Posts Tagged ‘Work’

Aleatory Contract Definition, Use in Insurance Policies

Written by admin. Posted in A, Financial Terms Dictionary

Aleatory Contract Definition, Use in Insurance Policies

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What Is an Aleatory Contract?

An aleatory contract is an agreement whereby the parties involved do not have to perform a particular action until a specific, triggering event occurs. Events are those that cannot be controlled by either party, such as natural disasters and death. Aleatory contracts are commonly used in insurance policies. For example, the insurer does not have to pay the insured until an event, such as a fire that results in property loss. Aleatory contracts—also called aleatory insurance—are helpful because they typically help the purchaser reduce financial risk.

Key Takeaways

  • An aleatory contract is an agreement whereby the parties involved do not have to perform a particular action until a specific event occurs.
  • The trigger events aleatory contracts are those that cannot be controlled by either party, such as natural disasters or death.
  • Insurance policies use aleatory contracts whereby the insurer doesn’t have to pay the insured until an event, such as a fire resulting in property loss.

Understanding an Aleatory Contract

Aleatory contracts are historically related to gambling and appeared in Roman law as contracts related to chance events. In insurance, an aleatory contract refers to an insurance arrangement in which the payouts to the insured are unbalanced. Until the insurance policy results in a payout, the insured pays premiums without receiving anything in return besides coverage. When the payouts do occur, they can far outweigh the sum of premiums paid to the insurer. If the event does not occur, the promise outlined in the contract will not be performed.

How Aleatory Contracts Work

Risk assessment is an important factor to the party, taking a higher risk when considering entering into an aleatory contract. Life insurance policies are considered aleatory contracts, as they do not benefit the policyholder until the event itself (death) comes to pass. Only then will the policy allow the agreed amount of money or services stipulated in the aleatory contract. The death of someone is an uncertain event as no one can predict in advance with certainty that when the insured will die. However, the amount which the insured’s beneficiary will receive is certainly much more than what the insured has paid as a premium.

In certain cases, if the insured has not paid the regular premiums to keep the policy in force, the insurer is not obliged to pay the policy benefit, even though an insured has made some premium payments for the policy. In other types of insurance contracts, if the insured doesn’t die during the policy term, then nothing will be payable on maturity, such as with term life insurance.

Annuities and Aleatory Contracts

Another type of aleatory contract where each party takes on a defined level of risk exposure is an annuity. An annuity contract is an agreement between an individual investor and an insurance company whereby the investor pays a lump sum or a series of premiums to the annuity provider. In return, the contract legally binds the insurance company to pay periodic payments to the annuity holder—called the annuitant—once the annuitant reaches a certain milestone, such as retirement. However, the investor might risk losing the premiums paid into the annuity if they withdraw the money too early. On the other hand, the person might live a long life and receive payments that far exceed the original amount that was paid for the annuity.

Annuity contracts can be very helpful to investors, but they can also be extremely complex. There are various types of annuities each with its own rules that include how and when payouts are structured, fee schedules, and surrender charges—if money is withdrawn too soon.

Special Considerations

For investors who plan on leaving their retirement funds to a beneficiary, it’s important to note that the U.S. Congress passed the SECURE Act in 2019, which made rule changes to beneficiaries of retirement plans. As of 2020, non-spousal beneficiaries of retirement accounts must withdraw all of the funds in the inherited account within ten years of the owner’s death. In the past, beneficiaries could stretch out the distributions—or withdrawals—over their lifetime. The new ruling eliminates the stretch provision, which means all of the funds, including annuity contracts within the retirement account–must be withdrawn within the 10-year rule.

Also, the new law reduces the legal risks for insurance companies by limiting their liability if they fail to make annuity payments. In other words, the Act reduces the ability for the account holder to sue the annuity provider for breach of contract. It’s important that investors seek help from a financial professional to review the fine print of any aleatory contract as well as how the SECURE Act might impact their financial plan.

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Activity Cost Driver: Definition and Examples

Written by admin. Posted in A, Financial Terms Dictionary

Activity Cost Driver: Definition and Examples

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What Is an Activity Cost Driver?

An activity cost driver is an action that triggers higher or lower variable costs for a business. Sometimes referred to as a causal factor, it is associated with the managerial accounting concept of activity-based costing (ABC). Keeping tabs on activity cost drivers is important as it can help boost efficiency and company profits.

Key Takeaways

  • An activity cost driver is an action that triggers higher or lower variable costs for a business.
  • Activity cost drivers give a more accurate determination of the true cost of business activity by considering the indirect expenses.
  • Keeping tabs on these fluctuating costs can help boost efficiency and company profits.
  • Activity cost drivers are used in activity-based accounting (ABC).

How Activity Cost Drivers Work

A cost driver affects the cost of specific business activities. In ABC, an activity cost driver influences the costs of labor, maintenance, or other variable costs. Cost drivers are essential in ABC, a branch of managerial accounting that allocates the indirect costs, or overheads, of an activity.

There may be multiple cost drivers associated with an activity. For example, direct labor hours are a driver of most activities in product manufacturing. If the expenditure for labor is high, this will increase the cost of producing all company products or services. If the cost of warehousing is high, this will also increase the expenses incurred for product manufacturing or providing services.

Keeping tabs on cost drivers makes it easier to determine the actual cost of production and make more accurate financial projections.

More technical cost drivers are machine hours, the number of engineering change orders, the number of customer contacts, the number of product returns, the machine setups required for production, or the number of inspections. If a business owner can identify the cost drivers, the business owner can more accurately estimate the true cost of production for the business.

Cost Allocation

When a factory machine requires periodic maintenance, the cost of the maintenance is allocated to the products produced by the machine. For example, the cost driver selected is machinery hours. After every 1,000 machine hours, there is a maintenance expense of $500. Therefore, every machine hour results in a 50-cent (500 / 1,000) maintenance cost allocated to the product being manufactured based on the cost driver of machine hours.

Distribution of Overhead Costs

Using cost drivers simplifies the allocation of manufacturing overhead. The correct allocation of manufacturing overhead is important to determine the true cost of a product. Internal management uses the cost of a product to determine the prices of the products they produce. For this reason, the selection of accurate cost drivers has a direct impact on the profitability and operations of an entity.

Activity-based costing (ABC) is a more accurate way of allocating both direct and indirect costs. ABC calculates the true cost of each product by identifying the amount of resources consumed by a business activity, such as electricity or man hours.

Special Considerations: The Subjectivity of Cost Drivers

Management selects cost drivers as the basis for manufacturing overhead allocation. There are no industry standards stipulating or mandating cost driver selection. Company management selects cost drivers based on the variables of the expenses incurred during production.

What Are Some Examples of Activity Cost Drivers?

Activity cost drivers include direct labor hours, the cost of warehousing, order frequency, and product returns.

What Do You Mean by Cost Driver?

Cost drivers are the activities that trigger business expenses.

What Is the Activity-Based Costing Method?

Activity-based costing (ABC) is a method of assigning overhead and indirect costs—such as salaries and utilities—to products and services. Doing this helps to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy and churn out higher profits.

The Bottom Line

Examining activity cost drivers helps companies to reduce unnecessary expenses and get to grips with how much an order really costs. The importance of accessing this knowledge shouldn’t be understated. The ultimate goal is to maximize profits; a key way to accomplish this is by being aware of all expenses and keeping them in check.

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What Are Actual Deferral & Actual Contribution Percentage Tests?

Written by admin. Posted in A, Financial Terms Dictionary

What Are Actual Deferral & Actual Contribution Percentage Tests?

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What Are the Actual Deferral Percentage (ADP) & Actual Contribution Percentage (ACP) Tests?

The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are two tests that companies must conduct to ensure that their 401(k) plans don’t unfairly benefit highly-paid employees at the expense of others.

Companies that offer 401(k) plans must conduct the tests in order to retain the qualified status of their plans under IRS rules and the Employee Retirement Income Security Act (ERISA).

If the plan fails either test, the employer must take corrective action in the 12-month period following the close of the plan year in which the oversight occurred. Failure to do so can result in the IRS imposing pecuniary penalty fees, plan disqualification, and fiduciary liability on the part of the employer. 

How ADP and ACP Tests Work

The ADP test compares the average salary deferral percentages of highly compensated employees (HCE) to that of non-highly compensated employees (NHCE). An HCE is any employee who owns more than 5% interest in the company at any time during the current or previous plan year or earned more than $130,000 during the 2020 tax year. 

The ADP test takes into account both pre-tax deferrals and after-tax Roth deferrals, but no catch-up contributions, which may be made only by employees age 50 and over. To pass the test, the ADP of the HCE may not exceed the ADP of the NHCE by more than two percentage points. In addition, the combined contributions of all HCEs may not be more than two times the percentage of NHCE contributions.

The ACP test uses a similar method as the ADP test except that it uses matching contributions or employee after-tax contributions.

Correcting an ADP/ACP Test Failure

When employers fail the ADP/ACP tests, they can remedy the failure by refunding excess contributions back to HCEs in the amount necessary to pass the test. However, these refunds will be liable for income tax for the HCE individuals. 

Some companies set buffer zones within their plan documents to steer plans away from potentially failing the ADP/ACP test in the first place. One option is setting a cap on contributions by HCEs. Another option is to place a contribution limit on HCEs at the point where the plan would fail an ADP/ACP test. Setting plan buffer zones may require employers to conduct ADP/ACP test projections, typically in the middle of the plan year, to determine if any restrictions need to be applied. 

Still, some companies use a Safe Harbor 401(k) plan to avoid the ADP/ACP test entirely.

What Is a Safe Harbor Plan? 

Safe Harbor 401(k) plans allow sponsors to bypass ADP/ACP and other non-discrimination testing in exchange for providing eligible matching or nonelective contributions on behalf of their employees.

To qualify for Safe Harbor, a company must provide a basic match, such as a 100% match on the first 3% of deferred compensation and a 50% match on deferrals of 3% to 5%. They may also provide each employee with a nonelective contribution of at least 3% of compensation, regardless of how much the employee contributes or if they contribute at all.

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Appellate Courts: What Are Appellate Courts? How They Work, Functions, and Example

Written by admin. Posted in A, Financial Terms Dictionary

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What Are Appellate Courts?

Appellate courts, also known as the court of appeals, are the part of the American judicial system that is responsible for hearing and reviewing appeals from legal cases that have already been heard in a trial-level or other lower court.

Persons or entities such as corporations that experience an unsuccessful outcome in a trial-level or other lower courts may file an appeal with an appellate court to have the decision reviewed. If the appeal has merit, the lower ruling may be reversed. Appellate courts are present at both the state and federal levels and do not include a jury. 

Key Takeaways

  • Appellate courts hear and review appeals from legal cases that have already been heard and ruled on in lower courts. 
  • Appellate courts exist for both state and federal-level matters but feature only a committee of judges (often called justices) instead of a jury of one’s peers.
  • There are 13 appeals courts on the federal level, with each state having its own appeals court system, some of which include intermediate appellate courts.

How Appellate Courts Work

Appellate courts review the decisions of lower courts to determine if the court applied the law correctly. They exist as part of the judicial system to provide those who have judgments made against them an opportunity to have their case reviewed.

A publicly traded company with an unfavorable judgment against it will likely experience a drop in share price, but an appeal could overturn this previous ruling. If an appeal is successful, the stock price usually jumps.

Unsuccessful appeals may further be appealed to the Supreme Court.

Courts at the appellate level review the findings and evidence from the lower court and determine if there is sufficient evidence to support the determination made by the lower court. In addition, the appellate court will determine if the trial or lower court correctly applied the law.

The highest form of an appellate court in the U.S. is the U.S. Supreme Court, which hears only appeals of major importance and consequence.

Appellate Courts vs. Supreme Courts

Supreme courts typically have more authority and breadth than appellate courts. The U.S. Supreme Court is the highest legal authority there is in America and many states have their own supreme courts, or court of last resort.

Supreme courts review decisions made by appeals courts. Overall, there are 13 appellate courts on the federal level⁠—12 district appellate courts and an appeals court for the Federal Circuit. 

Many states have intermediate appellate courts, which serve as appeals courts meant to cut down on the workload for the state Supreme Court.

Forty-one of the 50 states have at least one intermediate appellate court.

Example of an Appellate Court Ruling

Shares of ride-sharing companies Uber Technologies Inc. and Lyft Inc. rose in the summer of 2020 after an appellate court granted a delay in the implementation of a new California law that requires many so-called “gig workers,” including drivers for ride-share companies, to be reclassified as employees.

In this instance, the appellate court decided that a previous ruling from a lower California court, affirming the constitutionality or legality of the state employment law, would be put on hold until it could evaluate the appeal and rule on its merits.

Not long after, investor hopes that Uber and Lyft could potentially get away with offering drivers no access to benefit plans or workers’ compensation coverage were dashed. In October of 2020, the California First District Court of Appeals ruled that the law was, in fact, legal and enforceable, meaning Uber and Lyft must treat their California drivers as employees, rather than independent contractors, and provide them with the benefits and wages they are entitled to under state labor law.

In February of 2021, the U.S. Supreme Court refused to hear Uber and Lyft’s appeal, affirming the lower court’s decision. The U.K. Supreme Court has also done the same.

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