What is Settlement Date Accounting?

Settlement date accounting is an accounting method that accountants may use when recording financial exchange transactions in the company's general ledger. Under this method, a transaction is recorded on the "books" at the point in time when the given transaction has been fulfilled.

Key Takeaways

  • Under settlement date accounting, a transaction is recorded in the general ledger when it is "fulfilled" or "settled."
  • This is contrasted with trade date accounting, where transactions are recorded in the general ledger at the initiation date rather than at completion.
  • Settlement date accounting is a conservative accounting method, and it ensures that any transactions recorded in the general ledger have actually been executed.
  • However, it does not allow financial statement users to see the impact of planned transactions that have not yet been finalized.

How Settlement Date Accounting is Used

Settlement date accounting records a transaction at the point of "fulfillment." A transaction is considered to be fulfilled when performance by both parties has been satisfied, such as when ownership of an asset has been transferred from one party to another.

In the case of trading securities, the point at which the transaction is fulfilled is when the traded security has settled. This is the date at which the buyer must make payment to the seller, while the seller delivers the assets to the buyer. Any interest associated with the trade must also be accrued when the transaction is settled.

Settlement Date Accounting vs. Trade Date Accounting

Settlement date accounting can be contrasted with trade date accounting, in which a company's accountant records the financial exchange transaction on the initiation date rather than the completion date. Under generally accepted accounting principles (GAAP), a company may choose whether to apply the settlement date or trade date accounting methods. However, a company needs to remain consistent with its chosen method in order to preserve the integrity of information recorded in its general ledger, which is used to create the company's financial statements.

Advantages and Disadvantages of Settlement Date Accounting

Settlement date accounting is beneficial in the sense that any transaction recorded in the general ledger is guaranteed to have occurred and been executed in the dollar amount recorded. It is a conservative accounting method, which means that it errs on the side of caution when recording journal entries in the general ledger. There is a higher degree of verification before the transaction is recorded.

However, settlement date accounting is not without its drawbacks. Under this method, any pending transactions that have not been finalized by the balance sheet date will not be recorded in the company's general ledger. Any transaction not recorded in the general ledger will also not flow through to the company's financial statements for that period.

This causes issues when a large financial transaction occurs around the end of an accounting period because the financial statement users may not see the impact of a looming transaction. If there is a high degree of certainty that a transaction will occur as planned, it may be beneficial to record it at the initiation date in order to project more accurate financial figures.

Example of Settlement Date Accounting

Assume XYZ Company, which has a December 31 year end, entered into a loan agreement with a bank on December 27. The loan was not delivered until January 15 of the following year. Under the settlement date method, the financial statements dated on December 31 will not include the loan amount.