The adjusted balance method is the most common method used by banks and finance companies to calculate the interest income or finance charges associated with a bank account or credit card account, respectively. In essence, the bank or finance company waits until the end of the billing period, aggregates all adjustments made to the account during the period, and then calculates any interest or finance charges based on this ending balance.
Since the ending balance usually includes payments made by customers (for credit card accounts), the balance is greatly reduced from what an averaging method might derive. Thus, the adjusted balance method tends to result in lower interest and fee charges to customers for credit card accounts. This can be a key decision factor for a person or business investigating which credit card to adopt. Similarly, a bank using this method calculates the interest income that an account holder earns for a month based on the ending balance in the account.
For example, a credit card has a beginning balance of $500. The card holder makes $350 of additional purchases during the month, and pays down the account by $275. The adjusted balance method nets all of these items to arrive at an ending balance of $575, from which a finance charge is calculated.
The two alternative calculation methods are:
- Previous balance method. Calculates based on the balance at the end of the immediately preceding period.
- Average daily balance method. Calculates based on the average daily account balance during the reporting period.