Posts Tagged ‘Standard’

Accounting Standard Definition: How It Works

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Accounting Standard Definition: How It Works

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What Is an Accounting Standard?

An accounting standard is a common set of principles, standards, and procedures that define the basis of financial accounting policies and practices.

Key Takeaways

  • An accounting standard is a set of practices and policies used to systematize bookkeeping and other accounting functions across firms and over time.
  • Accounting standards apply to the full breadth of an entity’s financial picture, including assets, liabilities, revenue, expenses, and shareholders’ equity.
  • Banks, investors, and regulatory agencies count on accounting standards to ensure information about a given entity is relevant and accurate.

Understanding Accounting Standards

Accounting standards improve the transparency of financial reporting in all countries. In the United States, the generally accepted accounting principles (GAAP) form the set of accounting standards widely accepted for preparing financial statements. International companies follow the International Financial Reporting Standards (IFRS), which are set by the International Accounting Standards Board and serve as the guideline for non-U.S. GAAP companies reporting financial statements.

The generally accepted accounting principles are heavily used among public and private entities in the United States. The rest of the world primarily uses IFRS. Multinational entities are required to use these standards. The International Accounting Standards Board (IASB) establishes and interprets the international communities’ accounting standards when preparing financial statements.

Accounting standards relate to all aspects of an entity’s finances, including assets, liabilities, revenue, expenses, and shareholders’ equity. Specific examples of accounting standards include revenue recognition, asset classification, allowable methods for depreciation, what is considered depreciable, lease classifications, and outstanding share measurement.

The American Institute of Accountants, which is now known as the American Institute of Certified Public Accountants, and the New York Stock Exchange attempted to launch the first accounting standards in the 1930s. Following this attempt came the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission. Accounting standards have also been established by the Governmental Accounting Standards Board for accounting principles for all state and local governments.

Accounting standards specify when and how economic events are to be recognized, measured, and displayed. External entities, such as banks, investors, and regulatory agencies, rely on accounting standards to ensure relevant and accurate information is provided about the entity. These technical pronouncements have ensured transparency in reporting and set the boundaries for financial reporting measures.

U.S. GAAP Accounting Standards

The American Institute of Certified Public Accountants developed, managed, and enacted the first set of accounting standards. In 1973, these responsibilities were given to the newly created Financial Accounting Standards Board. The Securities and Exchange Commission requires all listed companies to adhere to U.S. GAAP accounting standards in the preparation of their financial statements to be listed on a U.S. securities exchange.

Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities follow the same rules, accounting standards make the financial statements credible and allow for more economic decisions based on accurate and consistent information.

Financial Accounting Standards Board (FASB)

An independent nonprofit organization, the Financial Accounting Standards Board (FASB) has the authority to establish and interpret generally accepted accounting principles (GAAP) in the United States for public and private companies and nonprofit organizations. GAAP refers to a set of standards for how companies, nonprofits, and governments should prepare and present their financial statements.

Why Are Accounting Standards Useful?

Accounting standards improve the transparency of financial reporting in all countries. They specify when and how economic events are to be recognized, measured, and displayed. External entities, such as banks, investors, and regulatory agencies, rely on accounting standards to ensure relevant and accurate information is provided about the entity. These technical pronouncements have ensured transparency in reporting and set the boundaries for financial reporting measures.

What Are Generally Accepted Accounting Principles (GAAP)?

In the United States, the generally accepted accounting principles (GAAP) form the set of accounting standards widely accepted for preparing financial statements. Its aim is to improve the clarity, consistency, and comparability of the communication of financial information. Basically, it is a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants compile their financial statements.

What Are International Financial Reporting Standards (IFRS)?

International companies follow the International Financial Reporting Standards (IFRS), which are set by the International Accounting Standards Board and serve as the guideline for non-U.S. GAAP companies reporting financial statements. They were established to bring consistency to accounting standards and practices, regardless of the company or the country. IFRS is thought to be more dynamic than GAAP in that it is regularly being revised in response to an ever-changing financial environment.

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What Are Assurance Services, and Why Are They Important?

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What Are Assurance Services, and Why Are They Important?

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What Are Assurance Services?

Assurance services are a type of independent professional service usually provided by certified or chartered accountants such as certified public accountants (CPAs). Assurance services can include a review of any financial document or transaction, such as a loan, contract, or financial website. This review certifies the correctness and validity of the item being reviewed by the CPA.

Key Takeaways

  • Assurance services are a type of independent professional service usually provided by certified or chartered accountants such as CPAs.
  • Assurance Services are defined as independent professional services that improve the quality or context of information for decision-makers.
  • Information risk is reduced by assurance services, allowing for better decision making.
  • Businesses use assurance services to increase the transparency, relevance, and value of the information they disclose to the market and their investors.
  • Assurance services can be applied to risk assessments, business performance, information systems reliability, e-commerce, and healthcare performance.

Understanding Assurance Services

Assurance services are aimed at improving the quality of information for the individuals making decisions. Providing independent assurance is a way to bring comfort that the information on which one makes decisions is reliable, and therefore reduces risks, in this case, information risk.

Providers of assurance services will help clients navigate the complexities, risks, and opportunities in their partner networks by proactively managing and monitoring risks presented by third-party relationships. Businesses use assurance services to increase the transparency, relevance, and value of the information they disclose to the market and their investors. Many find by sharing business performance better, it becomes a sustainable growth and competitive differentiation strategy.

Technical guidance for certified accountants who wish to engage in assurance services can be found in the International Standard on Assurance Engagements (ISAE) 3000 and in The Assurance Sourcebook published by the Institute of Chartered Accountants in England and Wales (ICAEW) that also includes practical advice for firms choosing among different assurance services.

Certain regulations over the past years have increased the demand for assurance services, such as the Sarbanes-Oxley Act of 2002, with the goal of protecting investors from false financial information.

Types of Assurance Services

Assurance services can come in a variety of forms and are meant to provide the firm contracting the CPA with pertinent information to ease decision making. For example, the client could request that the CPA carefully go over all of the numbers and math that are on the client’s mortgage website to ensure that all of the calculations and equations are correct. Below is a list of the most common assurance services.

Risk Assessment

Entities are subjected to greater risks and more precipitous changes in fortune than ever before. Managers and investors are concerned about whether entities have identified the full scope of these risks and taken precautions to mitigate them. This service assures that an entity’s profile of business risks is comprehensive and evaluates whether the entity has appropriate systems in place to effectively manage those risks.

Business Performance Measurement

Investors and managers demand a more comprehensive information base than just financial statements; they need a “balanced scorecard.” This service evaluates whether an entity’s performance measurement system contains relevant and reliable measures for assessing the degree to which the entity’s goals and objectives are achieved or how its performance compares to its competitors.

Information Systems Reliability

Managers and other employees are more dependent on good information than ever and are increasingly demanding it online. It must be right in real-time. The focus must be on systems that are reliable by design, not correcting the data after the fact. This service assesses whether an entity’s internal information systems (financial and non-financial) provide reliable information for operating and financial decisions.

Electronic Commerce

The growth of electronic commerce has been hindered by a lack of confidence in the systems. This service assesses whether systems and tools used in electronic commerce provide appropriate data integrity, security, privacy, and reliability.

Healthcare Performance Measurement

The motivations in the $1 trillion healthcare industry have flipped 180 degrees in the last few years. The old system (fee for service) rewarded those who delivered the most services. The new system (managed care) rewards those who deliver the fewest services.

As a result, healthcare recipients and their employers are increasingly concerned about the quality and availability of healthcare services. This service provides assurance about the effectiveness of healthcare services provided by HMOs, hospitals, doctors, and other providers.

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Arbitrageur: Definition, What They Do, Examples

Written by admin. Posted in A, Financial Terms Dictionary

Activities of Daily Living (ADL)

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What Is an Arbitrageur?

An arbitrageur is a type of investor who attempts to profit from market inefficiencies. These inefficiencies can relate to any aspect of the markets, whether it is price, dividends, or regulation. The most common form of arbitrage is price.

Arbitrageurs exploit price inefficiencies by making simultaneous trades that offset each other to capture risk-free profits. An arbitrageur would, for example, seek out price discrepancies between stocks listed on more than one exchange by buying the undervalued shares on one exchange while short selling the same number of overvalued shares on another exchange, thus capturing risk-free profits as the prices on the two exchanges converge.

In some instances, they also seek to profit by arbitraging private information into profits. For example, a takeover arbitrageur may use information about an impending takeover to buy up a company’s stock and profit from the subsequent price appreciation.

Key Takeaways

  • Arbitrageurs are investors who exploit market inefficiencies of any kind. They are necessary to ensure that inefficiencies between markets are ironed out or remain at a minimum.
  • Arbitrageurs tend to be experienced investors, and need to be detail-oriented and comfortable with risk.
  • Arbitrageurs most commonly benefit from price discrepancies between stocks or other assets listed on multiple exchanges.
  • In such a scenario, the arbitrageur might buy the issue on one exchange and short sell it on the second exchange, where the price is higher.

Understanding an Arbitrageur

Arbitrageurs are typically very experienced investors since arbitrage opportunities are difficult to find and require relatively fast trading. They also need to be detail-oriented and comfortable with risk. This is because most arbitrage plays involve a significant amount of risk. They are also bets with regards to the future direction of markets.

Arbitrageurs play an important role in the operation of capital markets, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be.

Examples of Arbitrageur Plays

As a simple example of what an arbitrageur would do, consider the following.

The stock of Company X is trading at $20 on the New York Stock Exchange (NYSE) while, at the same moment, it is trading for the equivalent of $20.05 on the London Stock Exchange (LSE). A trader can buy the stock on the NYSE and immediately sell the same shares on the LSE, earning a total profit of 5 cents per share, less any trading costs. The trader exploits the arbitrage opportunity until the specialists on the NYSE run out of inventory of Company X’s stock, or until the specialists on the NYSE or LSE adjust their prices to wipe out the opportunity.

An example of an information arbitrageur was Ivan F. Boesky. He was considered a master arbitrageur of takeovers during the 1980s. For example, he minted profits by buying stocks of Gulf oil and Getty oil before their purchases by California Standard and Texaco respectively during that period. He is reported to have made between $50 million to $100 million in each transaction.

The rise of cryptocurrencies offered another opportunity for arbitrageurs. As the price of Bitcoin reached new records, several opportunities to exploit price discrepancies between multiple exchanges operating around the world presented themselves. For example, Bitcoin traded at a premium at cryptocurrency exchanges situated in South Korea as compared to the ones located in the United States. The difference in prices, also known as the Kimchi Premium, was mainly because of the high demand for crypto in these regions. Crypto traders profited by arbitraging the price difference between the two locations in real-time.

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After-Hours Trading: How It Works, Advantages, Risks, Example

Written by admin. Posted in A, Financial Terms Dictionary

Accrued Interest Definition & Example

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What Is After-Hours Trading?

After-hours trading is securities trading that starts at 4 p.m. U.S. Eastern Time after the major U.S. stock exchanges close. The after-hours trading session can run as late as 8 p.m., though volume typically thins out much earlier in the session. Trading in the after hours is conducted through electronic communication networks (ECNs).

Key Takeaways

  • After-hours trading starts once the the day’s normal trading session closes at 4 p.m. and ends at around 8 p.m.
  • Premarket trading sessions are also available to investors, generally from 7 a.m. to 9:25 a.m.
  • After-hours trading and premarket trading is referred to as extended-hours trading.
  • Advantages of after-hours trading include convenience and opportunity.
  • Risks include low liquidity, wide bid-ask spreads, and order restrictions.

What’s After-Hours Trading?

Understanding After-Hours Trading

Traders and investors engage in after-hours trading for a variety of reasons. They may prefer trading with fewer market participants or their schedules may require it. They may want to take positions as a result of news that breaks after the close of the stock exchange. Or, they may want to close out a position before they leave on vacation.

Generally, after-hours trading refers to trading that takes place after normal market hours and up until about 8 pm. Premarket trading refers to trading that takes place before the start of normal market hours, generally from 7 a.m. until 9:25 a.m. Together, after-hours trading and premarket trading are referred to as extended-hours trading.

The precise times of extended-hours trading can depend on the ECN an investor uses or the financial institution where they place their orders. For instance, Wells Fargo allows after-hours trading from 4:05 p.m. ET until just 5 p.m.

Electronic markets (or ECNs) used in after-hours trading automatically attempt to match up buy and sell orders. If they can do so, trades are completed. If they can’t, trades remain unfilled.

After-hours trading typically only allows limit orders to buy, sell, or short, although a particular brokerage may be less restrictive. No stop, stop-limit, or orders with special instructions (such as fill or kill or all or none) are accepted. Moreover, orders are normally only good for the after-hours trading session in which they’re placed.

The maximum share amount per order is 25,000.

Quotes provided are limited to those available through the electronic market used. Investors may have access to other participating ECNs but it isn’t guaranteed.

Volume

In after-hours trading, the trading volume for a stock may spike on the initial release of news but most of the time thins out as the session progresses. The growth of volume generally slows significantly by 6 p.m. So, there is a substantial risk that investors will be trading illiquid stocks after-hours. 

Price

Not only does volume sometimes come at a premium in the after-hours trading sessions, so does price. It is not unusual for the spreads to be wide in the after-hours. The spread is the difference between the bid and the ask prices. Due to fewer shares trading, the spread may be significantly wider than during the normal trading session.

Participation

If liquidity and prices weren’t enough to make after-hours trading risky, the lack of participants may do the trick. That’s why certain investors and institutions may choose not to participate in after-hours trading, regardless of news or events.

It’s quite possible for a stock to fall sharply in the after hours only to rise once the regular trading session resumes the next day at 9:30 a.m. Many big institutional investors have a certain view of price action during after-hours trading sessions and express that view with their trades once the regular market re-opens.

Since volume is thin and spreads are wide in after-hours trading, it is much easier to push prices higher or lower. Fewer shares and trades are needed to make a substantial impact on a stock’s price. That’s why after-hours orders usually are restricted to limit orders. If your brokerage doesn’t restrict them, consider them anyway as a means to protect yourself from unexpected price swings and order fills.

Standard Trading vs. After-Hours Trading

Standard Trading  After-Hours Trading
Orders placed anytime and executed from 9:30 a.m. to 4 p.m. ET. Orders placed and possibly executed after 4 p.m. through 8 p.m.
Takes place on stock exchanges and Nasdaq via market makers and ECNs Takes place via ECNs
No limit on order size 25,000 share maximum order size
No restrictions on order type Orders normally restricted to limit orders
Orders can carry over to subsequent sessions Orders normally expire in same trading session they’re placed
Wide variety of securities traded (stocks, options, bonds, mutual funds, ETFs) Most listed and Nasdaq securities are available
Large volume, greater liquidity = executed trades Orders may not get filled due to lower liquidity

Advantages of After-Hours Trading

The ability to place trades and have them filled in trading sessions that occur after normal stock exchange business hours can be important to some traders and investors. After-hours trading offers certain advantages.

Opportunity

Investors get the opportunity to trade on news that can move markets that’s released after the market closes or before it opens, such as the monthly jobs report or earnings reports. In addition, investors can take positions in response to unexpected events they believe may push prices higher (or lower).

After-hours trading may be an advantage to a dividend stock investor who misses the chance to buy a stock during regular market hours on the day before the ex-dividend date. The investor could try to buy it in after-hours trading in time to be eligible for the dividend.

Convenience

For any number of reasons, traders and investors may seek to trade after hours. For example, they may be occupied from 9:30 a.m. to 4 p.m. but still want to trade. Or, it might be part of a trading strategy to either take or close out positions when participants are fewer.

If the electronic communication network (ECN) that you’re using for after-hours trading suddenly becomes unavailable for technical reasons, your broker may try to direct orders to other participating ECNs so that they can continue to be filled. If this isn’t possible, a broker may find it necessary to cancel all orders entered for the after-hours session.

Risks of After-Hours Trading

If you’re considering after-hours trading, it’s important that you understand the risks associated with it. Bear in mind, these are on top of the inherent risks of stock trading.

In fact, some brokerages require that investors accept the ECN user agreement and speak with their brokerage representative before they’re allowed to trade, so that they fully grasp and accept those risks. Here’s a rundown:

  • Low liquidity: After-hours trading involves low volume trading. That means that investors may find it difficult (even impossible) to buy and sell stocks.
  • Price uncertainty: You may not see or get filled at the best available price since the prices/quotes available during after-hours trading are those provided by, usually, one ECN. They aren’t the consolidation of the best available prices that occurs in normal trading sessions.
  • Price volatility: Low liquidity results in volatile prices, which can make orders a challenge to fill.
  • Wider than normal bid-ask spreads: These can indicate an illiquid security, which can be difficult to buy or sell.
  • Competition: Professional traders abound in after-hours trading. This can spark volatility and the potential for greater than normal losses for less experienced investors.
  • Restricted orders: Depending on the ECN and brokerage, after-hours trading may be restricted to limit orders, which may mean your trades go unfilled.

Example of After-Hours Trading

Nvidia Corp. (NVDA) earnings results in February 2019 are an excellent example of the challenge of after-hours trading and the dangers that come with it. Nvidia reported quarterly results on Feb. 14. The stock was greeted by a big jump in price, rising to nearly $169 from $154.50 in the 10 minutes following the news.

As the chart shows, volume was steady in the first 10 minutes and then dropped quickly after 4:30 p.m. During the first five minutes of trading, around 700,000 shares traded and the stock jumped nearly 6%. However, volume slowed materially with just 350,000 shares trading between 4:25 and 4:30. By 5 p.m., volume measured only 100,000 shares, while the stock was still trading around $165.

Image by Sabrina Jiang © Investopedia 2020


However, the next morning was a different story. When the market opened for normal trading, traders and investors had a chance to weigh in on Nvidia’s results. From 9:30 a.m. 9:35 a.m., nearly 2.3 million shares traded, more than three times the volume in the initial minutes of the previous day’s after-hours trading. The price dropped from $164 to $161.

The stock proceeded to trade lower throughout the rest of the day, closing at $157.20. That was just $3 higher than the previous day’s close. Moreover, it was a plummet from the nearly $15 increase made in the after-hours session. Sadly, nearly all of the after-hours gains made by investors during that session had evaporated.

Does After-Hours Trading Affect Opening Price?

It certainly can. Since a great deal of trading may be taking place after hours, prices of securities can change from their levels when the regular market previously closed.

Can You Actually Trade After Hours?

Yes, provided your brokerage authorizes you to do so. You’ll first want to make sure you clearly understand how after-hours trading works and the risks involved in it. Your brokerage may ask that you meet with a investment representative to make sure you know the difficulties posed by after-hours and premarket trading.

Why Can Stocks Be So Volatile in After-Hours Trading?

Lower trading volume and less liquidity results when fewer traders and investors are in the market. This causes wider bid-ask spreads and, in turn, greater stock price volatility. This is the challenging trading environment that can exist in after-hours trading.

The Bottom Line

After-hours trading of securities occurs after the close of the regular trading session at 4 p.m. ET and can last until about 8 p.m. ET. While it offers investors certain advantages, it also can be quite risky. So, in addition to understanding those risks, be sure to consider your investing goals, your tolerance for risk, and your trading style before getting involved.

Most investors may want to stick with the familiar buy and hold strategy that can be executed during normal trading sessions. However, for those prepared for it, after-hours trading may be a useful investment tool and worth trying out.

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