What Is an Account Balance?

An account balance is the amount of money present in a financial repository, such as a savings or checking account, at any given moment. The account balance is always the net amount after factoring in all debits and credits. An account balance that falls below zero represents a net debt—for example, when there is an overdraft on a checking account. For financial accounts that have recurring bills, such as an electric bill or a mortgage, an account balance may also reflect an amount owed.

Understanding an Account Balance

Your account balance shows your total assets minus total liabilities. Sometimes this can be referred to as your net worth or total wealth because it subtracts any debts or obligations from positive sums. For specific accounts at a financial institution, such as a checking account or a brokerage account, your account balance will reflect the current sum of funds or value of that account. For investments or other risky assets, your account balance will tend to change over time as security prices rise and fall in the market.

Many other financial accounts also have an account balance. Everything from a utility bill to a mortgage account needs to show you the balance of the account. For financial accounts that have recurring bills, such as a water bill, your account balance usually shows the amount owed. An account balance can also refer to the total amount of money you owe to a third party, such as a credit card company, utility company, mortgage banker, or another type of lender or creditor.

In banking, the account balance is the amount of money you have available in your checking or savings account. Your account balance is the net amount available to you after all deposits and credits have been balanced with any charges or debits. Sometimes your account balance does not reflect the most accurate representation of your available funds, due to pending transactions or checks that have not been processed.

Examples of Account Balances

In the case of a credit card, you may have made various purchases of $100, $50, and $25 and returned another item costing $10. The account balance includes the purchases made, which total $175, but also the item returned for $10. The net of the debits and credits is $165, or $175 minus $10, and that amount is your account balance.

In the case of a checking account, if your starting balance is $500, and you received a check for $1,500 and also wrote a check or scheduled an automatic payment for $750, then your account balance might show $2,000 immediately, depending on the banking establishment. However, the true account balance is $1,250. It is important to keep track of account balances by recording every credit and debit and then reconciling your calculated balance with the bank statement balance each month.

Account Balance vs. Available Credit

For credit cards, account balances are the total amount of debt owed at the start of the statement date. Your account balance on a credit card also includes any debt rolled over from previous months, which may have accrued interest charges. Available credit is the term used alongside the account balance to indicate how much of the credit line you have left to spend.

For some bank accounts, deposits may not clear in whole or in part immediately, taking up to a few business days to show up in your account. In such situations the bank will usually indicate to you the current available balance alongside the unavailable amount that is waiting to clear.

What Is an Accrued Expense?

An accrued expense, also known as accrued liabilities, is an accounting term that refers to an expense that is recognized on the books before it has been paid. The expense is recorded in the accounting period in which it is incurred.

Understanding Accrued Expenses

Since accrued expenses represent a company’s obligation to make future cash payments, they are shown on a company’s balance sheet as current liabilities. An accrued expense can be an estimate and differ from the supplier’s invoice that will arrive at a later date. Following the accrual method of accounting, expenses are recognized when they are incurred, not necessarily when they are paid.

An example of an accrued expense is when a company purchases supplies from a vendor but has not yet received an invoice for the purchase. Other forms of accrued expenses include interest payments on loans, warranties on products or services received, and taxes—all of which have been incurred or obtained, but for which no invoices have been received nor payments made. Employee commissions, wages, and bonuses are accrued in the period they occur although the actual payment is made in the following period.

Accrual vs. Cash Basis Accounting

Accrual accounting differs from cash basis accounting, which records financial events and transactions only when cash is exchanged—often resulting in the overstatement and understatement of income and account balances.

Although the accrual method of accounting is labor-intensive because it requires extensive journaling, it is a more accurate measure of a company’s transactions and events for each period. This more complete picture helps users of financial statements to better understand a company’s present financial health and predict its future financial position.

Accrued Expenses vs. Prepaid Expenses

Accrued expenses are the opposite of prepaid expenses. Prepaid expenses are payments made in advance for goods and services that are expected to be provided or used in the future. While accrued expenses represent liabilities, prepaid expenses are recognized as assets on the balance sheet. This is because the company is expected to receive future economic benefit from the prepayment.

On the other hand, an accrued expense is an event that has already occurred in which cash has not been a factor. Not only has the company already received the benefit, it still needs to remit payment. Therefore, it is literally the opposite of a prepayment; an accrual is the recognition of something that has already happened in which cash is yet to be settled.

Advantages and Disadvantages of Accrued Expenses

Advantages

Accrued expenses theoretically make a company’s financial statements more accurate. While the cash method is more simple, accrued expenses strive to include activity that may not have fully been incurred but will still happen. Consider an example where a company enters into a contract to incur consulting services. If the company receives an invoice for $5,000, accounting theory states the company should technically recognize this transaction because it is contractually obligated to pay for the service.

Accrued expenses also may make it easier for companies to plan and strategize. Accrued expenses often yield more consistent financial results as companies can include recurring transactions in their financial reports that may not yet have been paid. In addition, accrued expenses may be a financial reporting requirement depending on the company and their Securities and Exchange Commission filing requirements.

Disadvantages

Because of additional work of accruing expenses, this method of accounting is more time-consuming and demanding for staff to prepare. There is a greater chance of misstatements, especially is auto-reversing journal entries are not used. In addition, a company runs of the risk of accidently accruing an expense that they may have already paid.

Last, the accrual method of accounting blurs cash flow and cash usage as it includes non-cash transactions that have not yet impacted bank accounts. For a large company, the general ledger will be flooded with transactions that report items that have had no bearing on the company’s bank statement nor impact to the current amount of cash on hand.

Special Considerations

Reversing Entries

A critical component to accrued expenses is reversing entries, journal entries that back out a transaction in a subsequent period.

Accrued expenses are not meant to be permanent; they are meant to be temporary records that take the place of a true transaction in the short-term. Every accrued expense must have a reversing entry; without the reversing entry, a company risks duplicating transactions by recording both the actual invoice when it gets paid as well as the accrued expense.

Month-End/Year-End

Accrued expenses are prevalent during the end of an accounting period. A company often attempts to book as many actual invoices it can during an accounting period before closing its accounts payable ledger. Then, supporting accounting staff analyze what transactions/invoices might not have been recorded by the AP team and book accrued expenses.

For companies that are responsible for external reporting, accrued expenses play a big part in wrapping up month-end, quarter-end, or fiscal year-end processes. A company usually does not book accrued expenses during the month; instead, accrued expenses are booked during the close period.

Example of Accrued Expense

A company pays its employees’ salaries on the first day of the following month for services received in the prior month. So, employees that worked all of November will be paid in December. If on Dec. 31, the company’s income statement recognizes only the salary payments that have been made, the accrued expenses from the employees’ services for December will be omitted.

Because the company actually incurred 12 months’ worth of salary expenses, an adjusting journal entry is recorded at the end of the accounting period for the last month’s expense. The adjusting entry will be dated Dec. 31 and will have a debit to the salary expenses account on the income statement and a credit to the salaries payable account on the balance sheet.

When the company’s accounting department receives the bill for the total amount of salaries due, the accounts payable account is credited. Accounts payable is found in the current liabilities section of the balance sheet and represents the short-term liabilities of a company. After the debt has been paid off, the accounts payable account is debited and the cash account is credited.

The Bottom Line

Companies using the accrual method of accounting recognize accrued expenses, costs that have not yet been paid for but have already been incurred. Accrued expenses make a set of financial statements more consistent by recording charges in specific periods, though it takes more resources to perform this type of accounting. While the cash method of accounting recognizes items when they are paid, the accrual method recognizes accrued expenses based on when service is performed or received. 

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 Is an Acquisition?

An acquisition is when one company purchases most or all of another company’s shares to gain control of that company. Purchasing more than 50% of a target firm’s stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company’s other shareholders. Acquisitions, which are very common in business, may occur with the target company’s approval, or in spite of its disapproval. With approval, there is often a no-shop clause during the process.

We mostly hear about acquisitions of large well-known companies because these huge and significant deals tend to dominate the news. In reality, mergers and acquisitions (M&A) occur more regularly between small- to medium-size firms than between large companies.

Understanding Acquisitions

Companies acquire other companies for various reasons. They may seek economies of scale, diversification, greater market share, increased synergy, cost reductions, or new niche offerings. Other reasons for acquisitions include those listed below.

As a Way to Enter a Foreign Market

If a company wants to expand its operations to another country, buying an existing company in that country could be the easiest way to enter a foreign market. The purchased business will already have its own personnel, a brand name, and other intangible assets, which could help to ensure that the acquiring company will start off in a new market with a solid base.

As a Growth Strategy

Perhaps a company met with physical or logistical constraints or depleted its resources. If a company is encumbered in this way, then it’s often sounder to acquire another firm than to expand its own. Such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit.

To Reduce Excess Capacity and Decrease Competition

If there is too much competition or supply, companies may look to acquisitions to reduce excess capacity, eliminate the competition, and focus on the most productive providers.

To Gain New Technology

Sometimes it can be more cost-efficient for a company to purchase another company that already has implemented a new technology successfully than to spend the time and money to develop the new technology itself.

Acquisition, Takeover, or Merger?

Although technically, the words “acquisition” and “takeover” mean almost the same thing, they have different nuances on Wall Street.

In general, “acquisition” describes a primarily amicable transaction, where both firms cooperate; “takeover” suggests that the target company resists or strongly opposes the purchase; the term “merger” is used when the purchasing and target companies mutually combine to form a completely new entity. However, because each acquisition, takeover, and merger is a unique case, with its own peculiarities and reasons for undertaking the transaction, the exact use of these terms tends to overlap in practice.

Acquisitions: Mostly Amiable

Friendly acquisitions occur when the target firm agrees to be acquired; its board of directors (B of D, or board) approves of the acquisition. Friendly acquisitions often work toward the mutual benefit of the acquiring and target companies. Both companies develop strategies to ensure that the acquiring company purchases the appropriate assets, and they review the financial statements and other valuations for any obligations that may come with the assets. Once both parties agree to the terms and meet any legal stipulations, the purchase proceeds.

Takeovers: Usually Inhospitable, Often Hostile

Unfriendly acquisitions, commonly known as “hostile takeovers,” occur when the target company does not consent to the acquisition. Hostile acquisitions don’t have the same agreement from the target firm, and so the acquiring firm must actively purchase large stakes of the target company to gain a controlling interest, which forces the acquisition.

Even if a takeover is not exactly hostile, it implies that the firms are not equal in one or more significant ways.

Mergers: Mutual, But Creates a New Entity

As the mutual fusion of two companies into one new legal entity, a merger is a more-than-friendly acquisition. Mergers generally occur between companies that are roughly equal in terms of their basic characteristics—size, number of customers, the scale of operations, and so on. The merging companies strongly believe that their combined entity would be more valuable to all parties (especially shareholders) than either one could be alone.

Evaluating Acquisition Candidates

Before making an acquisition, it is imperative for a company to evaluate whether its target company is a good candidate.

• Is the price right? The metrics investors use to value an acquisition candidate vary by industry. When acquisitions fail, it’s often because the asking price for the target company exceeds these metrics.
• Examine the debt load. A target company with an unusually high level of liabilities should be viewed as a warning of potential problems ahead.
• Undue litigation. Although lawsuits are common in business, a good acquisition candidate is not dealing with a level of litigation that exceeds what is reasonable and normal for its size and industry.
• Scrutinize the financials. A good acquisition target will have clear, well-organized financial statements, which allows the acquirer to exercise due diligence smoothly. Complete and transparent financials also help to prevent unwanted surprises after the acquisition is complete.

Example of Acquisitions

AOL and Time Warner and AT&T

AOL Inc. (originally America Online) was the most publicized online service of its time, and had been extolled as “the company that brought the internet to America.” Founded in 1985, by the year 2000 AOL had grown to become the United States’ largest internet provider. Meanwhile, the legendary media conglomerate, Time Warner, Inc. was being labeled an “old media” company, given its range of tangible businesses like publishing, and television, and an enviable income statement.

In 2000, in a masterful display of overweening confidence, the young upstart AOL purchased the venerable giant Time Warner (TWX) for $165 billion; this dwarfed all records and became the biggest merger in history. The vision was that the new entity, AOL Time Warner, would become a dominant force in the news, publishing, music, entertainment, cable, and Internet industries. After the merger, AOL became the largest technology company in America.

However, the joint phase lasted less than a decade. As AOL lost value and the dot-com bubble burst, the expected successes of the merger failed to materialize, and AOL and Time Warner dissolved their union:

• In 2009, AOL Time Warner dissolved in a spin-off deal.
• From 2009 to 2016, Time Warner remained an entirely independent company. 
• In 2015, Verizon Communications, Inc. (NYSE: VZ) acquired AOL for $4.4 billion.

Then, in October 2016, AT&T (NYSE: T) and Time Warner (TWX) announced a deal in which AT&T will buy Time Warner for $85.4 billion, morphing AT&T into a media heavy-hitter. In June 2018, after a protracted court battle, AT&T completed its acquisition of Time Warner.

Certainly, the AT&T-Time Warner acquisition deal of 2018 will be as historically significant as the AOL-Time Warner deal of 2000; we just can’t know exactly how yet. These days, 18 years equals numerous lifetimes—especially in media, communications, and technology—and much will continue to change. For the moment, however, two things seem certain:

1. The consummation of the AT&T-Time Warner merger already has begun to reshape much of the media industry.
2. M&A enterprise is still alive and well.