Ratable Accrual Method

  

Categories: Accounting

You probably think of income tax going something like this: you get a check, and some of that check is withheld for taxes. Later, you file a little form that details when you got paid and what taxes got taken out. However, if you make money from more esoteric endeavors then working for a living, things get more complicated. As such, there are other ways to calculate the amount of taxes owed.

Enter the ratable accrual method. Instead of counting income as its paid, the income gets counted as it accrues. The process often comes up related to bond income.

The calculations for the ratable accrual method can get complicated, depending on the situation, but here's a simplified example:

A bond pays you $1,200 every quarter. You are set to collect your next $1,200 check on January 31. However, your tax year closes on December 31. If you're counting the income as it's paid, the full $1,200 would count in the next tax year. However, if you calculate the income as its accrued, then $800 was accrued before the end of the year, i.e. $1,200 divided by the three months in a quarter. January's $400 counts for next year, but the $800 for November and December count for this year.

Related or Semi-related Video

Finance: What is Accrued Interest?42 Views

00:00

Finance allah shmoop What is a crude interest A crude

00:07

interest would be an investment holding in oil Black crude

00:11

texas t remember jed boy Howdy coming Listen to a

00:15

story about a man named about that Alright all good

00:18

but that's not what a crude interest is at all

00:22

while street never sleeps right So even though a given

00:25

bond might pay forty bucks twice a year what happens

00:28

if you buy the bond midway through a semester period

00:32

Like let's say this particular bond has a coupon paying

00:35

eight percent a year So on a thousand dollars a

00:37

principle this bond pays eighty bucks a year in the

00:40

form of interest or forty bucks twice a year paid

00:43

on june thirtieth in december thirty first Well think about

00:46

the number's here on a monthly basis each month that

00:49

bond creeps closer to its next interest payment and over

00:53

the course of a year there are twelve creeps Different

00:56

creeps each month that goes by the bonds creep further

00:59

into the eighty dollars a year or eighty dollars per

01:02

twelve months or eight twelves of a bond payment each

01:05

month Well at eighty bucks a year despond pay six

01:09

Dollars and sixty seven cents a month in interest Yeah

01:12

we got the math there Yeah So let's say you

01:15

sell it halfway into its period Presumably the market price

01:18

would reflect the accrued interest on the bond or three

01:21

months worth of interest or three times that six sixty

01:24

seven figure or yes twenty bucks And that makes sense

01:27

right You've held that bond a quarter a quarter of

01:30

a year a quarter of a year's interest of eighty

01:33

boxes one fourth of eighty or yep twenty So yeah

01:37

the math works What do you know So the price

01:39

of the bond would creep upward to reflect that accrued

01:42

interest That is if you sold it on the exact

01:45

end of the quarter that thousand dollar bond which was

01:48

conveniently selling it exactly part The end of the last

01:51

payment Well that bond would likely sell in the market

01:54

place for about a thousand twenty dollars The buyer would

01:57

get a check for forty bucks just ninety days later

02:00

from the a company that issued the bond And well

02:02

they can take that forty dollars and reinvested in crude

02:06

oil How about that Now you've made old jed very

02:09

proud So come and listen to a story about a

02:11

man named shmoop Poor rests A writer barely kept his

02:14

family fed and one day there was a site of 00:02:18.46 --> [endTime] web and well stuff happens

Up Next

Finance: What is Accrual Accounting?
39 Views

What is Accrual Accounting? Accrual accounting is used to determine how well a company is doing by looking at the present and the future. It takes...

Find other enlightening terms in Shmoop Finance Genius Bar(f)