Posts Tagged ‘Securities’

Accounting Principles Explained: How They Work, GAAP, IFRS

Written by admin. Posted in A, Financial Terms Dictionary

Accounting Principles Explained: How They Work, GAAP, IFRS

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What Are Accounting Principles?

Accounting principles are the rules and guidelines that companies and other bodies must follow when reporting financial data. These rules make it easier to examine financial data by standardizing the terms and methods that accountants must use.

The International Financial Reporting Standards (IFRS) is the most widely used set of accounting principles, with adoption in 167 jurisdictions. The United States uses a separate set of accounting principles, known as generally accepted accounting principles (GAAP).

Key Takeaways

  • Accounting standards are implemented to improve the quality of financial information reported by companies.
  • In the United States, the Financial Accounting Standards Board (FASB) issues generally accepted accounting principles (GAAP).
  • GAAP is required for all publicly traded companies in the U.S.; it is also routinely implemented by non-publicly traded companies as well.
  • Internationally, the International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS).
  • The FASB and the IASB sometimes work together to issue joint standards on hot-topic issues, but there is no intention for the U.S. to switch to IFRS in the foreseeable future.

The Purpose of Accounting Principles

The ultimate goal of any set of accounting principles is to ensure that a company’s financial statements are complete, consistent, and comparable.

This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies. Accounting principles also help mitigate accounting fraud by increasing transparency and allowing red flags to be identified.

The ultimate goal of standardized accounting principles is to allow financial statement users to view a company’s financials with certainty that the information disclosed in the report is complete, consistent, and comparable.

Comparability

Comparability is the ability for financial statement users to review multiple companies’ financials side by side with the guarantee that accounting principles have been followed to the same set of standards.

Accounting information is not absolute or concrete, and standards are developed to minimize the negative effects of inconsistent data. Without these rules, comparing financial statements among companies would be extremely difficult, even within the same industry. Inconsistencies and errors also would be harder to spot.

What Are the Basic Accounting Principles?

Some of the most fundamental accounting principles include the following:

  • Accrual principle
  • Conservatism principle
  • Consistency principle
  • Cost principle
  • Economic entity principle
  • Full disclosure principle
  • Going concern principle
  • Matching principle
  • Materiality principle
  • Monetary unit principle
  • Reliability principle
  • Revenue recognition principle
  • Time period principle

The most notable principles include the revenue recognition principle, matching principle, materiality principle, and consistency principle. Completeness is ensured by the materiality principle, as all material transactions should be accounted for in the financial statements. Consistency refers to a company’s use of accounting principles over time.

When accounting principles allow a choice among multiple methods, a company should apply the same accounting method over time or disclose its change in accounting method in the footnotes to the financial statements.

Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) are uniform accounting principles for private companies and nonprofits in the U.S. These principles are largely set by the Financial Accounting Standards Board (FASB), an independent nonprofit organization whose members are chosen by the Financial Accounting Foundation.

A similar organization, the Governmental Accounting Standards Board (GASB), is responsible for setting the GAAP standards for local and state governments. And a third body, the Federal Accounting Standards Advisory Board (FASAB), publishes the accounting principles for federal agencies.

Although privately held companies are not required to abide by GAAP, publicly traded companies must file GAAP-compliant financial statements to be listed on a stock exchange. Chief officers of publicly traded companies and their independent auditors must certify that the financial statements and related notes were prepared in accordance with GAAP.

Privately held companies and nonprofit organizations also may be required by lenders or investors to file GAAP-compliant financial statements. For example, annual audited GAAP financial statements are a common loan covenant required by most banking institutions. Therefore, most companies and organizations in the U.S. comply with GAAP, even though it is not a legal requirement.

Accounting principles differ around the world, meaning that it’s not always easy to compare the financial statements of companies from different countries.

International Financial Reporting Standards (IFRS)

The International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS). These standards are used in more than 120 countries, including those in the European Union (EU).

The Securities and Exchange Commission (SEC), the U.S. government agency responsible for protecting investors and maintaining order in the securities markets, has expressed interest in transitioning to IFRS. However, because of the differences between the two standards, the U.S. is unlikely to switch in the foreseeable future.

However, the FASB and the IASB continue to work together to issue similar regulations on certain topics as accounting issues arise. For example, in 2014, the FASB and the IASB jointly announced new revenue recognition standards.

Since accounting principles differ around the world, investors should take caution when comparing the financial statements of companies from different countries. The issue of differing accounting principles is less of a concern in more mature markets. Still, caution should be used, as there is still leeway for number distortion under many sets of accounting principles.

Who sets accounting principles and standards?

Various bodies are responsible for setting accounting standards. In the United States, generally accepted accounting principles (GAAP) are regulated by the Financial Accounting Standards Board (FASB). In Europe and elsewhere, International Financial Reporting Standards (IFRS) are established by the International Accounting Standards Board (IASB).

How does IFRS differ from GAAP?

IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the U.S. IFRS is seen as a more dynamic platform that is regularly being revised in response to an ever-changing financial environment, while GAAP is more static.

Several methodological differences exist between the two systems. For instance, GAAP allows companies to use either first in, first out (FIFO) or last in, first out (LIFO) as an inventory cost method. LIFO, however, is banned under IFRS.

When were accounting principles first set forth?

Standardized accounting principles date all the way back to the advent of double-entry bookkeeping in the 15th and 16th centuries, which introduced a T-ledger with matched entries for assets and liabilities. Some scholars have argued that the advent of double-entry accounting practices during that time provided a springboard for the rise of commerce and capitalism. What would become the American Institute of Certified Public Accountants (AICPA) and the New York Stock Exchange (NYSE) attempted to launch the first accounting standards to be used by firms in the United States in the 1930s.

What are some critiques of accounting principles?

Critics of principles-based accounting systems say they can give companies far too much freedom and do not prescribe transparency. They believe because companies do not have to follow specific rules that have been set out, their reporting may provide an inaccurate picture of their financial health. In the case of rules-based methods like GAAP, complex rules can cause unnecessary complications in the preparation of financial statements. These critics claim having strict rules means that companies must spend an unfair amount of their resources to comply with industry standards.

The Bottom Line

Accounting principles are rules and guidelines that companies must abide by when reporting financial data. Whether it’s GAAP in the U.S. or IFRS elsewhere, the overarching goal of these principles is to boost transparency and basically make it easier for investors to compare the financial statements of different companies.

Without these rules and standards, publicly traded companies would likely present their financial information in a way that inflates their numbers and makes their trading performance look better than it actually was. If companies were able to pick and choose what information to disclose and how, it would be a nightmare for investors.

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10-K Wrap

Written by admin. Posted in #, Financial Terms Dictionary

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What Is a 10-K Wrap?

A 10-K wrap is a summary report of a company’s annual performance that bundles the 10-K report required by the Securities and Exchange Commission (SEC) with additional commentary from the company, covering such things as the corporate vision, letter to shareholders, and business overview, among other topics.

The 10-K wrap is often released instead of a traditional annual report and generally contains fewer images and comments from management.

Key Takeaways

  • A 10-K wrap is part of a larger annual performance document required by the SEC.
  • The “wrap” is a short commentary covering the more personal side of the business, and usually includes a letter to the shareholders and a corporate vision statement.
  • The 10-K wrap report is shorter than a company’s annual report.
  • While a 10-K wrap (typically) has a lower-value production budget with limited graphics, its cover may be extremely polished by comparison.
  • The basic sections of a 10-K wrap summarize the company’s financial status, plus an overview of the company’s financial plans for upcoming quarters.
  • Usually, a 10-K wrap provides debt and spending level forecasts, as well.

Understanding a 10-K Wrap

Form 10-K is a detailed annual report that is required to be submitted to the U.S. Securities and Exchange Commission (SEC). The filing provides a comprehensive summary of a company’s performance for the year. It is more detailed than the annual report that is sent to shareholders during the annual meeting to elect directors. SEC filing 10-K outlines the company’s history, equity, subsidiaries, organizational structure, audited financial statements, and other relevant information.

The most significant difference between the traditional annual report and the 10-K wrap is how the information is presented and how much additional information is included above the required 10-K information.

The traditional annual report has a greater focus on comments from the company, and the document includes more images and graphs to communicate performance, as well as a list of corporate objectives of the company.

By contrast, the 10-K wrap is essentially the 10-K filed with the SEC and some additional editorial from the company—but not nearly as much as the annual report. It usually has a lower production cost because it is often printed on lower-quality paper.

 The 10-K wrap is typically made available in print and digital formats to maximize access for shareholders, investors, and analysts.

Elements of a 10-K Wrap

The basic elements of a 10-K wrap typically include a summary of the company’s financial results for the previous year and an overview of its plans for upcoming quarters, including spending and debt level forecasts.

A 10-K plan can also include an elaborate cover design, with perhaps a theme that focuses on investors and analysts involved in the company’s projects for the upcoming year.

Graphics in the 10-K wrap will usually provide a brief overview of the company’s financials, including revenue, net profit, costs, income, and any highlights from the previous year. The graphics may also outline the company’s geographical reach or other elements of growth.

2022 10-K Filing Deadlines

10-K: Due Monday, April 18, 2022, for the fiscal year ended on Jan. 31, 2022.

10-Q: Due Tuesday, May 10, 2022, for the quarterly period ended on March 31, 2022.

Special Considerations

As the 10-K wrap has evolved, it has come to include more images and content, such as a shareholder letter and high-quality photographs. However, pictures will often be kept to a minimum.

The 10-K wrap document is usually no more than four pages long and could be even shorter, depending on what company executives want to see from the 10-K wrap report.

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What Are Alternative Investments? Definition and Examples

Written by admin. Posted in A, Financial Terms Dictionary

What Are Alternative Investments? Definition and Examples

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What Is an Alternative Investment?

An alternative investment is a financial asset that does not fall into one of the conventional investment categories. Conventional categories include stocks, bonds, and cash. Alternative investments can include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.

Key Takeaways

  • An alternative investment is a financial asset that does not fit into the conventional equity/income/cash categories.
  • Private equity or venture capital, hedge funds, real property, commodities, and tangible assets are all examples of alternative investments.
  • Most alternative investments have fewer regulations from the U.S. Securities and Exchange Commission (SEC) and tend to be somewhat illiquid.
  • While traditionally aimed at institutional or accredited investors, alternative investments have become feasible to retail investors via alternative funds.

Understanding Alternative Investments

Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk. Many alternative investments have high minimum investments and fee structures, especially when compared to mutual funds and exchange-traded funds (ETFs). These investments also have less opportunity to publish verifiable performance data and advertise to potential investors. Although alternative assets may have high initial minimums and upfront investment fees, transaction costs are typically lower than those of conventional assets due to lower levels of turnover.

Most alternative assets are fairly illiquid, especially compared to their conventional counterparts. For example, investors are likely to find it considerably more difficult to sell an 80-year old bottle of wine compared to 1,000 shares of Apple Inc. due to a limited number of buyers. Investors may have difficulty even valuing alternative investments, since the assets, and transactions involving them, are often rare. For example, a seller of a 1933 Saint-Gaudens Double Eagle $20 gold coin may have difficulty determining its value, as there are only 13 known to exist and only one can be legally owned.

Regulation of Alternative Investments

Even when they don’t involve unique items like coins or art, alternative investments are prone to investment scams and fraud due to the lack of regulations.

Alternative investments are often subject to a less clear legal structure than conventional investments. They do fall under the purview of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and their practices are subject to examination by the U.S. Securities and Exchange Commission (SEC). However, they usually don’t have to register with the SEC. As such, they are not overseen or regulated by the SEC as are mutual funds and ETFs.

So, it is essential that investors conduct extensive due diligence when considering alternative investments. In some cases, only accredited investors may invest in alternative offerings. Accredited investors are those with a net worth exceeding $1 million—not counting their primary residence—or with an annual income of at least $200,000 (or $300,000 combined with a spousal income). Financial professionals who hold a FINRA Series 7, 65, or 82 license may also qualify as an accredited investor.

Some alternative investments are only available to accredited investors—e.g., those with a net worth above $1 million, or an annual income of at least $200,000.

Strategy for Alternative Investments

Alternative investments typically have a low correlation with those in standard asset classes. This low correlation means they often move counter to the stock and bond markets. This feature makes them a suitable tool for portfolio diversification. Investments in hard assets, such as gold, oil, and real property, also provide an effective hedge against inflation, which hurts the purchasing power of paper money.

Because of this, many large institutional funds such as pension funds and private endowments often allocate a small portion of their portfolios—typically less than 10%—to alternative investments such as hedge funds.

The non-accredited retail investor also has access to alternative investments. Alternative mutual funds and exchange-traded funds—also called alt funds or liquid alts—are now available. These alt funds provide ample opportunity to invest in alternative asset categories, previously difficult and costly for the average individual to access. Because they are publicly traded, alt funds are SEC-registered and regulated, specifically by the Investment Company Act of 1940.

Example of Alternative Investments

Just being regulated does not mean that alt funds are safe investments. The SEC notes, “Many alternative mutual funds have limited performance histories.”

Also, although its diversified portfolio naturally mitigates the threat of loss, an alt fund is still subject to the inherent risks of its underlying assets. Indeed, the track record of ETFs that specialize in alternative assets has been mixed.

For example, as of January 2022, the SPDR Dow Jones Global Real Estate ETF had an annualized five-year return of 6.17%. In contrast, the SPDR S&P Oil & Gas Exploration & Production ETF posted a return of –6.40% for the same period.

What Are the Key Characteristics of Alternative Investments?

Alternative investments tend to have high fees and minimum investments, compared to retail-oriented mutual funds and ETFs. They also tend to have lower transaction costs, and it can be harder to get verifiable financial data for these assets. Alternative investments also tend to be less liquid than conventional securities, meaning that it may be difficult even to value some of the more unique vehicles because they are so thinly traded.

How Can Alternative Investments Be Useful to Investors?

Some investors seek out alternative investments because they have a low correlation with the stock and bond markets, meaning that they maintain their values in a market downturn. Also, hard assets such as gold, oil, and real property are effective hedges against inflation. For these reasons, many large institutions such as pension funds and family offices seek to diversify some of their holdings in alternative investment vehicles.

What Are the Regulatory Standards for Alternative Investments?

Regulations for alternative investments are less clear than they are for more traditional securities. Although alternative investment vehicles are regulated by the SEC, their securities do not have to be registered. As a result, most of these investment vehicles are only available to institutions or wealthy accredited investors.

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Alternative Trading System (ATS) Definition, Regulation

Written by admin. Posted in A, Financial Terms Dictionary

Alternative Trading System (ATS) Definition, Regulation

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What Is an Alternative Trading System (ATS)?

An alternative trading system (ATS) is a trading venue that is more loosely regulated than an exchange. ATS platforms are often used to match large buy and sell orders among its subscribers. The most widely used type of ATS in the United States are electronic communication networks (ECNs)—computerized systems that automatically match buy and sell orders for securities in the market.

Key Takeaways

  • Alternative trading systems (ATS) are venues for matching large buy and sell transactions.
  • They are not as highly regulated as exchanges.
  • Examples of ATS include dark pools and ECNs.
  • SEC Regulation ATS establishes a regulatory framework for these trading venues.

Understanding an Alternative Trading System (ATS)

ATS account for much of the liquidity found in publicly traded issues worldwide. They are known as multilateral trading facilities in Europe, ECNs, cross networks, and call networks. Most ATS are registered as broker-dealers rather than exchanges and focus on finding counterparties for transactions.

Alternative trading system (ATS) is the terminology used in the U.S. and Canada. In Europe, they are known as multilateral trading facilities.

Unlike some national exchanges, ATS do not set rules governing the conduct of subscribers or discipline subscribers, other than by excluding them from trading. They are important in providing alternative means to access liquidity.

Institutional investors may use an ATS to find counterparties for transactions, instead of trading large blocks of shares on national stock exchanges. These actions may be designed to conceal trading from public view since ATS transactions do not appear on national exchange order books. The benefit of using an ATS to execute such orders is that it reduces the domino effect that large trades might have on the price of an equity.

Between 2013 and 2015, ATS accounted for approximately 18% of all stock trading, according to the Securities and Exchange Commission (SEC). That figure represented an increase of more than four times from 2005.

Criticisms of Alternative Trading Systems (ATS)

These trading venues must be approved by the SEC. In recent years, regulators have stepped up enforcement actions against ATS for infractions such as trading against customer order flow or making use of confidential customer trading information. These violations may be more common in ATS than national exchanges because ATS face fewer regulations.

Dark Pools

A hedge fund interested in building a large position in an equity may use an ATS to prevent other investors from buying in advance. ATS used for these purposes may be referred to as dark pools.

Dark pools entail trading on ATS by institutional orders executed on private exchanges. Information about these transactions is mostly unavailable to the public, which is why they are called “dark.” The bulk of dark pool liquidity is created by block trades facilitated away from the central stock market exchanges and conducted by institutional investors (primarily investment banks).

Although they are legal, dark pools operate with little transparency. As a result, dark pools, along with high-frequency trading (HFT), are oft-criticized by those in the finance industry; some traders believe that these elements convey an unfair advantage to certain players in the stock market.

Regulation of Alternative Trading Systems (ATS)

SEC Regulation ATS established a regulatory framework for ATS. An ATS meets the definition of an exchange under federal securities laws but is not required to register as a national securities exchange if the ATS operates under the exemption provided under Exchange Act Rule 3a1-1(a). To operate under this exemption, an ATS must comply with the requirements in Rules 300-303 of Regulation ATS.

To comply with Regulation ATS, an ATS must register as a broker-dealer and file an initial operation report with the Commission on Form ATS before beginning operations. An ATS must file amendments to Form ATS to provide notice of any changes to its operations, and must file a cessation of operation report on Form ATS if it closes. The requirements for filing reports using Form ATS is in Rule 301(b)(2) of Regulation ATS. These requirements include mandated reporting of books and records.

In recent times, there have been moves to make ATS more transparent. For example, the SEC amended Regulation ATS to enhance “operational transparency” for such systems in 2018. Among other things, this entails filing detailed public disclosures to inform the general public about potential conflicts of interest and risks of information leakage. ATS are also required to have written safeguards and procedures to protect subscribers’ trading information.

The SEC formally defines an alternative trading system as “any organization, association, person, group of persons, or systems (1) that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 under the Exchange Act; and (2) that does not (i) set rules governing the conduct of subscribers other than the conduct of such subscribers’ trading on such organization, association, person, group of persons, or system, or (ii) discipline subscribers other than by exclusion from trading.”

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