional administrator as the employer pays a negotiated fee to the third party rather than salaries and benefits to dedicated staff. These cost savings can offset rises in claims and be used to help the company grow. Alternatively, if claims consistently exceed forecasts, the cost for ASO may exceed that of a traditional administrator plan.

On the other hand, employers would be responsible for any deficit if claims exceed budgeted amounts. Catastrophic claims or sudden and unexpected events are of particular concern as they can exceed projected budgets and erode profits. Employers often invest in a stop-loss insurance policy to provide an additional level of protection in the event of these cases.

In some cases, an ASO arrangement may not be suitable for life insurance and extended healthcare benefits. Employers need to weigh the risks and benefits of how different ASO arrangements might affect their organizations.

Administrative Services Only FAQs

What Is a Recommended Stop Loss Level for an ASO Plan?

A common stop loss level for an ASO plan is $10,000 per eligible employee.

Is Self-Funded Healthcare the Same as Administrative Services Only?

Self-funded healthcare and administrative services only (ASO) are the same. These terms indicate an insurance arrangement in which the employer or organization assumes full responsibility for the cost of covered claims.

Who Keeps the Profits in Fully Insured Coverage?

Under a fully insured plan, the insurance company retains profits.

What Is an American Depositary Receipt (ADR)?

The term American depositary receipt (ADR) refers to a negotiable certificate issued by a U.S. depositary bank representing a specified number of shares—usually one share—of a foreign company’s stock. The ADR trades on U.S. stock markets as any domestic shares would.

ADRs offer U.S. investors a way to purchase stock in overseas companies that would not otherwise be available. Foreign firms also benefit, as ADRs enable them to attract American investors and capital without the hassle and expense of listing on U.S. stock exchanges.

How American Depositary Receipts (ADRs) Work

American depositary receipts are denominated in U.S. dollars. The underlying security is held by a U.S. financial institution, often by an overseas branch. These securities are priced and traded in dollars and cleared through U.S. settlement systems.

In order to begin offering ADRs, a U.S. bank must purchase shares on a foreign exchange. The bank holds the stock as inventory and issues an ADR for domestic trading. ADRs list on either the New York Stock Exchange (NYSE) or the Nasdaq, but they are also sold over-the-counter (OTC).

U.S. banks require that foreign companies provide them with detailed financial information. This requirement makes it easier for American investors to assess a company’s financial health.

Types of American Depositary Receipts

American depositary receipts come in two basic categories:

Sponsored ADRs

A bank issues a sponsored ADR on behalf of the foreign company. The bank and the business enter into a legal arrangement. The foreign company usually pays the costs of issuing an ADR and retains control over it, while the bank handles the transactions with investors. Sponsored ADRs are categorized by what degree the foreign company complies with Securities and Exchange Commission (SEC) regulations and American accounting procedures.

Unsponsored ADRs

A bank also issues an unsponsored ADR. However, this certificate has no direct involvement, participation, or even permission from the foreign company. Theoretically, there could be several unsponsored ADRs for the same foreign company, issued by different U.S. banks. These different offerings may also offer varying dividends. With sponsored programs, there is only one ADR, issued by the bank working with the foreign company.

One primary difference between the two types of ADRs is where they trade. All except the lowest level of sponsored ADRs register with the SEC and trade on major U.S. stock exchanges. Unsponsored ADRs will trade only over the counter. Unsponsored ADRs never include voting rights.

ADR Levels

ADRs are additionally categorized into three levels, depending on the extent to which the foreign company has accessed the U.S. markets.

Level I

This is the most basic type of ADR where foreign companies either don’t qualify or don’t want to have their ADR listed on an exchange. This type of ADR can be used to establish a trading presence but not to raise capital.

Level I ADRs found only on the over-the-counter market have the loosest requirements from the Securities and Exchange Commission (SEC) and they are typically highly speculative. While they are riskier for investors than other types of ADRs, they are an easy and inexpensive way for a foreign company to gauge the level of U.S. investor interest in its securities.

Level II

As with Level I ADRs, Level II ADRs can be used to establish a trading presence on a stock exchange, and they can’t be used to raise capital. Level II ADRs have slightly more requirements from the SEC than do Level I ADRs, but they get higher visibility and trading volume. 

Level III

Level III ADRs are the most prestigious. With these, an issuer floats a public offering of ADRs on a U.S. exchange. They can be used to establish a substantial trading presence in the U.S. financial markets and raise capital for the foreign issuer. Issuers are subject to full reporting with the SEC.

American Depositary Receipt Pricing and Costs

An ADR may represent the underlying shares on a one-for-one basis, a fraction of a share, or multiple shares of the underlying company. The depositary bank will set the ratio of U.S. ADRs per home-country share at a value that they feel will appeal to investors. If an ADR’s value is too high, it may deter some investors. Conversely, if it is too low, investors may think the underlying securities resemble riskier penny stocks.

Because of arbitrage, an ADR’s price closely tracks that of the company’s stock on its home exchange. Remember that arbitrage is buying and selling the same asset at the same time in different markets. This allows traders to profit from any differences in the asset’s listed price. 

ADR Fees

Investing in an ADR may incur additional fees that are not charged for domestic stocks. The depositary bank that holds the underlying stock may charge a fee, known as a custody fee, to cover the cost of creating and issuing an ADR.

This fee will be outlined in the ADR prospectus, and typically ranges from one to three cents per share. The fee will be either deducted from dividends, or passed on to the investor’s brokerage firm.

ADRs and Taxes

Holders of ADRs realize any dividends and capital gains in U.S. dollars. However, dividend payments are net of currency conversion expenses and foreign taxes. Usually, the bank automatically withholds the necessary amount to cover expenses and foreign taxes.

Since this is the practice, American investors would need to seek a credit from the IRS or a refund from the foreign government’s taxing authority to avoid double taxation on any capital gains realized.

Those interested in learning more about ADRs and other financial topics may want to consider enrolling in one of the best investing courses currently available.

Advantages and Disadvantages of American Depositary Receipts

As with any investment, there are distinct advantages and disadvantages of investing in ADRs. We’ve listed some of the main ones below.

Advantages

As noted above, ADRs are just like stocks. This means they trade on a stock exchange or over the counter, making them fairly easy to access and trade. Investors can also easily track their performance by reviewing market data.

Purchasing ADRs is easy because they’re available directly through American brokers. This eliminates the need to go through foreign channels to buy stock in a company in which you may be interested. Since they’re available domestically, shares are denominated in U.S. dollars. But that doesn’t mean you avoid any direct risks associated with fluctuations in currency rates.

One of the most obvious benefits of investing in ADRs is that they provide investors with a way to diversify their portfolios. Investing in international securities allows you to open your investment portfolio up to greater rewards (along with the risks).

Disadvantages

The main problems associated with ADRs are that they may involve double taxation—locally and abroad—and how many companies are listed. Unlike domestic companies, there are a limited number of foreign entities whose ADRs are listed for the public to trade.

As noted above, some ADRs may not comply with SEC regulations. These are called unsponsored ADRs, which have no direct involvement by the company. In fact, some companies may not even provide permission to list their shares this way.

Although investors can avoid any of the direct risks that come with currency exchange, they may incur currency conversion fees when they invest in ADRs. These fees are established in order to directly link the foreign security and the one traded on the domestic market.

History of American Depositary Receipts

Before American depositary receipts were introduced in the 1920s, American investors who wanted shares of a non-U.S. listed company could only do so on international exchanges—an unrealistic option for the average person back then.

While easier in the contemporary digital age, there are still drawbacks to purchasing shares on international exchanges. One particularly daunting roadblock is currency exchange issues. Another important drawback is the regulatory differences between U.S. and foreign exchanges.

Before investing in an internationally traded company, U.S. investors have to familiarize themselves with the different financial authority’s regulations, or they could risk misunderstanding important information, such as the company’s financials. They might also need to set up a foreign account, as not all domestic brokers can trade internationally.

ADRs were developed because of the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values. J.P. Morgan’s (JPM) predecessor firm Guaranty Trust pioneered the ADR concept. In 1927, it created and launched the first ADR, enabling U.S. investors to buy shares of famous British retailer Selfridges and helping the luxury depart store tap into global markets. The ADR was listed on the New York Curb Exchange.

A few years later, in 1931, the bank introduced the first sponsored ADR for British music company Electrical & Musical Industries (also known as EMI), the eventual home of the Beatles. Today, J.P. Morgan and BNY Mellon, another U.S. bank, continue to be actively involved in the ADR markets.

Real-World Example of ADRs

Between 1988 and 2018, German car manufacturer Volkswagen AG traded OTC in the U.S. as a sponsored ADR under the ticker VLKAY. In August 2018, Volkswagen terminated its ADR program. The next day, J.P. Morgan established an unsponsored ADR for Volkswagen, now trading under the ticker VWAGY.

Investors who held the old VLKAY ADRs had the option of cashing out, exchanging the ADRs for actual shares of Volkswagen stock—trading on German exchanges—or exchanging them for the new VWAGY ADRs.

The Bottom Line

American Depositary Receipts, or ADRs, allow Americans to invest in foreign companies. Although these companies do not ordinarily trade on the U.S. stock market, an ADR allows an investor to buy these stocks as easily as they would invest in any domestic stock. The arrangement also benefits foreign firms, allowing them to raise capital from the U.S. market.

Correction—Jan. 24, 2023: A previous version of this article wrongly stated that foreign currency exchange rate fluctuations do not affect the price of ADR and therefore ADR holders avoid any direct risks associated with fluctuations in currency rates. Actually, ADR have exchange rate risk and the price of an ADR is affected by the movements of both the company’s local share price and the national currency rate of exchange against the U.S. dollar.