What Is an 8-K?

An 8-K is a report of unscheduled material events or corporate changes at a company that could be of importance to the shareholders or the Securities and Exchange Commission (SEC). Also known as a Form 8K, the report notifies the public of events, including acquisitions, bankruptcy, the resignation of directors, or changes in the fiscal year.

Understanding Form 8-K

An 8-K is required to announce significant events relevant to shareholders. Companies usually have four business days to file an 8-K for most specified items.

Documents fulfilling Regulation Fair Disclosure (Reg FD) requirements may be due before four business days have passed. An organization must determine if the information is material and submit the report to the SEC. The SEC makes the reports available through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) platform.

The SEC outlines the various situations that require Form 8-K. There are nine sections within the Investor Bulletin. Each of these sections may have anywhere from one to eight subsections. The most recent permanent change to Form 8-K disclosure rules occurred in 2004.

Benefits of Form 8-K

First and foremost, Form 8-K provides investors with timely notification of significant changes at listed companies. Many of these changes are defined explicitly by the SEC. In contrast, others are simply events that firms consider to be sufficiently noteworthy. In any case, the form provides a way for firms to communicate directly with investors. The information provided is not filtered or altered by media organizations in any way. Furthermore, investors do not have to watch TV programs, subscribe to magazines, or even wade through financial news websites to get the 8-K.

Form 8-K also provides substantial benefits to listed companies. By filing an 8-K in a timely fashion, the firm’s management can meet specific disclosure requirements and avoid insider trading allegations. Companies may also use Form 8-K to notify investors of any events that they consider to be important.

Finally, Form 8-K provides a valuable record for economic researchers. For example, academics might wonder what influence various events have on stock prices. It is possible to estimate the impact of these events using regressions, but researchers need reliable data. Because 8-K disclosures are legally required, they provide a complete record and prevent sample selection bias.

Criticism of Form 8-K

Like any legally required paperwork, Form 8-K imposes costs on businesses. There is the cost of preparing and submitting the forms, as well as possible penalties for failing to file on time. Although it is only one small part of the problem, the need to file Form 8-K also deters small companies from going public in the first place. Requiring companies to provide information helps investors make better choices. However, it can reduce their investment options when the burden on businesses becomes too high.

Requirements for Form 8-K

The SEC requires disclosure for numerous changes relating to a registrant’s business and operations. Changes to a material definitive agreement or the bankruptcy of an entity must be reported. Other financial information disclosure requirements include the completion of an acquisition, changes in the firm’s financial condition, disposal activities, and substantial impairments. The SEC mandates filing an 8-K for the delisting of a stock, failure to meet listing standards, unregistered sales of securities, and material modifications to shareholder rights.

An 8-K is required when a business changes accounting firms used for certification. Changes in corporate governance, such as control of the registrant or amendments to articles of incorporation, need to be reported. Changes in the fiscal year and modifications of the registrant’s code of ethics must also be disclosed.

The SEC also requires a report upon the election, appointment, or departure of a director or specific officers. Form 8-K must be used to report changes related to asset-backed securities. The form may also be used to meet Regulation Fair Disclosure requirements.

Form 8-K reports may be issued based on other events up to the company’s discretion that the registrant considers to be of importance to shareholders.

What Is Absolute Advantage?

Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than its competitors.

Absolute advantage can be accomplished by creating the good or service at a lower absolute cost per unit using a smaller number of inputs, or by a more efficient process.

Understanding Absolute Advantage

The concept of absolute advantage was developed by 18th-century economist Adam Smith in his book The Wealth of Nations to show how countries can gain from trade by specializing in producing and exporting the goods that they can produce more efficiently than other countries. Countries with an absolute advantage can decide to specialize in producing and selling a specific good or service and use the generated funds to purchase goods and services from other countries.

Smith argued that specializing in the products that they each have an absolute advantage in and then trading the products can make all countries better off, as long as they each have at least one product for which they hold an absolute advantage over other nations.

Absolute advantage explains why it makes sense for individuals, businesses, and countries to trade with each other. Since each has advantages in producing certain goods and services, both entities can benefit from the exchange.

This mutual gain from trade forms the basis of Smith’s argument that specialization, the division of labor, and subsequent trade lead to an overall increase in prosperity from which all can benefit. This, Smith believed, was the root source of the eponymous “Wealth of Nations.”

Absolute Advantage vs. Comparative Advantage

Absolute advantage can be contrasted with comparative advantage, which is when a producer has a lower opportunity cost to produce a good or service than another producer. An opportunity cost is the potential benefits an individual, investor, or business misses out on when choosing one alternative over another.

Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in producing some good. If a producer lacks any absolute advantage, then Adam Smith’s argument would not necessarily apply.

However, the producer and its trading partners might still be able to realize gains from trade if they can specialize based on their respective comparative advantages instead. In his book On the Principles of Political Economy and Taxation, David Ricardo argued that even if a country has an absolute advantage over trading many kinds of goods, it can still benefit by trading with other countries if that have different comparative advantages.

Assumptions of the Theory of Absolute Advantage

Both Smith’s theory of absolute advantage, and Ricardo’s theory of comparative advantage, rely on certain assumptions and simplifications in order to explain the benefits of trade.

Barriers to Trade

Both theories assume that there are no barriers to trade. They do not account for any costs of shipping or additional tariffs that a country might raise on another’s imported goods. In the real world, though, shipping costs impact how likely both the importer and exporter are to engage in trade. Countries can also leverage tariffs to create advantages for themselves or disadvantages for competitors.

Factors of Production

Both theories also assume that the factors of production are immobile. In these models, workers and businesses do not relocate in search of better opportunities. This assumption was realistic in the 1700s.

In modern trade, however, globalization has now made it easy for companies to move their factories abroad. It has also increased the rate of immigration, which impacts a country’s available workforce. In some industries, businesses will work with governments to create immigration opportunities for workers that are essential to their business operations.

Consistency and Scale

More crucially, these theories both assume that a country’s absolute advantage is constant and scales equally. In other words, it assumes that producing a small number of goods has the same per-unit cost as a larger number and that countries are unable to change their absolute advantages.

In reality, countries often make strategic investments to create greater advantages in certain industries. Absolute advantage can also change for reasons other than investment. Natural disasters, for example, can destroy farmland, factories, and other factors of production.

Pros and Cons of Absolute Advantage

One advantage of the theory of absolute advantage is its simplicity: The theory provides an elegant explanation of the benefits of trade, showing how countries can benefit by focusing on their absolute advantages.

However, the theory of comparative advantage does not fully explain why nations benefit from trade. This explanation would later fall to Ricardo’s theory of comparative advantage: Even if one country has an absolute advantage in both types of goods, it will still be better off through trade. In other words, if one country can produce all goods more cheaply than its trading partners, it will still benefit by trading with other countries.

Also, as explained earlier, the theory also assumes that absolute advantages are static—a country cannot change its absolute advantages, and they do not become more efficient with scale. Actual experience has shown this to be untrue: Many countries have successfully created an absolute advantage by investing in strategic industries.

In fact, the theory has been used to justify exploitative economic policies in the postcolonial era. Reasoning that all countries should focus on their advantages, major bodies like the World Bank and IMF have often pressured developing countries to focus on agricultural exports, rather than industrialization. As a result, many of these countries remain at a low level of economic development.

Example of Absolute Advantage

Consider two hypothetical countries, Atlantica and Pacifica, with equivalent populations and resource endowments, with each producing two products: guns and bacon. Each year, Atlantica can produce either 12 tubs of butter or six slabs of bacon, while Pacifica can produce either six tubs of butter or 12 slabs of bacon.

Each country needs a minimum of four tubs of butter and four slabs of bacon to survive. In a state of autarky, producing solely on their own for their own needs, Atlantica can spend one-third of the year making butter and two-thirds of the year making bacon, for a total of four tubs of butter and four slabs of bacon.

Pacifica can spend one-third of the year making bacon and two-thirds making butter to produce the same: four tubs of butter and four slabs of bacon. This leaves each country at the brink of survival, with barely enough butter and bacon to go around. However, note that Atlantica has an absolute advantage in producing butter and Pacifica has an absolute advantage in producing bacon.

If each country were to specialize in their absolute advantage, Atlantica could make 12 tubs of butter and no bacon in a year, while Pacifica makes no butter and 12 slabs of bacon. By specializing, the two countries divide the tasks of their labor between them.

If they then trade six tubs of butter for six slabs of bacon, each country would then have six of each. Both countries would now be better off than before, because each would have six tubs of butter and six slabs of bacon, as opposed to four of each good which they could produce on their own.

The Bottom Line

The theory of absolute advantage represents Adam Smith’s explanation of why countries benefit from trade, by exporting goods where they have an absolute advantage and importing other goods. While the theory is an elegant and simple illustration of the benefits of trade, it did not fully explain the benefits of international trade. That would later fall to David Ricardo’s theory of comparative advantages.

What Are Accounts Receivable (AR)?

Accounts receivable (AR) are the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivable are listed on the balance sheet as a current asset. Any amount of money owed by customers for purchases made on credit is AR.

Understanding Accounts Receivable

Accounts receivable refer to the outstanding invoices that a company has or the money that clients owe the company. The phrase refers to accounts that a business has the right to receive because it has delivered a product or service. Accounts receivable, or receivables, represent a line of credit extended by a company and normally have terms that require payments due within a relatively short period. It typically ranges from a few days to a fiscal or calendar year.

Companies record accounts receivable as assets on their balance sheets because there is a legal obligation for the customer to pay the debt. They are considered a liquid asset, because they can be used as collateral to secure a loan to help meet short-term obligations. Receivables are part of a company’s working capital.

Furthermore, accounts receivable are current assets, meaning that the account balance is due from the debtor in one year or less. If a company has receivables, this means that it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.

Accounts Receivable vs. Accounts Payable

When a company owes debts to its suppliers or other parties, these are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, imagine Company A cleans Company B’s carpets and sends a bill for the services. Company B owes them money, so it records the invoice in its accounts payable column. Company A is waiting to receive the money, so it records the bill in its accounts receivable column.

Benefits of Accounts Receivable

Accounts receivable are an important aspect of a business’s fundamental analysis. Accounts receivable are a current asset, so it measures a company’s liquidity or ability to cover short-term obligations without additional cash flows. 

Fundamental analysts often evaluate accounts receivable in the context of turnover, also known as accounts receivable turnover ratio, which measures the number of times a company has collected on its accounts receivable balance during an accounting period. Further analysis would include assessing days sales outstanding (DSO), the average number of days that it takes to collect payment after a sale has been made.

Example of Accounts Receivable

An example of accounts receivable includes an electric company that bills its clients after the clients received the electricity. The electric company records an account receivable for unpaid invoices as it waits for its customers to pay their bills. 

Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer this credit to frequent or special customers that receive periodic invoices. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service.

What Is Accrual Accounting?

Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred.

In other words, the revenue earned and expenses incurred are entered into the company’s journal regardless of when money exchanges hands. Accrual accounting is usually compared to cash basis of accounting, which records revenue when the goods and services are actually paid for.

Learn more about accrual accounting and how it differs from the other popular accounting method, cash accounting.

How Accrual Accounting Works

The general concept of accrual accounting is that accounting journal entries are made when a good or service is provided rather than when payment is made or received. Entries are also made for debts and payments due.

This method allows the current and future cash inflows or outflows to be combined to give a more accurate picture of a company’s current and long-term finances.

Accrual accounting follows the matching principal, which states that revenues and expenses should be recorded in the same period.

Accrual accounting is encouraged by International Financial Reporting Standards(IFRS) and Generally Accepted Accounting Principles (GAAP). As a result, it has become the standard accounting practice for most companies except for very small businesses and individuals.

Qualifying for Accrual Accounting

Larger companies are required to use the accrual method of accounting if their average gross receipt of revenues is more than $25 million over the previous three years. If a company does not meet the average revenue requirement, it can choose to use cash basis or accrual as its accounting method.

Accrual accounting is always required for companies that carry inventory or make sales on credit, regardless of the company size or revenue.

Benefits of Accrual Accounting

The accrual method does provide a more accurate picture of the company’s current condition, but its relative complexity makes it more expensive to implement.

This method arose from the increasing complexity of business transactions and a desire for more accurate financial information. Selling on credit, and projects that provide revenue streams over a long period, affect a company’s financial condition at the time of a transaction. Therefore, it makes sense that such events should also be reflected in the financial statements during the same reporting period that these transactions occur.

Under accrual accounting, firms have immediate feedback on their expected cash inflows and outflows, making it easier for businesses to manage their current resources and plan for the future.

Accrual Accounting vs. Cash Accounting

Accrual accounting can be contrasted with cash accounting, which recognizes transactions only when there is an exchange of cash. Additionally, cash basis and accrual differ in the way and time transactions are entered.

Cash Basis of Accounting

Cash accounting uses transactions when payments are made. For example, consider a consulting company that provides a $5,000 service to a client on Oct. 30. The client received the bill for services rendered and made a cash payment on Nov. 25. Under the cash basis method, the consultant would record an owed amount of $5,000 by the client on Oct. 30, and enter $5,000 in revenue when it is paid on Nov. 25 and record it as paid.

Accrual Basis of Accounting

In contrast, accrual accounting uses a technique called double-entry accounting. When the consulting company provided the service, it would enter a debit of $5,000 in accounts receivable (debits increase an asset account). When the payment is made on Nov. 25, the consultant credits (credits decrease an asset account) the accounts receivable by $5,000 and credits the service revenues account, a revenue account (credits increase a revenue account ) with $5,000.

The received capital can then be moved to other accounts, such as free cash, if needed—the company uses the same double-entry method to enter which account the capital came from and is moved to.

The Bottom Line

Accrual accounting is an accounting method in which payments and expenses are credited and debited when earned or incurred. Accrual accounting differs from cash basis accounting, where expenses are recorded when payment is made and revenues recorded when cash is received.

Accrual accounting uses double-entry accounting, where there are generally two accounts used when entering a transaction. This method is more accurate than cash basis accounting because it tracks the movement of capital through a company and helps it prepare its financial statements.