Does anyone know the formula for applying a "mid-year convention" to the Rule of 78?
Mid-year Convention for Rule of 78 Interest Calculation?
Answers
The rule of 78 calculation is usually based on monthly activity from the inception of the agreement, thus inherently producing a "mid-year" calculation for the first and last years. Wikipedia has a decent summary, which you can find by "googling" "rulse of 78".
Barrett,
Sorry about the confusion. The moderator(s) must have modified the subject line of my question. I am not looking for the Rule of 78 "Interest Calculation".
I am looking for the Rule of 78 as it applies to "Recurring Revenue".
Example:
Given: I have a recurring revenue estimate (e.g., $120 for 2012E). This revenue would be recognized over 12 months.
Question: I am interested in understanding how to properly 1) apply the Rule of 78, 2) apply a mid-year convention.
Thank in advance for the help!
"Revenue" is substituted foir "interest" in the calculation, but the mechanics are the same. Each recurring revenue amount should be separately calculated, and reflects the inherent mid-year convention built into the technique, which is essentially a sum-of-the months digits calculation.
The name "Rule of 78's" comes from the method of calculation. The sum of the numbers 1 through 12 equals 78. Therefore the rule of 78's is you take 12/78's in the first period 11/78's in the second period, an so on. This used to be the way some financial instututions calculated their earnings on loans. However, it is not longer an acceptable method for loan interest calculation as the calculation benefited the banks rather than the borrower in an early payoff.
Applying the rule to more than 12 months is simply a matter of finding the summation of the number of months you want to spread the revenue over.
But the bigger question is why use the rule of 78's at all?Does it approximate how the revenue is going to flow? The rule of 78's significantly front loads the revenue so you need to have a strong business case to front load revenue like that.
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FP&A