AP® Business with Personal Finance review sheet from Aim for Five (aimforfive.com/business-finance/units/3/3-3)
Unit 3 · Topic 3.3
3.3 Accounting and Financial Management
Accounting is how a business keeps score. Businesses record every money transaction and turn the records into financial statements that guide decisions, inform investors and lenders and keep the business within the law. You can track your own money the same way with a budget.
Key terms
- financial transaction
- financial statements
- GAAP
- managerial accounting
- financial accounting
- budget
Transactions change what you own and owe
Businesses make financial transactions all the time: buying materials, getting paid by customers, paying profits to owners, saving and borrowing. Each one changes the business's assets (what it owns), liabilities (what it owes) or owners' equity (what the business is worth to its owners).
Your money works the same way. Getting paid, buying things, saving and borrowing change your assets, your liabilities and your net worth, which is assets minus liabilities.
Why businesses keep careful records
Businesses record every transaction and summarize them in reports called financial statements. These statements are used to:
- Check the business's financial health.
- Guide decisions, like whether to hire or cut costs.
- Give accurate information to shareholders, investors and lenders.
- Follow laws and reporting rules.
GAAP and public companies
Corporations that sell shares to the public must follow generally accepted accounting principles (GAAP), a standard set of accounting rules in the U.S. They have to report all their financial information, good and bad, consistently each reporting period, usually every quarter (three months) and every year. That lets investors compare one period, or one company, with another.
The three main financial statements
Topics 3.6 to 3.8 cover the three statements every business keeps. Knowing what each one answers will help you pick the right one in a question.
| Statement | Time frame | Question it answers |
|---|---|---|
| Income statement | A period (month, quarter, year) | Did we make a profit? |
| Balance sheet | One moment in time | What do we own, what do we owe, and what's left for the owners? |
| Cash flow statement | A period | Where did our cash come from and go, and do we have enough to pay our bills? |
Who does the work
People can get help too: financial advisors help with planning and decisions, and accountants help with planning and with preparing tax returns.
| Role | What they do | Who uses their work |
|---|---|---|
| Accounting department | Identifies and records every transaction and prepares financial statements | Everyone below |
| Managerial accountants | Analyze numbers to help plan and decide | Managers and other internal stakeholders |
| Financial accountants | Prepare and explain financial information for outsiders | Shareholders, investors and lenders |
| Finance department | Analyzes the accounting data and recommends ways to keep or improve performance | Executives |
Budgets for individuals
Individuals usually don't have to record or report their transactions. But an organized system, such as a budget, helps you see where your money goes and make choices that match your goals. A budget is a plan for your income: how much goes to bills, to saving and to everything else.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Checking a monthly budget
Jade's net pay (take-home pay) is $3,200 a month. She plans: rent $1,100, car payment $280, car insurance $150, groceries $450, utilities and phone $220, gas $160 and savings $320. How much is left for everything else, and what share of her pay is she saving?
Show the solutionHide the solution
- Step 1: Add the planned items: $1,100 + $280 + $150 + $450 + $220 + $160 + $320 = $2,680.
- Step 2: Left over: $3,200 − $2,680 = $520 for entertainment, eating out, clothes and surprises.
- Step 3: Savings share: $320 ÷ $3,200 = 0.10 = 10%.
Answer: $520 is left for other spending, and she's saving 10% of her net pay.
Common mistakes
- Mixing up managerial accountants (serve people inside the business) and financial accountants (serve outsiders like investors and lenders).
- Thinking accounting and finance are the same department. Accounting records and reports; finance analyzes and recommends.
- Building a budget from gross pay. Plan with net pay, the amount you actually receive.
On the exam
- Questions may ask who would use a certain report (a manager, a lender, an investor) or why a public corporation must disclose bad news as well as good.
- Budget arithmetic on the exam is four-function: add the expenses, subtract from income and find percentages.
Connected topics
Videos
Check yourself: 3.3 Accounting and Financial Management
4 questions on 3.3 Accounting and Financial Management. Pick an answer to see if you got it, and why.
Cobalt Robotics is a corporation whose shares trade on a public stock exchange. Three employees describe their jobs.
Employee 1: "I prepare cost reports that help our managers decide which product lines to expand next year."
Employee 2: "I prepare the financial statements we release to shareholders, investors and lenders every quarter."
Employee 3: "I study the numbers the accountants put together and recommend ways to cut costs and raise profits."
Hypothetical job descriptions
Employee 1 is best described as a
Why must Cobalt release financial statements every quarter?
Employee 3 most likely works in which department?
Cobalt borrows $2 million from a bank and deposits the money in its account. How does this transaction affect Cobalt's records?
0 of 4 answered