THE EFFECT OF MATCHING METHODS ON THE COST BASIS CALCULATION

Transcription

1 THE EFFECT OF MATCHING METHODS ON THE COST BASIS CALCULATION Due to the Emergency Economic Stabilization Act of 2008 requiring custodians to provide cost basis information to investors, many advisors are taking a closer look at the cost basis calculations in PortfolioCenter. Differences in calculation of cost basis in PortfolioCenter and at the custodian can usually be attributed to different matching methods selected on the closing transactions. This document provides information about the matching method settings and as well as the various reports and exports that you can use to view matching methods for transactions. Online PortfolioCenter currently offers six matching methods. If you are unsure which matching methods you are using or o learn more about finding the matching methods associated with certain portfolios, see Verifying Portfolio Matching Methods. In addition, this document provides a sample scenario for a security and then shows the calculations within that scenario for the following matching methods: First In, First Out (FIFO) Scenario High Cost Scenario Beneficial Tax Scenario Last In, First Out (LIFO) Scenario Low Cost Scenario Average Cost Scenario Selected Lots Scenario DETERMINING MATCHING METHODS USED IN EXISTING PORTFOLIOCENTER DATA If you are already faced with a cost basis reconciliation discrepancy, compare the matching methods used in posted PortfolioCenter transactions to those on record with the custodian. There are two places Matching Methods appear in PortfolioCenter: Portfolio Details and Closing Transactions. FINDING DEFAULT MATCHING METHODS IN PORTFOLIO DETAILS In the Portfolio Details, you will find the Matching Method tab. This tab determines the default matching method of all closing transactions (listed in the section below). While this is a great way to take a quick inventory of the matching method, it is best to also look at the transactions posted into the portfolio if you are concerned about the calculation of the total cost basis. DocumentID: SPT Last Updated: March 19, 2014

2 FINDING MATCHING METHODS FROM POSTED CLOSING TRANSACTIONS Only position-closing or position exiting transactions have matching methods associated with them, and while the defaults for them are set on the portfolio level, it is possible to set a matching method per transaction, thus mixing matching methods with other trade lots (except for Average cost). The transactions that have Matching Methods in the transaction details are: Sell Debit of Security Transfer of Security Buy/Close Sell/Close Each of these position closing transactions have a Matching Method field on them, as shown in the example to the right. The default portfolio matching method is used primarily when manually posting a transaction, when a transaction is generated by a tool, such as the Account Transfer Wizard, and, in most cases, when posting transactions through the interface. However, you do have the ability to change the matching methods assigned to a specific transaction at any time, so it is always a good idea to verify the Settlement Method for all posted transactions, especially if you question the validity of the cost basis calculation you are seeing on reports. The sections below describe the two ways to see Settlement Method using PortfolioCenter Reports or exports. TRANSACTION LEDGER REPORTS Important The custodian should be used as the source of record for client s tax reporting. Even if cost basis is reconciled in PortfolioCenter, unrealized and realized gain/loss figures from the database should only be used as estimates. All reports displaying cost basis information should contain a disclaimer directing the client to the custodian s 1099 for tax reporting. The Transaction Ledger Report or Custom Ledger Reports are useful tools within PortfolioCenter for you to check matching methods for a particular portfolio. The best use of these reports is on a portfolio that has few trades or positions or a small amount of history, as it will be less data to have to pour through on the pages. To see the matching method on any of the transaction reports, you must add the Settlement Method column, similar to the example above. This column is not a default on these reports. Online For more information about customizing PortfolioCenter Reports and adding columns, see Customizing PortfolioCenter Analytical Reports. The Effect of Matching Methods on the Cost Basis Calculation Page 2 of 11

3 TRANSACTION EXPORT IN THE PORTFOLIOCENTER EXPORT WIZARD Another option and the one best suited for finding settlement methods for several portfolios, longer histories or with active traders is the Transaction Export in the PortfolioCenter Export Wizard. This export is based on the transaction ledger report above, so it includes much of the same information. However, the data is exported to a spreadsheet that you can use filters, sorts, find, and functions to quickly locate settlement methods or discrepancies in expected data. EXAMPLE SCENARIOS AND USING PORTFOLIOCENTER REPORTS In the following sections, we will show you how the cost basis was different for each of the matching methods. We will follow the same portfolio one position over a three-year time period, showing you the PortfolioCenter reports and how they change after each sell and buy. While the transactions are simplified for the purposes of our example, the calculations are the same in more complex situations. You will see the overall cost basis and change in average cost per share after each transaction. Online The examples in this section use a Custom Statement report to better demonstrate the calculations as we go through time. If you find that all the Custom Statement reports are being used for other purposes, you can create a new Report Profile to create a new report. For more information and steps on using Report Profiles, see Creating and Using Report Profiles for Analytical PortfolioCenter Reports. SAMPLE SCENARIO TRANSACTIONS In the following examples, we created a simplified portfolio with a limited number of transactions to better demonstrate the calculations as the matching methods change. All portfolios have the following transactions in the portfolio for AAPL: Because all of the first three trade lots are purchases, they are the same for all six examples: For all of the examples below, the portfolios begin with the following three buys: Trade Lot #1: buy of 300 shares on 3/15/09 at $105 per share Trade Lot #2: buy of 150 shares on 6/15/09 at $142 per share Trade Lot #3: buy of 500 shares on 9/15/09 at $125 per share The Effect of Matching Methods on the Cost Basis Calculation Page 3 of 11

4 After these first three transactions, however, we start adding sells out of the position, which changes the total position information, including cost basis and unit cost change, depending on the selected matching method selected. The four transactions highlighted in each section below are: 1 Sell #1 of 250 shares on 12/15/2009 for $ per share 2 Buy of Trade Lot Shares on 3/15/2010 for $ per share 3 Sell #2 of 350 shares on 6/15/2010 for $ per share 4 Sell #3 of 450 shares on 9/15/2010 for $ per share Let us take a closer look at each of the matching methods and how these calculations are changed once we start posting sells. Note In the examples below, we only use buy and sell transactions to simplify and demonstrate the effect of the matching method on the calculations. However, note that Debit of Security, Transfer of Security, Buy/Close and Sell/Close transactions all have matching method settings on them and can affect the calculations of cost basis in the same way. The Effect of Matching Methods on the Cost Basis Calculation Page 4 of 11

5 FIRST IN, FIRST OUT (FIFO) SCENARIO In this scenario, all the trade lots are sold off in the order they came into the portfolio first in, first out. This is the most common matching method and the one that is set as the default on the Matching Methods tab in the portfolio details. Let us take a look at what happens to the trade lots and cost basis as we start posting sells of the position: Sell #1: 250 shares sold on 12/15/09 After this sell, we see that sell of the 250 shares all came from Trade Lot #1, leaving only 50 shares available for the next sell from that trade lot. The cost of the shares sold was $105 (unit cost of trade lot #1) x 250 shares sold, or $26,250. Trade Lot #4: buy of 200 shares on 3/15/10. After this buy, we see an additional trade lot now four open trade lots listed on the Sell # 2: Sell of 350 shares on 6/15/2010. As we saw after the buy above, we had four open trade lots just before this sell. The quantity of this sell was large enough, however, to take all 50 shares available from Trade Lot #1, all 150 available shares from Trade Lot #2 and 150 shares from Trade Lot #3. The cost of the shares sold, then came from all three trade lots: Cost of Trade Lot #1: 50 x $105 = $5,250. Cost of Trade Lot #2: 150 x $142 = $21,300. Cost of Trade Lot #3: 150 x $125 = $18,750. Total cost of shares sold: $5,250 + $21,300 + $18,750 = $45,300 Sell #3: sell of 450 shares on 9/15/10. The last sell 450 shares removes all of the remaining 350 from Trade Lot #3 and half of the remaining shares from Trade Lot #4. The cost of shares sold comes to $43,750 from Trade Lot #3 plus $18,500 from Trade Lot #4 for a total of $62,250. The Effect of Matching Methods on the Cost Basis Calculation Page 5 of 11

6 LAST IN, FIRST OUT (LIFO) SCENARIO In this scenario, all the trade lots are sold off in the opposite order they came into the portfolio the most recent purchases are sold first. Let us take a look at what happens to the trade lots and cost basis as we start posting sells of the position: Sell #1: sell of 250 shares on 12/15/2009 for $ per share. After this sell, we see that sell of the 250 shares all came from the last trade lot purchased, Trade Lot #3, leaving 250 shares available for the next sell from that trade lot. The cost of the shares sold was $125 (unit cost of trade lot #3) x 250 shares sold, or $31,250. Trade Lot #4: buy of 200 shares on 3/15/2010 at $185 per share. After this buy, we see an additional trade lot now four open trade lots listed on the Sell # 2: Sell of 350 shares on 6/15/2010 for $ per share This sell was large enough to take all 200 of the shares from Trade Lot #4, as well as 150 shares from Trade Lot #3. The cost of the shares sold, then came from both trade lots: Cost of Trade Lot #4: 200 x $185 = $37,000. Cost of Trade Lot #3: 150 x $125 = $18,750. Total cost of shares sold: $37,000 + $18,750 = $55,750 Sell #3: sell of 450 shares on 9/15/2010 for $ per share. The last sell 450 shares removes all of the remaining shares from Trade Lots #3 and #2, and a significant portion of Trade Lot #1. The cost of shares sold is attributed to all three trade lots: Cost of Trade Lot #3 was $12,500 (100 x $125) + cost of Trade Lot #2 was $21,300 (150 x $142) + cost of Trade Lot #1 was $21,000 (200 x $105) = $54,800. The Effect of Matching Methods on the Cost Basis Calculation Page 6 of 11

7 HIGH COST SCENARIO In this scenario, all the trade lots are sold off in order of the most expensive trade lot first because they are the most expensive and you have the least amount of realized gain, or in some cases, a loss. Let us take a look at what happens to the trade lots and cost basis as we start posting sells of the position: Sell #1: sell of 250 shares on 12/15/2009 for $ per share. At the time of this sell, the most expensive trade lot (per share) available to sell was Trade Lot #2, at a cost of $142 per share, followed by Trade Lot #3 at a cost of $125 per share. Thus, the sell takes all 150 shares available from Trade Lot #1 plus 100 shares from Trade Lot #3. The cost of the shares sold was: $33,800: Trade Lot #3 $21,300 (150 x $142) + Trade Lot #2 $12,500 (100 x $125) = $33,800. Trade Lot #4: buy of 200 shares on 3/15/2010 at $185 per share. After this buy, we see an additional trade lot now four open trade lots listed on the Sell # 2: Sell of 350 shares on 6/15/2010 for $ per share This sell was large enough to take all 200 of the shares from Trade Lot #4, as of this sell, the most expensive lot, as well as another 150 shares from Trade Lot #3. The cost of the shares sold, then came from both trade lots: Trade Lot #4: $37,000 (200 x $185) + Trade Lot #3: $18,750 (150 x $125) = $55,750. Sell #3: sell of 450 shares on 9/15/2010 for $ per share. The last sell removes 450 shares from the shares remaining in Trade Lot #3 and a significant portion of Trade Lot #1. The cost of shares sold is attributed to both trade lots: Trade Lot #3: $31,250 (250 x $125) + Trade Lot #1 $21,000 (200 x $105) = $52,250 The Effect of Matching Methods on the Cost Basis Calculation Page 7 of 11

8 LOW COST SCENARIO In this scenario, all the trade lots are sold off in order of the least expensive trade lot first. Let us take a look at what happens to the trade lots and cost basis as we start posting sells of the position: Sell #1: sell of 250 shares on 12/15/2009 for $ per share. At the time of this sell, the least expensive trade lot (per share) available to sell was Trade Lot #1, at a cost of $105 per share. Thus, the sell takes 250 shares from the available 300 from Trade Lot #1 at a cost of $26,250 (250 x $105). Trade Lot #4: buy of 200 shares on 3/15/2010 at $185 per share. After this buy, we see an additional trade lot now four open trade lots listed on the Sell # 2: Sell of 350 shares on 6/15/2010 for $ per share This sell was large enough to take the remaining 50 shares of Trade Lot #1. The remaining 300 shares came from Trade Lot #3, the remaining least expensive trade lot at $125 per share. The cost of the shares sold, then came from both trade lots: Trade Lot #1: $5,250 (50 x $105) + Trade Lot #3: $37,500 (300 x $125) = $42,750 Sell #3: sell of 450 shares on 9/15/2010 for $ per share. The last sell removes all the shares remaining from Trade Lot #3 (at $125 per share), all of trade lot # 2 (at $142 per share) and 100 shares from Trade Lot #4 (at $185 per share). Thus, the cost of shares sold was: $64,800: Trade Lot 3: $25,000 (200 x $125) + Trade Lot 2: $21,300 (150 x $142) + Trade Lot 4: $18,500 (100 x $185) The Effect of Matching Methods on the Cost Basis Calculation Page 8 of 11

9 BENEFICIAL TAX SCENARIO In this scenario, all the trade lots are sold off in order of the trade lot producing the highest loss first to the trade lot producing the highest gain last. Let us take a look at what happens to the trade lots and cost basis as we start posting sells of the position: Sell #1: sell of 250 shares on 12/15/2009 for $ per share. At the time of this sell, the trade lots (per share) that would create the highest loss are Trade Lot #2, at a cost of $142 per share and Trade Lot #3, at a cost of $125 per share. Thus, the sell takes all 150 shares from Trade Lot #2 and 100 shares from the available 500 from Trade Lot #3. The cost of the shares sold came from both trade lots: Trade Lot #2: $21,300 (150 x $142) + Trade Lot #3: $12,500 (100 x $125) = $33,800. Trade Lot #4: buy of 200 shares on 3/15/2010 at $185 per share. After this buy, we see an additional trade lot now three open trade lots listed on the Sell # 2: Sell of 350 shares on 6/15/2010 for $ per share This sell was large enough to take all the shares from Trade Lot #4. Since the price per share of the sell is greater than the unit cost of the remaining buys, the matching method looks to sell trade lots that create the lowest gain. The remaining 150 shares came from Trade Lot #1, the remaining lowest gain trade lot at $105 per share. The cost of the shares sold, then came from both trade lots: Trade Lot #4: $37,000 (200 x $185) + Trade Lot #1: $15,750 (150 x $105) = $52,750 Sell #3: sell of 450 shares on 9/15/2010 for $ per share. The last sell removes all the shares remaining from Trade Lot #1 (at $105 per share). The remaining 300 shares came from Trade Lot #3 at $125 per share. The cost of the shares sold, then came from both trade lots: Trade Lot #1: $15,750 (150 x $105) + Trade Lot #3: $37,500 (300 x $125) = $53,250 The Effect of Matching Methods on the Cost Basis Calculation Page 9 of 11

10 AVERAGE COST SCENARIO When using this matching method, the shares are removed from the trade lots in the order in which received, like FIFO, but the cost of shares sold, which is used to calculate the realized gain and remaining cost basis, uses an average cost of all the trade lots purchased. Note Average cost accounting is not a typical matching method for the Equity security type, but we are using the equity security type in this example to explain the calculation and be consistent with the remainder of the examples in these sections. Important With the Emergency Economic Stabilization Act of 2008 regulations, many custodians are changing how Average Cost is calculated for mutual fund positions. The Average Cost for positions will be bifurcated, or divided into two groupings covered and uncovered securities. For more information about implementing the bifurcated average cost basis in PortfolioCenter, see Best Practices for Bifurcation Average Cost Basis for Mutual Funds. Sell #1: sell of 250 shares on 12/15/2009 for $ per share. At the time of this sell, the average cost of all three trade lots was $ Thus, all 250 shares were removed from Trade Lot #1, but the cost of shares sold was calculated using the $ price, rather than the $105 price originally associated with those shares. Cost of shares sold was $ x 250 = $30, Trade Lot #4: buy of 200 shares on 3/15/2010 at $185 per share. After this buy, we see an additional trade lot now four open trade lots listed on the Additionally, though, now the average unit cost is $ because of the more expensive shares now available for sell. Sell # 2: Sell of 350 shares on 6/15/2010 for $ per share Once again, the shares are removed from Trade Lot #1 as well as all of Trade Lot #2 and part of Trade Lot #3. However, as in the Sell #1 example, the cost of all 350 shares sold uses the $ average unit cost price rather than the prices associated with each trade lot. Thus, the total cost of shares sold was: $ x 350 = $47, The Effect of Matching Methods on the Cost Basis Calculation Page 10 of 11

11 Sell #3: sell of 450 shares on 9/15/2010 for $ per share. The last sell removes all the shares remaining from Trade Lot #3 100 shares from Trade Lot #4 at the average cost of $ per share. SELECTED LOTS SCENARIO We are not going to show the examples of selected lots since you have control over which lots to sell. When you post a trade using the Selected Trade Lot option, you should see a window similar to the example on the right, allowing you to select the trade lot you want to sell. If the selected trade lot has more shares than what is being sold, all of the shares are removed from that lot. However, if you are selecting a trade lot with fewer shares than you want to sell, the grid to the right of the dialog should show you how many shares you have left to match. Continue checking boxes to the left of a trade lot until the difference in the table is set to zero, similar to the example above. For institutional audiences only Schwab Performance Technologies ( SPT ). All rights reserved PortfolioCenter is a product of Schwab Performance Technologies ( SPT ). SPT is a subsidiary of The Charles Schwab Corporation separate from its affiliate Charles Schwab & Co., Inc. ( CS&Co ). CS&Co is a registered broker-dealer and member SIPC that provides brokerage services, while SPT licenses software and provides related technology products and services. Individual names, account numbers and contact information listed in this document are fictional and not intended to reflect any existing individuals. Both real and fictional securities are listed in the document. Securities and strategies reflected in the document are for educational purposes only and are not, nor should they be construed as, recommendations to buy, sell, or continue to hold any investment nor do the accounts listed reflect individual securities accounts or holdings. Any similarity to an existing individual or account is purely coincidental. Screen shots are provided for illustrative purposes only and may be abridged. This material is meant for educational purposes only and is not meant to provide investment planning, legal, tax, regulatory, nor compliance advice. Consult professionals in these fields to address your specific circumstance. Screen shots are provided for illustrative purposes only and may be abridged. The Effect of Matching Methods on the Cost Basis Calculation Page 11 of 11