AP Business 3.3: Accounting and Financial Management

Predict first

A bakery borrows $12,000 from a bank and uses it to buy a new oven the same day. On that day, what happens to the value of the bakery to its owners?

Transactions change what you own and what you owe

Businesses make all kinds of financial transactions: buying resources, receiving payment from customers, distributing profits to owners, saving, and borrowing. Each one affects the business's assets (things of value it owns, such as cash and equipment), its liabilities (what it owes, such as loans) and its owners' equity, the value of the business to its owners.

Households work the same way. Receiving income, buying goods and services, saving and borrowing all affect a consumer's assets, liabilities and net worth. Net worth is the household version of owners' equity: what you own minus what you owe. Adding it all up is the job of 3.7 The Balance Sheet and Net Worth.

Some transactions change the totals, and some only move money around. A paycheck raises your assets and your net worth. Money spent on groceries lowers both. Moving $200 from checking to savings changes neither, because one asset went down and another went up by the same amount.

Worked exampleOne week of Sam's transactions

Sam, 19, starts the week with $900 in checking, $1,500 in savings and a $2,000 student loan, so his net worth is 2,400 minus 2,000 = $400. During the week he deposits a $650 paycheck, spends $180 on groceries and gas, moves $200 from checking to savings, and borrows $1,000 from his credit union to cover a car repair next week. How does each transaction affect his assets, liabilities and net worth?

Receiving income. The $650 paycheck raises his assets by $650 and adds nothing he owes, so his net worth rises to $1,050.
Buying goods and services. The $180 lowers his assets by $180. The groceries get eaten and the gas gets burned, so his net worth falls to $870.
Saving. Moving $200 lowers checking by $200 and raises savings by $200. His total assets, liabilities and net worth do not change: the money only moved.
Borrowing. The $1,000 loan raises his assets by $1,000 and his liabilities by $1,000. They offset, so his net worth stays at $870.

Answer.

Income raised his net worth and spending lowered it. Saving and borrowing changed what his assets are and what he owes, but not his net worth, on the day they happened. Saving builds net worth over time because money you save is money you did not spend.

Why businesses keep records

A business records every financial transaction and uses those records to prepare reports and financial statements that summarize its financial performance. You will study three of them: the income statement, the balance sheet and the cash flow statement.

Financial statements are used to:

monitor the business's financial health,
guide decision making,
give accurate information to shareholders, investors and lenders, the people outside the business with money at stake, and
make sure the business complies with laws and reporting regulations.

Generally accepted accounting principles (GAAP) are the standard rules for preparing financial statements in the United States. For corporations that sell ownership shares to the public, they carry a strict requirement: consistently disclose their financial results, positive and negative, for each reporting period. A reporting period is typically a quarter (three months) or a year. A bad quarter gets reported just like a good one.

Households keep records too

Consumers are not usually required to record or report their financial transactions. But an organized system for tracking them, such as a budget, helps you monitor your finances and make decisions that line up with your financial goals. If you are saving $250 a month for a car, a budget is how you find out in March, not in December, that you are falling behind.

Consumers can also hire help. Financial advisors and accountants help households with financial planning and decision making, and with tax preparation.

Who does the work inside a business

The accounting department identifies and records every financial transaction during a time period and prepares the financial statements.

Accountants are told apart by who the information is for. Managerial accountants provide financial information and analysis to managers and other internal stakeholders, for business planning and decision making. A report for a regional manager on which of three stores is losing money is managerial accounting. Financial accountants provide financial information and analysis mainly to external stakeholders, specifically shareholders, investors and lenders. The quarterly statements a public corporation releases are financial accounting.

The finance department picks up where accounting leaves off. It analyzes the financial data the accounting department compiled and recommends strategies to maintain or improve the business's financial performance, such as replacing a loan with one at a lower interest rate or cutting a cost that is growing faster than sales.

Who handles a business's financial information
Who	What they do	Main audience
Accounting department	Identifies and records all financial transactions in a period and prepares the financial statements	Everyone who uses the statements, inside and outside the business
Managerial accountants	Provide financial information and analysis for business planning and decision making	Managers and other internal stakeholders
Financial accountants	Provide financial information and analysis about the business	Mainly external stakeholders: shareholders, investors and lenders
Finance department	Analyzes the data accounting compiled and recommends strategies to maintain or improve financial performance	Decision makers inside the business

Sort it

Each card is a piece of financial work. Tap it, then tap the kind of accountant who would provide it.

Managerial accountant

Financial accountant

Check your understanding

1

Bayline Shipping employs a team of financial accountants. Who is the main audience for their work?

2

Which task belongs to the finance department rather than the accounting department?

3

Ridgeline Outdoor Gear sells shares to the public. After a quarter of falling sales, its CEO suggests waiting until results improve before releasing more financial information. What do generally accepted accounting principles (GAAP) require?

4

Which transaction raises a consumer's net worth on the day it happens?

5

Consumers usually are not required to record their financial transactions. Why does keeping a budget still help Marcus, who is saving for a used car?