Ratable Accrual Method - Definition
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Ratable Accrual Method Definition
The ratable accrual method refers to a technique used to determine the amount of income earned, at a given period and the period the amount was earned. In other words, the ratable accrual method is the one used to calculate interest income. Note that this method only calculates the sum of income or accrued expenses and not the amount paid. Key Takeaways
- The ratable accrual method refers to a technique used to determine the amount of income earned at a given period, and the period the amount was earned.
- Compared to other accrual methods used for determining accrued market discount, ratable accrual method has the greatest discount accrual.
- To calculate market discount, you will divide the number of days from the maturity date of the bond, subtracting the date which the bond was purchased, then multiplied by the number of days in which the bond was held.
A Little More on What is a Ratable Accrual Method
Compared to other accrual methods used for determining accrued market discount, ratable accrual method has the greatest discount accrual. Also, it uses a calculation method that is simpler. This is because, when it comes to calculating market discount, you will be required to divide the total days from the maturity date of the bond, then minus the bonds purchase date. This is then multiplied by the sum of days of holding the bond by the investor.
Example of the Ratable Accrual Method
Assume that an investor bought a $20,000 bond for $18,000 which has 400 days until the maturity date. The bond was then sold at $19,000 after a period of 300 days. For an investor to calculate interest income, he or she would take a part of the period within which the bond was held, and multiply it by the increased value. Below is the calculation: 300/400 = 0.75. $19,500-$18,000 = $1,500. 0.75 x $1,500 = $1,125 (Note that from the above calculation, the $1,125 is the income interest meant for tax). An alternative of ratable accrual method is to accrete the bond discount year after the other, instead of recording the entire bond discount accretion income during the sales year. Note that this alternative only works if, during the purchase year, there is a valid election being made.
Uses of Ratable Accrual Method
- For tax purposes, you can use the ratable accrual method to calculate interest income.
- In the secondary bond market, ratable accrual method can be used to calculate a discount bonds accrued market discount.
- Ratable accrual method can also be used to determine a real estates property tax over a number of tax periods it has been held.