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Statutory Accounting Principles Working Group (E) to Develop SSAP Revisions Incorporating Definition of Principal-Based Obligations | Eversheds Sutherland (United States) LLP

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On August 26, 2021, the Statutory Accounting Principles Working Group (E) (SAP working group) of the National Association of Insurance Commissioners (NAIC) asked a new ’43R Study Group’ to continue work on a proposed principled obligation definition released on May 20, 2021 (Definition of proposed obligation). This group is responsible for proposing revisions to the Statement of statutory accounting principles (SSAP) # 26R and SSAP # 43R to incorporate the principles-based approach of the proposed obligation definition. The proposed definition of obligation is part of a project whose objective is to clarify what should be considered an obligation and Annex D-1: Long-term obligations. The project could result in significant changes to the current reporting categories in Schedule D-1, potentially excluding from the treatment of Schedule D-1 certain investments currently reported on Schedule D-1.

Investments eligible for treatment as bonds in Annex D-1 of an insurer’s statutory financial statements require a lower amount of risk capital (RBC) than equity instruments that are classified as assets in Annex BA. In addition, certain investments eligible for the treatment of obligations in Schedule D-1 may be eligible for valuation at amortized cost.

The SAPWG agreed that the next steps of the project will be as follows:

  • the development of a concept paper and the proposed revisions of the SSAP to incorporate the principle-based approach of the proposed definition of obligation,
  • development of statutory accounting principles (SAP) guidelines which specifically detail the accounting and reporting requirements for investments which are currently allowed to be classified as Annex D-1 investments and which are to be reclassified under these SAP guidelines and
  • development of more detailed reports on Annex D-1, which should result in significant changes to the current reporting categories in Annex D-1. For example, equity-backed bonds should be separately identifiable.

The first effective date of the proposed SSAP revisions is expected to be January 1, 2024. Until the adoption and entry into force of the revised guidelines, reporting entities may continue to report as they have been for investments currently within the scope of SSAP n ° 26R — Bonds Where SSAP n ° 43R – Loan-backed and structured securities.

During the SAPWG meeting, Julie Gann of the NAIC and Kevin Clark of the Iowa Division of Insurance indicated that there would be no “total grandfather” of the existing structures. They recognized that there will need to be a practical review of how the transition to the principled approach will happen.

Ms Gann also indicated that the SAPWG may proceed with a separate project to require, by January 1, 2024, consistent reporting by insurers of capital tranches of securitizations, including CLO capital tranches. It is expected that CLO equity and other equity tranches will need to be reported in Annex BA.

SAPWG Chairman Dale Bruggeman (OH) stressed the need for continued collaboration with the Securities Valuation Working Group and the Capital Adequacy Working Group as the project progresses. References to these working groups may be required with respect to credit quality / ratings and NAIC and RBC designations, respectively.

The remainder of this alert summarizes potential issues raised under the proposed bond definition with respect to “stapled investments” and debt securities backed by fund bonds (Debt of the chief financial officer), what questions should be addressed by the 43R Study Group.

  1. Stapled investments

The proposed bond definition addresses the following scenario involving a core investment: an insurer invests in a private equity fund under circumstances in which each fund investor is required to make 75% of its investment in debt and 25 % in the form of a share capital. According to the proposed definition of bond, if the debt is to be purchased with a proportional share of a stake in the fund and there is a restriction on the sale, disposal or transfer of the investment of the debt without also sell, cede or transfer the interest on a pro rata basis to the same party, the debt investment would not be classified as a Schedule D-1 obligation. The justification put forward for this conclusion is that the investor is in the same economic situation as if he held his entire investment in the form of a participation in the private equity fund. While “the debt investment would have legal priority of payment over the participation, the two interests must be contractually held in the same proportion by the reporting entity and cannot be sold, assigned or transferred independently, which does not give the priority that the reporting entity of payment over itself.

Working group members who participated in the August 26, 2021 call clarified that the treatment of stapled investments in the proposed bond definition could be changed following further discussion by the 43R Study Group. Study Group 43R will discuss the reasons why stapling exists to ensure that the treatment of stapled investments by the proposed bond definition will not have unintended consequences.

The 43R Study Group is expected to consider several issues relating to the treatment of investments stapled by the proposed bond definition:

  • What will be the statutory accounting and reporting and RBC processing of the portion of a stapled investment that is legal form debt?
  • Would such a portion of the debt be classified as a Schedule D-1 investment if the debt is not required to be purchased with a pro rata share of a stake in the private equity fund or if the debt is stapling is temporary?
  • Would the portion of the debt be classified as a Schedule D-1 obligation if the consent of a general partner, which should not be unreasonably withheld, is required for the sale, assignment or transfer of the business? investment of the insurer?

Debt of the CFO (see Annex I, example 3 of the proposed definition of obligation)

The insurance industry has raised several questions about the treatment of CFO debt in the proposed definition of obligation. According to the proposed definition of bonds, “debt securities guaranteed by equity [e.g., CFO debt] depend on distributions which are not contractually required and are not controlled by the issuer of the debt. Accordingly, there is a rebuttable presumption that a debt instrument secured by equity interests does not represent a creditor relationship in substance. In addition, the proposed definition of obligation would exclude CFO debt from Schedule D-1 if the CFO “relies significantly on the ability to refinance or sell the underlying holdings at maturity” .

[A] debt instrument the repayment of which depends significantly on the ability to refinance or sell the underlying holdings at maturity subjects the holder to a risk of valuation of the shares at a given point in time which is characteristic of the substance of the a relationship with shareholders rather than a relationship with creditors. Therefore, such an invocation would prevent the rebuttable presumption from being overcome.

A group of insurance industry stakeholders submitted a comment letter on the proposed definition of obligation that objected to excluding CFO debt from Schedule D-1 if debt repayment of the CFO depended significantly on the ability to refinance or sell the underlying collateral. . Interested parties pointed out that the phrase “significantly rests” can be interpreted to mean that only about 10% to 20% of such repayment is allowed from refinancing or the sale of collateral and they have done so. note that a failure of a CFO debt instrument to meet this test does not make the CFO classifiable as debt securities. Stakeholders support the elimination of the materiality rule in favor of an approach that assesses whether CFO debt qualifies for Schedule D-1 listing based on several factors, such as the diversification and characteristics of the underlying collateral, the amount of overcollateralisation and the presence of a liquidity facility intended to ensure payment of principal and contractual interest.

During the meeting, Mr. Clark noted that there was room for different views on the role of refinancing risk and he welcomed the continued discussions on the issue by regulators and regulators. insurers.

The treatment of CFO debt in the proposed definition of obligation raises several questions that Study Group 43R should consider further, including the following:

  • whether the debt of the CFO guaranteed by a diversified pool of private equity investments can be classified in the bond category of Annex D-1 if the repayment of the debt on the due date is based on refinancing but that CFO debt investors benefit from structural protections such as the following:
    • a maximum loan / value ratio (LTV) limitation which requires a sufficiently high level of overcollateralisation that a reasonable investor would refinance on the expected maturity date,
    • an increase in the coupon if the debt is not repaid on the due date,
    • the sponsor does not receive any cash flow if the LTV limit is exceeded or if the repayment of the CFO’s debt is not made on the due date and
    • a reserve account to cover debt service if necessary.
  • whether the debt of the CFO guaranteed by a diversified pool of private equity investments can be classified as a schedule D-1 obligation if the debt repayment is expected be constituted from the cash flows of the collateral at the expected maturity date and is obligatory to be made at the legal final maturity, provided that investors in CFO debt benefit from structural protections such as:
    • a maximum LTV limit which requires overcollateralisation by an amount intended to ensure that losses on the underlying collateral should not affect the payment of interest and principal
    • an increase in the coupon if the debt is not repaid on the due date,
    • the sponsor does not receive any cash flow if the LTV limit is not met or if the repayment of the CFO’s debt is not made on the due date and
    • a reserve account to cover debt service if necessary.
  • if the debt guaranteed by a diversified pool of large cap stocks can be classified in the bond category of Schedule D-1 if (1) the debt is 10 times oversized, (2) the dividends should cover the payments of interest but not more than 5% of the principal at maturity and (3) investors will decide whether they wish to refinance or sell securities to pay the principal at maturity.

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Mortgage amortization strategies

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For many people, buying a home is the biggest financial investment they will ever make. Due to the high price, most people generally need a mortgage. A mortgage is a type of amortized loan in which debt is paid off in regular installments over a period. The amortization period refers to the length of time, in years, that a borrower chooses to pay off a mortgage.

Although the most popular type is the 30-year fixed rate mortgage, buyers have other options, including 15-year mortgages. The amortization period affects not only the time it will take to pay off the loan, but also the amount of interest that will be paid over the life of the mortgage. Longer amortization periods usually mean smaller monthly payments and higher total interest charges over the life of the loan.

Shorter amortization periods, on the other hand, usually result in larger monthly payments and lower total interest charges. It’s a good idea for anyone looking for a mortgage to look at the various amortization options to find the one that works best in terms of manageability and potential savings. Here, we take a look at different mortgage amortization strategies for today’s homebuyers.

Key points to remember

  • Choosing the period over which you have to pay off your mortgage is a compromise between lower monthly payments and a lower overall cost.
  • The maturity of a mortgage follows an amortization schedule that keeps monthly payments equal while changing the relative amount of principal versus interest on each payment.
  • The longer the amortization schedule (say 30 years), the more affordable the monthly payments, but at the same time, the more interest payable to the lender over the life of the loan.

Amortization tables

The exact amount of principal and interest that make up each payment is indicated in the mortgage amortization plan (or amortization table). In the beginning, more of each monthly payment goes towards interest. Interest on a mortgage is tax deductible. If you are in a high tax bracket, this deduction will be more valuable than for those with lower tax rates. With each subsequent payment, more and more of the payment goes to principal and less to interest, until the mortgage is paid in full and the lender files a Mortgage Satisfaction with the county office. or the Land Registry Office.

Longer amortization periods reduce monthly payment

Loans with longer amortization periods have smaller monthly payments because you have more time to pay off the loan. This is a good strategy if you want more manageable payouts. The following figure shows an abbreviated example of an amortization schedule for a $ 200,000 30-year fixed rate loan at 4.5%:

Table 1: Mortgage amortization schedule
Month Payment Principal paid Interest paid
1 $ 1,013.37 $ 263.37 $ 750.00
2 $ 1,013.37 $ 264.36 $ 749.01
3 $ 1,013.37 $ 265.35 $ 748.02
180 (15 years) $ 1,013.37 $ 516.62 $ 496.75
240 (20 years) $ 1,013.37 $ 646.70 $ 366.67
300 (25 years) $ 1,013.37 $ 809.53 $ 203.84
360 (final payment) $ 1,013.37 $ 1,009.58 $ 3.79
NOTE: The mortgage payment for this 30-year 4.5% fixed rate mortgage is always the same each month ($ 1,013.37). The amounts that go towards principal and interest, however, change each month. Here are the first three months of the amortization schedule, then the payments at 180, 240, 300, and 360 months.

Summary of the 30-year fixed rate 4.5% loan:

  • Mortgage amount = $ 200,000
  • Monthly payment = $ 1,013.37
  • Interest amount = $ 164,813.42
  • Total cost = $ 364,813.20

Shorter amortization periods save you money

If you choose a shorter amortization period, say 15 years, you will have higher monthly payments, but you will also save significantly on interest over the life of the loan and you will own your home sooner. In addition, the interest rates on short-term loans are generally lower than those on longer-term loans. It’s a good strategy if you can comfortably cope with the higher monthly payments without undue hardship.

Remember that even though the amortization period is shorter, it still consists of making 180 sequential payments. It is important to determine whether or not you can maintain this level of payment.

Figure 2 shows what the amortization schedule looks like for the same $ 200,000 loan at 4.5%, but with amortization over 15 years (again, a shortened version for simplicity):

Table 2: Mortgage amortization schedule
Month Payment Principal paid Interest paid
1 $ 1,529.99 $ 799.99 $ 750.00
2 $ 1,529.99 $ 782.91 $ 747.08
3 $ 1,529.99 $ 785.85 $ 744.14
60 (5 years) $ 1,529.99 $ 976.38 $ 553.60
120 (10 years) $ 1,529.99 $ 1,222.23 $ 307.75
180 (final payment) $ 1,529.99 $ 1,524.27 $ 5.72
NOTE: The same loan of $ 200,000 at 4.5%, but with 15 year amortization. The first three months of the amortization schedule are shown, as are the payments at 60, 120 and 180 months.

Summary of the 15-year fixed rate 4.5% loan:

  • Mortgage amount = $ 200,000
  • Monthly payment = $ 1,529.99
  • Interest amount = $ 75,397.58
  • Total cost = $ 275,398.20

As the two examples show, the longer 30-year amortization translates to a more affordable payment of $ 1,013.37, compared to $ 1,529.99 for the 15-year loan, a difference of 516.62 $ per month. This can make a big difference for families on a tight budget or who just want to cap their monthly spending.

The two scenarios also illustrate that amortization over 15 years saves $ 89,416 in interest costs. While a borrower can comfortably afford higher monthly payments, considerable savings can be made with a shorter amortization period.

Expedited payment options

Even with a longer amortizing mortgage, it is possible to save money on interest and pay off the loan faster with accelerated amortization. This strategy involves adding additional payments to your monthly mortgage bill, which saves you tens of thousands of dollars and frees you from debt (at least in terms of the mortgage) years earlier.

Take the $ 200,000 30-year mortgage from the example above. If an additional payment of $ 100 were applied to principal each month, the loan would be paid off in full in 25 years instead of 30, and the borrower would realize a savings of $ 31,745 in interest payments. Bring that up to $ 150 more each month, and the loan would be satisfied in 23 years with a savings of $ 43,204.16. Even a single additional payment made each year can lower the interest amount and shorten the amortization, as long as the payment goes towards the principal and not the interest (make sure your lender treats the payment this way).

Naturally, you shouldn’t give up basic necessities or withdraw money from profitable investments to make additional payments. But cutting back on unnecessary expenses and spending that money on additional payments can be a good financial idea. And unlike the 15-year mortgage, it gives you the option of paying less for a few months.

Online mortgage amortization calculators can help you decide which mortgage is best for you and calculate the impact of making additional mortgage payments. Additionally, mortgage calculators can be used to determine the best interest rates available. To get started, try this calculator.

Alternative

Variable rate mortgages can allow you to pay even less per month than a 30-year fixed rate mortgage, and you may be able to adjust payments in other ways that could correspond to an expected increase in your personal income. . However, monthly payments on these can increase – the frequency depends on economic indicators and how the contract is drafted – and with mortgage interest still at near historic levels, they are probably a reckless bet for most people. owners. Likewise, interest-only mortgages and other types of balloon mortgages often have low payments, but will leave you with a huge balance at the end of the loan term, also a risky bet.

The bottom line

Deciding which mortgage you can afford shouldn’t be left up to the lender alone: ​​even in today’s lending climate with its stricter standards, you may be approved for a larger loan than you really need. If you like the idea of ​​a shorter amortization period so that you can pay less interest and own your home sooner, but can’t afford the higher payments, consider looking for a homeowner. house in a lower price range. With a smaller mortgage, you may be able to make higher payments that come with a shorter amortization period.

Since so many factors can influence which mortgage is best for you, it’s important to assess your situation. If you’re considering a huge mortgage and you’re in a high tax bracket, for example, your mortgage deduction is likely to be better than if you have a small mortgage and you’re in a lower tax bracket. Or, if you are getting good returns from your investments, it may not make financial sense to reduce your portfolio buildup to make higher mortgage payments. The best thing to do financially is to assess your needs and circumstances and take the time to determine the best mortgage amortization strategy for you.

Investopedia requires that writers use primary sources to support their work. These include white papers, government data, original reports, and interviews with industry experts. We also reference original research from other reputable publishers where applicable. You can read more about the standards we follow to produce accurate and unbiased content in our
editorial policy.

  1. Consumer Financial Protection Bureau. “Understand the loan options.” Accessed August 11, 2021.

  2. Internal Tax Service. “Publication 936 (2020), Home Mortgage Interest Deduction.” Accessed August 11, 2021.

  3. Financial reference. “Accelerated depreciation”. Accessed August 11, 2021.


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Changes in amortization of research and development

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Starting next year, companies will have to amortize their research and development (R&D) expenses over five years rather than immediately deducting them from taxable income, a policy change designed to increase federal tax revenues in the short term. As policymakers decide the future of this planned tax change, one option would be to delay amortization of R&D spending by four years until 2026. Within the ten-year budget window, a four-year delay would cost about $ 100 billion less than writing off outright depreciation, but that wouldn’t increase long-term economic growth.

The outright reversal of R&D depreciation would reduce federal revenues by about $ 131 billion between 2022 and 2031, while increasing long-term GDP and U.S. revenues by 0.1%. Delaying depreciation until 2026, on the other hand, would cost about $ 33.6 billion, or $ 100 billion less than write-off, over those ten years and would not increase GDP in the long run.

Effect on revenues of the deferral of R&D amortization until 2026
2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2022-2031
Conventional – $ 40.6 – $ 26.0 – $ 16.3 -10.6 $ – $ 5.2 $ 29.9 $ 17.5 $ 10.0 $ 5.8 $ 1.8 – $ 33.6

Source: General equilibrium model of the Tax Foundation, July 2021

Although deferring depreciation would cost less during the budget period, it would not increase GDP in the long run because temporary changes in tax policy do not affect long-term incentives. Temporary tax policy can change the timing of investment decisions, but not the long-term after-tax return on investment, which means that the long-term size of the economy is not affected.

There is also a risk that R&D expense will become a permanent “tax extender”, creating uncertainty about the tax treatment of R&D when companies make investment decisions.

While it may be better to extend the full deduction of R&D expenses until 2026 rather than allowing depreciation in 2022, a superior option for economic growth and the stability of the tax code would be to permanently cancel the tax code. future amortization of R&D expenses.

Modeling the timing of R&D deductions and impact on federal revenues

The move from full support for R&D costs to depreciation over five years temporarily limits the amount of deductions that companies can take. This increases the amount of basic income, and this income is one of the reasons R&D depreciation was included in the Tax Cuts and Jobs Act (TCJA). Delaying the switch to depreciation delays these higher incomes and has a somewhat counterintuitive interaction with the baseline of the current law.

As part of the deferral, between 2022 and 2026, companies would continue to take immediate deductions instead of amortizing them over five years. This would reduce corporate taxable income and tax liability during those years, which would reduce federal revenues. Between 2027 and 2031, businesses would begin to write off deductions, which would increase the taxable income and tax liability of businesses, thereby increasing federal revenues.

The table below illustrates the temporal difference of the delay compared to the reference base of the current law.

Imagine a company making $ 100 in R&D investments every year. The cost of this investment is fully deductible in 2021. Under current law, as of 2022, only one-fifth of the investment, or $ 20, is deductible each year. As a new investment is made each year, one-fifth is deductible, meaning that by 2023 the business would benefit from a total of $ 40 in deductions (reflecting one-fifth of the 2022 investment plus one-fifth of the ‘2023 investment). The trend continues until deductions for the 2022 investment are completed in 2026, when the total allowable deductions each year would stabilize. The total deductions each year would reflect one fifth of the total investment for the current year and the previous four years.

We can compare the deductions allowed each year under the current law baseline to the deductions allowed each year if depreciation is delayed to see how the schedule of deductions would change in the latter scenario.

If depreciation were delayed, more deductions would be allowed earlier in the budget window, reducing federal revenues from 2022 to 2026, as shown in Table 1. For example, in 2023, deductions would total $ 40 under the current law, but $ 100 if depreciation was delayed. After depreciation begins in 2026, the same phased-in deductions occur over five years, increasing federal revenues. For example, in 2028, deductions would have already increased to $ 100 under current law, but would only be $ 60 with the late option.

In the long run, however, both options have the same effect on annual revenue – from a federal budget perspective, this is simply a short-term change in the timing of deductions.

Illustrating how tax deductions for R&D change under current law and delay depreciation by 4 years
2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Total annual investment in R&D $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100
Total annual deductions under current law (amortization over 5 years from 2022) $ 20 40 $ $ 60 $ 80 $ 100 $ 100 $ 100 $ 100 $ 100 $ 100
Total annual deductions when 5-year amortization is deferred until 2026 $ 100 $ 100 $ 100 $ 100 $ 20 40 $ $ 60 $ 80 $ 100 $ 100
Difference in value of R&D deductions for the amortization period $ 80 $ 60 40 $ $ 20 -80 $ -60 $ -40 $ -20 $ $ 0 $ 0

Source: author’s calculations. Note: The face value of the R&D investment and the deductions are not adjusted for inflation.

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Sports owner deductions and depreciation

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In recent weeks, media have reported how wealthy taxpayers who own sports teams are reducing their tax liability by deducting the cost of purchasing a sports team over 15 years. Contrary to claims that deducting the cost of a sports team from taxable income is a “loophole”, such deductions are a normal and proper part of the income tax system.

Under current law, owners of sports teams can deduct the cost of purchasing a team over 15 years from their taxable income. Deductions are known as depreciation, and they are like taking depreciation deductions for the cost of physical assets but for intangible assets. Deductions for depreciation and depreciation ensure that businesses are taxed on net income.

For example, imagine a sports team bought by an investor for $ 10 million. From an accounting standpoint, deducting the cost of $ 10 million from taxable income over the next 15 years matches the deductions against income generated in the future to calculate a uniform measure of net income. If the $ 10 million deduction was not allowed, the sports team investor would effectively be taxed on the team’s purchase (as an excise tax) and on future income generated, rather than on the net income produced by the team.

The history of amortization of expenses for sports teams can also be instructive. Prior to 2004, many intangible costs associated with sports teams could not be amortized, but other deductions were allowed and were often the subject of tax disputes between sports team owners and the IRS. Properly valuing teams, allocating costs, and matching depreciation deductions to actual changes in the value of the sports team have proven difficult to administer.

In 2004, the tax law changed to allow owners of sports teams to write off intangible expenses. The Joint Committee on Taxation (JCT) actually called the change an increase in federal revenues – roughly $ 382 million over 10 years – because it ended disputes between sports team owners and the IRS in the past. subject of authorized deductions which tended to reduce revenue.

One of the concerns with the tax treatment of sports teams is that their purchase may be in part an expense of entertainment for the owners of the team, which would be a form of consumption and properly subject to tax under taxes. state sales. Skeptics of granting capital cost allowances to sports teams may argue that this is a good reason to deny deductions for federal income tax purposes, but the implications of doing so – essentially turning federal income tax into excise tax, but only under certain circumstances – would be a mess. And that would penalize the owners of sports teams who run them entirely for business purposes.

A more constructive alternative to concerns about tax-free consumption by the rich would be to levy consumption taxes in a direct and progressive manner. It would be less complicated and lead to less economic distortions than trying to create a refined system of amortization and depreciation deductions based on consumption within companies – which history tells us is full of complexities of business. ‘evaluation and litigation.

Providing deductions for business expenses is an integral part of our income tax system, even when the business is a sports team.

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Definition of accelerated depreciation

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What is accelerated depreciation?

Accelerated amortization is a process by which a mortgagor makes additional payments on the mortgage principal. With accelerated amortization, the borrower is allowed to add additional payments to their mortgage bill to pay off a mortgage before the loan settlement date.

The advantage of accelerated amortization is that it reduces the overall interest payments paid by the borrower over the life of the loan. And, of course, he pays off the debt sooner.

Accelerated depreciation should not be confused with accelerated depreciation, an accounting method for recognizing the decline in value of an item of property, plant and equipment over its useful life.

Key points to remember

  • Accelerated amortization occurs when a borrower makes additional payments on the principal of their mortgage in excess of the amount declared due.
  • There are a number of ways a borrower can make expedited payments, including increasing the amount of each payment or making more frequent payments.
  • Borrowers use an accelerated amortization strategy to save money on interest and pay off their mortgage faster.
  • Accelerated amortization has drawbacks: it can deprive the borrower of a tax deduction, and some lenders charge prepayment penalties.

How accelerated depreciation works

A mortgage loan is a type of amortized loan, which means that the borrower repays the loan in regular (usually monthly) installments over a period of time. These payments consist of both principal and interest.

Initially, most of the borrower’s payments will go towards paying the interest accrued on the loan, with a smaller portion of each payment going to pay off the principal. This ratio will reverse over time, and a larger portion of the borrower’s payment will go to repay the principal and a smaller portion will go to interest.

When a loan is taken out, the mortgage lender provides the borrower with an amortization schedule. This table shows how much of the borrower’s payment each month will be applied to the principal and how much interest until the loan is repaid.

With accelerated amortization, the borrower will make additional mortgage payments beyond what is shown in the amortization schedule. A borrower can speed up their loan amortization by increasing either the amount of each payment or the frequency of payments (bi-weekly mortgages are a common example). The additional accelerated payments serve directly to reduce the loan principal, which in turn reduces the outstanding balance and the amount owed on future interest payments.

Example of accelerated depreciation

Let’s say Amy has an initial mortgage loan of $ 200,000 at a fixed interest rate of 4.5% for 30 years. Composed of principal and interest, the monthly payment is $ 1,013.37. Increasing the payment by $ 100 per month will result in a loan repayment period of 25 years instead of the original 30 years, saving Amy five years in interest.

Benefits of accelerated depreciation

Adopting an accelerated amortization strategy has several advantages for borrowers.

The most obvious is that it shortens the term of the loan, which means you get rid of your debts sooner. Specifically, paying off a mortgage on an accelerated basis decreases the loan principal more quickly, which means that your equity (interest) in the home is also increasing faster. This increases your net worth and often strengthens your credit score.

In addition, accelerated amortization decreases the overall amount of additional interest incurred by the borrower. As a general rule, the longer a loan lasts, the more interest you pay. Although the interest rate itself does not change, by reducing the principal, you reduce the total interest charged on that principal, saving you money in the long run.

Limits of accelerated depreciation

There are also reasons why it might not make sense to prepay mortgage debt. The most important reason is that the interest on mortgage debt is tax deductible, according to the US tax code. Anyone who takes out a mortgage from December 15, 2017 to December 31, 2025 can deduct interest on a mortgage of up to $ 750,000, or $ 375,000 for married taxpayers filing separately. Although fewer US homeowners are choosing to claim the deduction than in the past, it does provide some homeowners with significant tax savings. By paying off a mortgage sooner, these homeowners could increase the income tax they owe.

In such a scenario, it may be wise for homeowners to use the funds they would have used for accelerated depreciation to invest in a retirement or college fund. Such a fund would generate a return while retaining the tax advantage of a mortgage interest deduction. However, very affluent buyers, who already have sufficient retirement funds and sufficient capital to make other investments, may want to pay off their mortgage sooner.

Some lenders include a prepayment penalty in their mortgage contracts. This is a clause that imposes a penalty on the borrower if they significantly repay or pay off their mortgage for a specified period (usually within the first five years of the mortgage issuance).

Special considerations

In the United States, homeowners typically take out a 30-year fixed-interest mortgage, secured by the property itself. The length of the loan and the fact that the interest rate is not variable mean that borrowers in the United States generally pay a higher interest rate on their loans than borrowers in other countries, such as Canada, where the interest rate on a mortgage is typically reset every five years.


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Amortization calculator

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An amortization calculator is useful for understanding the long-term cost of a fixed rate mortgage because it shows the total principal you will pay over the life of the loan. It is also helpful in understanding how your mortgage payments are structured. If you’ve ever wondered how much of your monthly payment will go to interest and how much will go to principal, an amortization calculator is an easy way to get that information.

Key points to remember

  • When you have a fully amortizing loan like a mortgage or car loan, you will pay the same amount each month. The lender will allocate a progressively smaller portion of your interest payment and a progressively larger portion of your principal payment until the loan is paid off.
  • Amortization calculators make it easy to see how monthly loan payments are divided into interest and principal.
  • You can use a regular calculator or a spreadsheet to do your own depreciation calculations, but an depreciation calculator will provide a faster result.

Estimate your monthly amortization payment

When you amortize a loan, you pay it back gradually through periodic interest and principal payments. A self-amortizing loan will be fully repaid when you make the last periodic payment.

The periodic payments will be your monthly principal and interest payments. Each monthly payment will be the same, but the amount that goes towards interest will gradually decrease each month, while the amount that will go towards principal will gradually increase each month. The easiest way to estimate your monthly amortization payment is to use an amortization calculator.

Explanation of the results of the amortization calculator

To use an amortization calculator, you will need these inputs:

Amount of the loan: How much are you planning to borrow or how much have you already borrowed?

Term of the loan: How many years do you have to repay the loan?

Interest rate: How much does the lender charge you each year for the loan?

With these entries, the Amortization Calculator will display your monthly payment.

For example, if your mortgage amount is $ 150,000, your loan term is 30 years and your interest rate is 3.5%, your monthly payment will be $ 673.57. The amortization schedule will also tell you that your total 30-year interest will be $ 92,484 ($ 92,484.13 to be precise, as the amortization schedule will show you).

For this and other additional details, you’ll want to dig into the amortization schedule.

What is an amortization schedule?

An amortization schedule gives you a full breakdown of each monthly payment showing how much goes towards principal and how much goes towards interest. It can also show the total interest you will have paid at any given time during the term of the loan and what your principal balance will be at any time.

Using the same $ 150,000 loan example above, an amortization schedule will show you that your first monthly payment will consist of $ 236.07 in principal and $ 437.50 in interest. Ten years later, your payment will be $ 334.82 in principal and $ 338.74 in interest. Your final monthly payment after 30 years will have less than $ 2 in interest, with the remainder paying off the last balance of your principal.

How do you calculate an amortization plan yourself?

A loan amortization schedule is calculated using the loan amount, the loan term and the interest rate. If you know these three things, you can use Excel’s PMT function to calculate your monthly payment. In our example above, the information to enter in an Excel cell would be = PMT (3.5% / 12,360 150,000). The result will be $ 673.57.

Once you know your monthly payment, you can calculate how much of your monthly payment goes to principal and how much goes to interest using this formula:

Principal payment = Total monthly payment – [Outstanding Loan Balance x (Interest Rate/12 Months)]

Multiply $ 150,000 by 3.5% / 12 to get $ 437.50. This is your interest payment for your first monthly payment. Subtract it from your monthly payment to get your principal payment: $ 236.07.

Next month your loan balance will be $ 236.07 lower, so you’ll repeat the calculation with a principal of $ 149,763.93. This time your interest payment will be $ 436.81 and your principal payment will be $ 236.76.

Just repeat this 358 times and you will have an amortization schedule for a 30-year loan yourself. Now you know why using a calculator is so much easier. But it’s good to understand how the math behind the calculator works.

You can create an amortization schedule for an adjustable rate mortgage, but that involves guesswork. If you have an ARM 5/1, the amortization schedule for the first five years is easy to calculate because the rate is fixed for the first five years. After that, the rate will adjust once a year. The terms of your loan indicate by how much your rate can increase each year and the highest rate can go, as well as the lowest rate.

How to calculate depreciation with an additional payment

Sometimes people want to pay off their loans faster to save money on interest. Even if you have a low interest rate, you might decide to make an additional payment on your principal when you can afford it because you don’t want to be in debt.

If you wanted to add $ 50 to each monthly payment, you could use the formula above to calculate a new amortization schedule and see how long you would pay off your loan sooner and how much interest you would have to pay less. In this example, investing an additional $ 50 per month on your mortgage would increase the monthly payment to $ 723.57.

Your interest payment in month 1 would still be $ 437.50, but your principal payment would be $ 286.07. Your loan balance for the second month would then be $ 149,713.93 and the interest payment for the second month would be $ 436.67. You will have already saved 14 cents in interest! No, it’s not very exciting. What’s exciting is that if you held it until your loan was paid off, your total interest would rise to $ 80,545.98 instead of $ 92,484.13. You would also be free of your debts almost three and a half years earlier.

Mortgage amortization is not the only one

We’ve talked a lot about mortgage amortization so far, because that’s what people usually think of when they hear the word “amortization”. But a mortgage is not the only type of loan that can pay off. Auto loans, home equity loans, student loans, and personal loans are also amortized. They have fixed monthly payments and a predetermined repayment date.

What types of loans do not amortize? If you can borrow money again after you’ve paid it off and you don’t have to pay off your entire balance by a certain date, then you have an amortizing loan. Examples of non-amortizing loans are credit cards and lines of credit.

How can using an amortization calculator help me?

Our amortization calculator can help you do several things:

  1. See how much principal you will owe at a future date during the term of your loan.
  2. See how much interest you’ve paid on your loan so far.
  3. See how much interest you will pay if you keep the loan until the end of its term.
  4. Figure out how much equity you should have if you question your monthly loan statement.
  5. See how much interest you’ll pay over the life of a loan and show the impact of choosing a longer or shorter loan term or getting a higher or lower interest rate.

The bottom line

An amortization calculator offers a convenient way to see the effect of different loan options. By changing the inputs (interest rate, loan term, amount borrowed), you can see what your monthly payment will be, how much of each payment will go to principal and interest, and what your long-term interest charges will be. This type of calculator works for any loan with fixed monthly payments and a set end date, whether it’s a student loan, car loan, or fixed rate mortgage.


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Mortgage amortization calculator

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Although your monthly payment is the same every month, the principal amount will increase each month and the interest amount will decrease each month as you pay off your balance. The calculator’s amortization table (click above to open it) will show you the details.

Most people need a mortgage to buy a home. The median American home costs over $ 300,000, and few people have that much extra cash lying around. Plus, mortgage rates are so low that even people with a lot of savings may prefer to borrow to buy a home in order to maintain the financial security of having well-funded emergency and retirement savings accounts. And, of course, there is the mortgage interest tax deduction.

With our mortgage amortization calculator, you can see your estimated monthly payment and the evolution of the total cost of your mortgage based on your interest rate. Try out different entries for the house price, down payment, interest rate, and loan term to understand the long-term impact of a mortgage before signing the paperwork. This calculator can help you whether you are buying a home or refinancing.

A mortgage amortization calculator will show you the long-term cost of a fixed rate mortgage by tabulating the total interest you will pay over the life of your mortgage. It also details the principal and interest of each monthly payment to show you how your mortgage payments are structured.

Explanation of the results of the mortgage amortization calculator

Monthly payment: See what you’ll pay for principal and interest each month. Keep in mind that there are many other monthly expenses associated with home ownership: home insurance, property taxes, utilities, maintenance and repairs. Depending on your neighborhood and the type of property, you may also pay a homeowner’s association fee. If you put less than 20%, your lender may ask you to pay mortgage insurance premiums.

Total capital paid: The mortgage amount (the amount you borrow) and the total principal paid are the same thing. This amount equals the purchase price of the home minus your down payment plus any closing costs you finance.

Total interest paid: The largest portion of your total cost of borrowing if you hold your loan for the full term (typically 15 or 30 years) is the total interest paid. You can add your mortgage closing costs and mortgage insurance premiums (if applicable) to the total interest paid to understand the true cost of borrowing over the long term.

Estimated final payment date: You don’t really need a calculator to give you your estimated loan repayment date. Just add 15 or 30 years to the date you start paying off your loan. If you make your first payment on March 1, 2021, your 30-year mortgage will be paid off by March 1, 2051. But we’ll save you the math and let the calculator tell you the estimated repayment date.

Total accumulated interest: As you expand the amortization schedule created by the calculator, you will see a column showing the amount of interest you paid for each point on your mortgage. It could be $ 5,000 by March 1, 2022; $ 9,500 by March 1, 2023; etc.

Total remaining balance: Expanding the amortization schedule will also show you how close you are to repaying your loan principal each month. After one year, you could still owe $ 196,000 on a $ 200,000 mortgage; after two years, $ 192,000; after 10 years, $ 155,000; etc.

How to speed up mortgage amortization

Are you horrified at the total cost of interest the calculator tells you? It’s normal. It’s one thing to know that your monthly payment is $ 900, and quite another to see that you will be paying $ 123,000 in interest over the next 30 years. Fortunately, you have several options to make your mortgage amortization faster, to pay off your loan faster, and to save money.

Choose a shorter loan term: If you choose a shorter amortization period for your mortgage, say 15 years instead of 30, you will save significantly on interest over the life of the loan and you will own your home sooner. In addition, interest rates on short-term loans are often lower than those on longer-term loans. A shorter term mortgage can be a good option if you can handle higher monthly payments without difficulty over the life of the loan. Otherwise, there is another option.

Make additional principal payments: To maintain the same term of your mortgage and avoid being subject to higher monthly payments, you can make an additional principal payment per year in the amount of your normal monthly payment. This will save you about five years on a 30-year mortgage. If you have financial hardship for a year, you can skip the additional payment. If you get a big bonus or a one year tax refund, you can double the extra payout. You will have more control, but less responsibility, if you choose this strategy to speed up mortgage amortization.

Understanding mortgage amortization

A mortgage amortization schedule is calculated using the loan amount, the loan term and the interest rate. If you know these three things, you can use Excel’s PMT function to calculate your monthly payment. For a mortgage of $ 150,000 over 30 years with an interest rate of 3.5%, the date to enter in an Excel cell would be = PMT (3.5% / 12,360,150,000). The result will be $ 673.57.

Once you know your monthly payment, you can calculate how much of your monthly payment goes to principal and how much goes to interest using this formula:

Principal payment = Total monthly payment – [Outstanding Loan Balance x (Interest Rate / 12 Months)]

Multiply $ 150,000 by 3.5% / 12 to get $ 437.50. This is your interest payment for your first monthly payment.

Subtract it from your monthly payment to get your principal payment: $ 236.07.

Check your calculations: $ 437.50 + $ 236.07 = $ 673.57, the total monthly payment we calculated above.

Next month, your loan balance will be $ 236.07 lower because that’s the principal portion of your payment. To see how much of next month’s monthly payment goes to principal and interest, repeat the calculation with a principal amount of $ 149,763.93, the result of subtracting $ 236.07 from $ 150,000.

This time your interest payment will be $ 436.81 and your principal payment will be $ 236.76.

Just repeat this process 358 times and you will have an amortization schedule for a 30 year loan yourself.

Now you know why using a mortgage amortization calculator is so much easier. But some people may find it easier to understand mortgage amortization by understanding how the math behind the calculator works.


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Definition of accounting principles

What are the accounting principles?

Accounting principles are the rules and guidelines that companies must follow when reporting financial data. The Financial Accounting Standards Board (FASB) publishes a standard set of accounting principles in the United States, called generally accepted accounting principles (GAAP).

Key points to remember

  • Accounting standards are implemented to improve the quality of financial information published by companies.
  • In the United States, the Financial Accounting Standards Board (FASB) publishes generally accepted accounting principles (GAAP).
  • GAAP is required for all publicly traded companies in the United States; it is also regularly implemented by unlisted companies.
  • Internationally, the International Accounting Standards Board (IASB) publishes International Financial Reporting Standards (IFRS).
  • The FASB and the IASB sometimes collaborate to publish common standards on hot topics, but the United States does not intend to switch to IFRS in the foreseeable future.

Understand 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 specific time period. It also facilitates the comparison of financial information between different companies. Accounting principles also help mitigate accounting fraud by increasing transparency and identifying red flags.

Generally accepted accounting principles (GAAP)

Companies publicly traded in the United States are required to regularly file generally accepted accounting principles or financial statements in accordance with GAAP in order to remain publicly traded. The officers of listed companies and their independent auditors must certify that the financial statements and accompanying notes have been prepared in accordance with GAAP.

Some of the most fundamental accounting principles are as follows:

  • Principle of accumulation
  • Principle of conservatism
  • Principle of consistency
  • Cost principle
  • Principle of economic entity
  • Principle of full disclosure
  • Principle of going concern
  • Principle of reconciliation
  • Principle of materiality
  • Principle of monetary unit
  • Principle of reliability
  • Principle of revenue recognition
  • Principle of the period

Accounting principles help to govern the world of accounting according to general rules and guidelines. GAAP attempts to standardize and regulate the definitions, assumptions and methods used in accounting. There are a number of principles, but some of the most notable include the principle of revenue recognition, the principle of correspondence, the principle of materiality and the principle of consistency. The ultimate goal of standard accounting principles is to enable users of financial statements to view a company’s financial statements with confidence that the information disclosed in the report is complete, consistent and comparable.

Completeness is guaranteed by the principle of materiality, as all significant transactions must be recognized in the financial statements. Consistency refers to a company’s use of accounting principles over time. When accounting principles allow a choice between more than one method, an enterprise should apply the same accounting policy over time or disclose its change in accounting policy in the footnotes of financial statements.

Comparability is the ability for users of financial statements to examine the financial statements of multiple companies side by side with the assurance that the accounting principles have been followed under the same set of standards. Accounting information is neither absolute nor concrete, and standards such as GAAP are developed to minimize the negative effects of inconsistent data. Without GAAP, it would be extremely difficult to compare the financial statements of companies, even within the same industry, which would complicate the comparison between apples and apples. Inconsistencies and errors would also be more difficult to spot.

Private companies and not-for-profit organizations may also be required by lenders or investors to file GAAP-compliant financial statements. For example, annual audited GAAP financial statements are a common loan clause required by most banking institutions. Therefore, most companies and organizations in the United States comply with GAAP, although this is not necessarily a requirement.

International Financial Reporting Standards (IFRS)

Accounting principles differ from country to country. The International Accounting Standards Board (IASB) publishes International Financial Reporting Standards (IFRS). These standards are used in more than 120 countries, including those of the European Union (EU).The Securities and Exchange Commission (SEC), the U.S. government agency responsible for protecting investors and policing securities markets, has said the United States will not transition to IFRS for 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 across the world, investors should exercise caution when comparing financial statements of companies from different countries. The issue of different accounting principles is less of a concern in more mature markets. Nevertheless, caution should be exercised as there is still some leeway for distortion of numbers in many sets of accounting principles.

Frequently Asked Questions

Who sets the accounting principles and standards?

Various organizations issue accounting standards. In the United States, GAAP is regulated by the Financial Accounting Standards Board (FASB). In Europe and elsewhere, IFRS are defined by the International Accounting Standards Board (IASB).

How are IFRSs different from GAAP?

IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the United States. IFRS is viewed as a more dynamic platform that is regularly revised in response to an ever-changing financial environment, while GAAP is more static. Although the majority of the world uses IFRS, it is still not part of the world of US financial accounting. The SEC continues to review the transition to IFRS, but has not yet done so.

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

When were the accounting principles first established?

Standardized accounting principles date 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 this era provided a springboard for the rise of commerce and capitalism. 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 used by companies in the United States in the years 1930.

What are the criticisms of accounting principles?

Critics of principles-based accounting systems say they can give companies too much freedom and don’t mandate transparency. They believe that because companies do not have to follow specific rules that have been set, their reports can provide an inaccurate picture of their financial health. In the case of rules-based methods such as GAAP, complex rules can cause unnecessary complications in the preparation of financial statements. And having strict rules means that accountants can try to make their businesses more profitable than they actually are because of accountability to their shareholders.


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How is a loan amortization schedule calculated?

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There are many types of loans that people take. Whether you get a mortgage to buy a house, a home equity loan to do renovations or access cash, a car loan to buy a vehicle, or a personal loan for a variety of purposes, most loans have two things in mind. Common: They provide a fixed period to pay off the loan and charge you a fixed interest rate over your repayment period.

When you take out a fixed rate loan with a fixed repayment term, you usually receive a loan amortization schedule. This calendar gives you important information about your monthly payment amount and allows you to calculate the total amount of interest you will pay over the course of the loan as well as how quickly you will repay the loan. main balance. By understanding how to calculate a loan amortization schedule, you will be in a better position to consider attractive actions, such as making additional payments to pay off your loan faster.

What is a loan amortization schedule?

A loan amortization schedule gives you the most basic information about your loan and how you are going to pay it back. It usually includes a complete list of all the payments you will need to make during the life of the loan. Each payment on the calendar is broken down according to the portion of the payment that goes towards interest and principal. You will usually also receive the outstanding loan balance after each monthly payment, so that you will be able to see how your total debt will go down as the loan is paid off.

You will also usually get a summary of your loan repayment, either at the bottom of the amortization schedule or in a separate section. The summary will add up all of the interest payments that you have paid during the course of the loan, while also verifying that the total principal payments matches the total outstanding loan amount.

How to calculate a loan amortization schedule if you know your monthly payment

It is relatively easy to produce a loan amortization schedule if you know the amount of the monthly loan payment. From the first month, take the total loan amount and multiply it by the loan interest rate. Then for a loan with monthly repayments, divide the result by 12 to get your monthly interest. Subtract the interest from the total monthly payment, and the remaining amount is what goes towards the principal. For the second month, do the same, except start with the first month’s remaining principal balance rather than the original loan amount. At the end of the loan term, your principal should be zero.

Let’s take a simple example: Suppose you have a mortgage of $ 240,000 over 30 years at an interest rate of 5% with a monthly payment of $ 1,288. In the first month, you would take $ 240,000 and multiply it by 5% to get $ 12,000. Divide that by 12, and you would have $ 1,000 in interest for your first monthly payment. The remaining $ 288 is used to repay the principal.

For the second month, your outstanding principal balance is $ 240,000 less $ 288, or $ 239,712. Multiply that by 5% and divide by 12, and you get a slightly smaller amount – $ 998.80 – for interest. Gradually over the following months, less money will be spent on interest and your principal balance will be reduced more and more quickly. In month 360, you owe only $ 5 in interest and the remaining $ 1,283 pays off the balance in full.

Calculating an amortization schedule if you don’t know your payment

Sometimes when you are considering taking out a loan all you know is how much you want to borrow and what the rate will be. In this case, the first step will be to determine what the monthly payment will be. Then you can follow the above steps to calculate the amortization schedule.

There are several ways to go about it. The easiest way is to use a calculator that lets you enter your loan amount, interest rate, and repayment term. For example, our mortgage calculator will give you a monthly payment on a home loan. You can also use it to calculate payments for other types of loans by simply changing the terms and removing any estimate of house expenses.

If you are a handyman, you can also use an Excel spreadsheet to make the payment. The PMT feature gives you the payout based on the interest rate, number of payments, and loan principal balance. For example, to calculate the monthly payment in the example above, you can set an Excel cell to = PMT (5% / 12,360,240,000). That would give you the figure of $ 1,288 that you saw in this example.

Why an amortization schedule can be useful

There are many ways to use the information in a loan amortization schedule. Knowing the total amount of interest you will pay over the life of a loan is a good incentive to get you to make principal payments sooner. When you make additional payments that reduce the outstanding principal, they also reduce the amount of to come up payments that must go towards interest. This is why just a little extra amount paid can make a huge difference.

To demonstrate, in the example above, let’s say that instead of paying $ 1,288 the first month, you spend an additional $ 300 on capital reduction. You might think the impact would be to save you $ 300 on your final payment, or maybe a little more. But thanks to reduced interest, just an extra $ 300 is enough to keep you from winning the full amount of your last payment. In other words, $ 300 saves you over $ 1,300 later.

Be smart with your loans

Even when your lender gives you a loan amortization schedule, it can be easy to ignore it in the pile of other documents you need to process. But information on an amortization schedule is crucial to understanding the ins and outs of your loan. By knowing how a deadline is calculated, you can determine exactly how useful it can be to pay off your debt as quickly as possible.


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Accounting Principles Generally Accepted in Japan – CVA Accounting

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In April 2021, generally accepted accounting principles in Japan (JGAAP) will incorporate the credit assessment adjustment (HOW ARE YOU) and debt value adjustment (DVA) the pricing of portfolios of derivative products. With several challenges ahead and the looming deadline, companies have little time to act. Banks need to prepare JGAAP HOW ARE YOU change now

Hiroyuki Yoshizawa, IHS Note the

Adopt HOW ARE YOU reflecting the fair value of derivatives has been done more slowly in banks in Japan than in Europe, the Middle East and Africa, and the Americas. However, in April 2021 JGAAP will require companies to account for their derivative exposures using both HOW ARE YOU and DVA for the first time.

Large Japanese financial institutions have incorporated a series of valuation adjustments (xVAs) into their pricing and risk management processes in recent years, but adoption by smaller entities has been slower. According to Hiroyuki Yoshizawa, Executive Director, Price Reviews and Benchmarks, IHS Markit Group Japan, April 2021 JGAAP the deadline is a “significant change for local and regional Japanese banks who will use HOW ARE YOU and DVA for the first time”.

When Mizuho Bank restated its profits using Basel III methodologies for the first time in March 2019, the mega-bank was forced to write down the value of its derivatives portfolio in JPY30 billion ($ 270 million). But, according to Yoshizawa, the problems facing small financial institutions in Japan in implementing HOW ARE YOU and DVA price for JGAAP is the adoption of technological and operational processes rather than market issues.

Five challenges

With larger institutions having implemented HOW ARE YOU in their business structures, they already have the systems, market data and, most importantly, the people in place to absorb changes in business. JGAAP rules. However, this is not the case for regional banks in Japan. According to IHS Markit, several Japanese institutions will have to start accounting for their HOW ARE YOU and DVA exhibits for the first time in April 2021. Yoshizawa says the majority of them face five challenges in implementing the updated requirements in their pricing and risk management protocols.

1. Technology

The first of these challenges is technology.

amended JGAAP will require HOW ARE YOU/DVA figures measured at fair value and the calculation of final results will lead to a significant increase in the technological infrastructure required by financial institutions. Market standard HOW ARE YOU/DVA the calculation will require an increase in computing power compared to the traditional value-at-risk of market risk; while calculating xVA sensitivity requirements for coverage increases requires a similar increase in technology capacity.

To help businesses overcome this challenge, IHS Markit offers daily and real-time credit default swaps (CDS) price data, which is a basic data for HOW ARE YOU pricing and modeling. It also offers a monthly plan HOW ARE YOU/DVA calculation service using a risk engine that has been tested and proven in top tier banks for their internal model method (IMM) approvals. This range of capabilities means that banks looking to meet their JGAAP HOW ARE YOU/DVA requirements can use IHS by Markit CDS data service to fuel their calculations, or they can choose to outsource the entire process using IHS Markit’s analytical service.

2. Model risk

Once the technological problem is solved, banks face model risk. A key aspect of HOW ARE YOU/DVA the calculation calibrates models to ensure that companies’ prices are in line with consensus and market behavior, and this applies to an external supplier as well as an internal system, explains Yoshizawa.

“If they outsource their calculation, banks need to assess whether the supplier can calculate the appropriate scenarios. The optimal way is to validate the transactional data available when banks are performing in the market and compare it with their HOW ARE YOU pricing. IHS Markit offers consensus service for over-the-counter products (OTC) global derivative valuations and backtest the output to validate model calibration. IHS Markit also offers a HOW ARE YOU pricing tool, which has the same model and input data and is part of the HOW ARE YOU calculation service.

AsiaRisk1220_IHS Markit_Fig1

3. Accurate market data

The third challenge is to ensure that the model contains accurate market data. In order to get the right HOW ARE YOU and DVA numbers, banks should calculate the probability of default (PD) as well as the default loss (ACL).

Those who treat OTC derivatives transactions must offer securities for transactions with a maturity covering the short end of the credit curve (less than six months) up to 30 years. Given the wide range of CDS tenors in portfolios, it is essential that they use CDS price data with a term structure based on market consensus figures and available liquidity.

A lack of liquidity in Japan CDS market, especially with regard to unique names, is a well-known and even greater challenge for banks which have CDS exhibitions. However, it is possible for companies to find “proxy curves”, which are calculated from CDS data using IHS Note the CDS Sector curves tool. These figures are derived from the best CDS data that uses the three fundamental ideas of rating, sector and region within its factor model.

“Banks should select suppliers based on those who can provide a specific consensus or the market PD and ACL numbers – something IHS Markit can do this thanks to his CDS Data service pricing, ”says Yoshizawa.

An additional advantage of adopting an outsourced approach to HOW ARE YOU/DVA calculation to meet the requirements of JGAAP is that banks will already have the systems in place to cope with subsequent regulatory standards.

“Our risk engine is able to meet the general requirements of Basel so that banks that outsource HOW ARE YOU/DVA calculation for us can also use our platform for future regulatory calculations, as well as to answer JGAAP requirements, ”says Yoshizawa.

4. Operational challenges

The penultimate challenge is operational. Concretely, the new JGAAP obligation to calculate HOW ARE YOU Consensus-compliant means offering a market exit price for each derivative transaction using qualified market data, such as volatility, skewness and correlation. Large Japanese banks already have this capacity due to their regulatory obligations IMMs, but small regional businesses in Japan need to acquire this skill set quickly. An obvious solution to this problem is to use IHS Markit, who can easily provide a pricing platform that calculates values ​​according to market consensus.

AsiaRisk1220_IHS Markit_Fig2

5. Timelines

The final and most difficult challenge is that of timelines. Local banks have historically used packaged software to establish pricing OTC derivatives. However, upgrading these systems to meet the increased demands of HOW ARE YOU and DVA calculation for JGAAP will be expensive or, in some cases, impossible because existing software cannot handle the new requirements. If banks seek to outsource this calculation process, they will need to provide transaction data and counterparty data – as well as the underlying legal documentation related to each transaction – in order to replenish the full cash flow on the platforms. providers.

Japanese local banks with a relatively large derivative portfolio typically have thousands of derivative transactions, and the process of outsourcing them HOW ARE YOU and DVA the calculations will be complex and could take several months.

“Outsourcing is not easy: information stores have to provide a lot of information, which can be time consuming given the resources and development that may be required,” Yoshizawa explains. “My message to the market is that it should make decisions quickly and minimize all operational risks as much as possible. These five challenges must be addressed in a timely manner, which will contribute to a smooth transition to the April 2021 deadline. ”


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