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In this questin, students will understand how to balance a budget and the organized way of presenting solutions.

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Practicing questions will help to understand the concept deeply.

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Support the Teaching and Learning of Mathematics 

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Financial Literacy- Questions and Comments

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This learning station is created to help grade 8 students .

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Pros and Cons of Shopping With a Credit Card - NerdWallet

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Credit cards are tools. Like most tools, they can be incredibly helpful when used properly but dangerous when used incorrectly.

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What Is a Transaction?

A transaction is a completed agreement between a buyer and a seller to exchange goods, services, or financial assets in return for money. The term is also commonly used in corporate accounting. In business bookkeeping, this plain definition can get tricky. A transaction may be recorded by a company earlier or later depending on whether it uses accrual accounting or cash accounting.

Key Takeaways

Understanding Transactions

A sales transaction between a buyer and a seller is relatively straightforward. Person A pays person B in exchange for a product or service. When they agree on the terms, money is exchanged for the good or service and the transaction is complete.

Transactions can be more complex in the accounting world because businesses may make a deal today which won't be settled until a future date. Or, they may have revenues or expenses that are known but not yet due. Third-party transactions can also complicate the process.

Whether a business records income and expense transactions using the accrual method of accounting or the cash method of accounting affects the company's financial and tax reporting.

The accrual accounting method requires a transaction to be recorded when it occurs, regardless of when the money is received or the expenses are paid.

The cash accounting method records a transaction only when the money is received or the expenses are paid. This may require a letter of intent or a memorandum of understanding.

Transactions Using Accrual Accounting

When accrual accounting is used, a company records income when completing a service or delivering goods. If an inventory is required when accounting for a company's income and the company has gross receipts with an average of over $26 million over the prior three years, the company normally uses the accrual method of accounting for sales and purchases.

Examples of Accrual Accounting

A company selling merchandise to a customer on store credit in October records the transaction immediately as an item in accounts receivable (AR). Even if the customer does not make a cash payment on the merchandise until December or pays in installments, the transaction is recorded as income for October.

The same goes for goods or services the company purchases. Business expenses are recorded when the products or services are received. Supplies purchased on credit in April are recorded as expenses for April, even if the business does not make a cash payment on the supplies until May.

Transactions Using Cash Accounting

Most small businesses, especially sole proprietorships and partnerships, use the cash accounting method. Income is recorded when cash, checks, or credit card payments are received from customers.

Examples of Cash Accounting

Let's say a business sells $10,000 of widgets to a customer in March. The customer pays the invoice in April. The company recognizes the sale only after the cash is received in April.

Meanwhile, expenses are recorded only when a payment is made. A business may purchase $500 of office supplies in May, for example, and pay for them in June. The business recognizes the purchase when it pays the bill in June.

For tax reasons, the cash basis of accounting is available only if a company has an average of less than $26 million over the prior three years in annual sales. The cash basis is easier than the accrual basis for recording transactions because no complex accounting transactions, such as accruals and deferrals, are necessary. Its drawback is that the profit of the business may vary wildly from month to month, at least on paper.

What Is an ACH Transaction?

An ACH transaction is an electronic payment made between banks. They are processed through the Automated Clearing House. Examples of ACH transactions include direct deposits for things like your salary or tax refund, and bill payments that are made online or through your bank.

How Do I Cancel a Pending Transaction?

Pending transactions are those that have been made but aren't posted to your account. These include payments, purchases, pre-authorized debits, and any other related transactions. Purchases made with a debit or credit card are held for a certain period of time before they work their way through the electronic system from your bank to the recipients. Contact the merchant and/or your bank to request a reversal if, for whatever reason, you want to cancel the transaction.

How Are Transactions Different in Accounting?

Accounting transactions are a little different because of the way they may be recorded. In the accrual method of accounting, transactions are recorded once they are executed. But in the cash accounting method, transactions are recorded only when money is received or paid.

The Bottom Line

A transaction signals a financial agreement between two parties where one benefits financially by selling goods and services to another. In simple terms, a transaction is completed when the goods and services change hands for money. But things get a little complicated when it comes to transactions in accounting. Businesses that use the accrual method of accounting record transactions when they are completed. In the cash method, they are documented only when payments are made or received.

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A transaction is a finalized agreement between a buyer and a seller, but it can get a bit more complicated from an accounting perspective.

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The balance of payments is the record of all international trade and financial transactions made by a country's residents.

The balance of payments has three components: the current account, the financial account, and the capital account. Current accounts measure international trade, net income on investments, and direct payments. The financial account describes the change in international ownership of assets. The capital account includes any other financial transactions that don't affect the nation's economic output.

Key Takeaways

What It Means

A country's balance of payments tells you whether it saves enough to pay for its imports. It also reveals whether the country produces enough economic output to pay for its growth. The BOP is reported for a quarter or a year.

Note

It's like taking out a school loan to pay for education. Your expected higher future salary is worth the investment.

In the long-term, the country becomes a net consumer, not a producer, of the world's economic output. It will have to go into debt to pay for consumption instead of investing in future growth. If the deficit continues long enough, the country may have to sell its assets to pay its creditors. These assets include natural resources, land, and commodities.

Note

A surplus may boost economic growth in the short term. There are enough excess savings to lend to countries that buy its products. The increased exports boost production in its factories, allowing them to hire more people. In the long run, the country becomes too dependent on export-driven growth. It must encourage its residents to spend more.

Note

Current Account

The current account measures a country's trade balance plus the effects of net income and direct payments. When the activities of a country's people provide enough income and savings to fund all their purchases, business activity, and government infrastructure spending, then the current account is in balance.﻿﻿

Current Account Deficit

A current account deficit is when a country's residents spend more on imports than they save. Other countries lend funds or invest in the deficit country's businesses to fund that national deficit. The lender country is usually willing to pay for the deficit because its businesses profit from exports to the deficit country. In the short run, the current account deficit is a win-win for both nations.

But if the current account deficit continues for a long time, it will slow economic growth. Foreign lenders will begin to wonder whether they will get an adequate return on their investment. If demand falls off, the value of the borrowing country's currency may also decline. This fall in currency value leads to inflation as import prices rise. It also creates higher interest rates as the government must pay higher yields on its bonds.

The U.S. current account deficit reached a record $816 billion in 2006. That created concern about the sustainability of such an imbalance. It fell during the recession but is now growing again.

The Congressional Budget Office warned about the danger of the current account deficit. It also proposed several solutions. First, Americans should cut back on credit card spending and increase their savings rate. That will help to fund domestic business growth. Second, the government must reduce its health care spending. The best way to do that is to lower the cost of health care. That was the goal of the Affordable Care Act.

If these solutions don't work, it could lead to inflation, higher interest rates, and a lower standard of living.

Current Account: Trade Balance

The trade balance measures a country's imports and exports. This portion is the largest component of the current account, which is itself the largest component of the balance of payments. Most countries try to avoid a trade deficit, but it's a good thing for emerging market countries. It helps them grow faster than they could if they were to maintain a surplus.

Trade Balance: U.S. Imports and Exports

In 2021, the United States traded $5.9 trillion with foreign countries. That was $2.5 trillion in exports and $3.4 trillion in imports, each of which set records.

With its size and wealth, it should be exporting more. One of the major challenges to increasing U.S. exports is that other countries have lower costs of living. They can make things more cheaply because they pay their workers less.

Domestic manufacturing would cost a lot more. Most people aren't willing to pay more to save U.S. jobs. U.S. imports tend to cost less than domestically made products. America imports more than half of its goods from just five countries.

Trade Deficit Definition

A trade deficit is a result of a country's importing more than it exports. Imports are any goods and services produced in a foreign country, even if these are produced overseas by a domestic company.

A trade deficit can then occur even if all of the imports are being sold by, and sending profit to, a domestic firm. With the rise of multinational corporations and job outsourcing, trade deficits are on the rise.

U.S. Trade Deficit

America's reliance on foreign oil causes a large part of the U.S. trade deficit. When oil prices rise, so does the trade deficit. America also imports a lot of automobiles and consumer products. U.S. exports include many of the same things, but not enough to outweigh the deficit.

In 2020, the United States outranked 20 countries by racking up the highest trade balance deficit by far, approximating $975.91 billion. Dependence on foreign oil, high import consumption, increase in multinational corporations, and job outsourcing increases that trade deficit.

Financial Account

The financial account measures changes in domestic ownership of foreign assets and foreign ownership of domestic assets. If foreign ownership increases more than domestic ownership does, it creates a deficit in the financial account. This increase means that the country is selling its assets, like gold, commodities, and corporate stocks, more quickly than the nation is acquiring foreign assets.

Capital Account

The capital account measures financial transactions that don't affect a country's income, production, or savings. For example, it records international transfers of drilling rights, trademarks, and copyrights. Many capital account transactions rarely happen, such as cross-border insurance payments. The capital account is the smallest component of the balance of payments.

Frequently Asked Questions (FAQs)

How do you calculate the balance of payments?

How do you calculate the trade deficit?

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The balance of payments is a record of a country's international trade plus the financial transactions that make it possible. It has three components.

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What is a 'Balanced Budget'

A balanced budget is a situation in financial planning or the budgeting process where total revenues are equal to or greater than total expenses. A budget can be considered balanced in hindsight, after a full year's worth of revenues and expenses have been incurred and recorded. A company's operating budget for an upcoming year can also be called balanced based on predictions or estimates.

BREAKING DOWN 'Balanced Budget'

The phrase "balanced budget" is commonly used in reference to official government budgets. For example, governments may issue a press release stating that they have a balanced budget for the upcoming fiscal year, or politicians may campaign on a promise to balance the budget once in office. It is important to understand that the phrase "balanced budget" can refer to either a situation where revenues equal expenses or where revenues exceed expenses, but not where expenses exceed revenues.

Budget Deficits and Surpluses

The term "budget surplus" is often used in conjunction with a balanced budget. A budget surplus occurs when revenues exceed expenses, and the surplus amount represents the difference between the two. In a business setting, surpluses can be invested back into the company, such as for research and development (R&D) expenses, paid out to employees in the form of bonuses, or they can be distributed to shareholders as dividends.

In a government setting, a budget surplus occurs when tax revenues in a calendar year exceed government expenditures. The United States government has only achieved a budget surplus -- or a balanced budget, for that matter -- four times since 1970. It happened during consecutive years from 1998 until 2001.

A budget deficit, by contrast, is the result of expenses eclipsing revenues. Budget deficits almost invariably result in debt being incurred. For example, the U.S. national debt in excess of $19 trillion as of June 2016 is the result of accumulated budget deficits over many decades.

Arguments For and Against a Balanced Budget

Proponents of a balanced budget argue that budget deficits saddle future generations with untenable debt. Eventually, taxes must be raised or the money supply artificially increased -- thus devaluing the currency -- to service this debt.

Other economists feel budget deficits serve a valuable purpose. Deficit spending represents a key tactic in the government's arsenal to fight recessions. During economic contraction, demand falls, which leads to gross domestic product (GDP) declines. Moreover, since unemployment rises during a recession, the government's income tax revenue falls. In order to balance the budget, it must cut spending to match lower tax receipts. This reduces demand and erodes GDP further, potentially throwing the economy into a dangerous downward spiral. Deficit spending, proponents argue, stimulates a lagging economy by infusing it with much-needed capital.

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A situation in financial planning or the budgeting process where total revenues are equal to or greater than total expenses. A budget can be considered balanced in hindsight, after a full year's worth of revenues and expenses have been incurred and recorded; a company's operating budget for an upcoming year can also be called balanced based on predictions or estimates.

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What Is an Expense?

An expense is the cost of operations that a company incurs to generate revenue. It is simply defined as the cost one is required to spend on obtaining something. As the popular saying goes, "it costs money to make money."

Common expenses include payments to suppliers, employee wages, factory leases, and equipment depreciation. Businesses are allowed to write off tax-deductible expenses on their income tax returns to lower their taxable income and thus their tax liability. However, the Internal Revenue Service (IRS) has strict rules on which expenses businesses are allowed to claim as a deduction.

Key Takeaways

Understanding Expenses

One of the main goals of company management teams is to maximize profits. This is achieved by boosting revenues while keeping expenses in check. Slashing costs can help companies to make even more money from sales.

However, if expenses are cut too much it could also have a detrimental effect. For example, paying less on advertising reduces costs but also lowers the company's visibility and ability to reach out to potential customers.

How Expenses Are Recorded

Companies break down their revenues and expenses in their income statements. Accountants record expenses through one of two accounting methods: cash basis or accrual basis. Under cash basis accounting, expenses are recorded when they are paid. In contrast, under the accrual method, expenses are recorded when they are incurred.

For example, if a business owner schedules a carpet cleaner to clean the carpets in the office, a company using the cash basis records the expense when it pays the invoice. Under the accrual method, the business accountant would record the carpet cleaning expense when the company receives the service. Expenses are generally recorded on an accrual basis, ensuring that they match up with the revenues reported in accounting periods.

Important

Types of Business Expenses

There are two main categories of business expenses in accounting:

Operating Expenses

Operating expenses are the expenses related to the company's main activities, such as the cost of goods sold, administrative fees, office supplies, direct labor, and rent. These are the expenses that are incurred from normal, day-to-day activities.

Operating expense is deducted from revenue to arrive at operating income; the amount of profit a company earns from its direct business activities. Companies need to manage their operating expenses to ensure that they are maximizing profits; this is usually done by keeping expenses at a minimum; however, reducing expenses too much can reduce the company's productivity.

Non-operating Expenses

Non-operating expenses are not directly related to the business's core operations. Common examples include interest charges and other costs associated with borrowing money. These are expenses that occur outside of a company's day-to-day activities. These costs may occur from restructuring, reorganizing, interest charges on debt, or on obsolete inventory.

Non-operating expenses are separate from operating expenses from an accounting perspective so as to be able to determine how much a company earns from its core activities.

Special Considerations

Capital Expenses

Capital expenditures, commonly known as CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, an industrial plant, technology, or equipment.

The IRS treats capital expenses differently than most other business expenses. While most costs of doing business can be expensed or written off against business income the year they are incurred, capital expenses must be capitalized or written off slowly over time.

The IRS has a schedule that dictates the portion of a capital asset a business may write off each year until the entire expense is claimed. The number of years over which a business writes off a capital expense varies based on the type of asset.

Not All Expenses Can Be Deducted

According to the IRS, to be deductible, a business expense "must be both ordinary and necessary." Ordinary means the expense is common or accepted in that industry, while necessary means the expense is helpful in the pursuit of earning income. Business owners are not allowed to claim their personal, non-business expenses as business deductions. They also cannot claim lobbying expenses, penalties, and fines.

What Are Examples of Expenses?

Examples of expenses include rent, utilities, wages, salaries, maintenance, depreciation, insurance, and the cost of goods sold. Expenses are usually recurring payments needed to operate a business.

What Are the Types of Expenses?

Expenses can be categorized in a variety of ways. Expenses can be defined as fixed expenses, such as rent or mortgage; those that do not change with the change in production. Expenses can also be defined as variable expenses; those that change with the change in production. These include utilities and the cost of goods sold. Expenses can also be categorized as operating and non-operating expenses. The former are the expenses directly related to operating the company, and the latter is indirectly related.

Is Salary Considered an Expense?

Yes, salary is considered an expense and is reported as such on a company's income statement.

The Bottom Line

An expense is a cost that businesses incur in running their operations. Expenses include wages, salaries, maintenance, rent, and depreciation. Expenses are deducted from revenue to arrive at profits. Businesses are allowed to deduct certain expenses from taxes to help alleviate the tax burden and bulk up profits.

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Expense: Definition, Types, and How Expenses Are Recorded

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An expense is the cost of operations that a company incurs to generate revenue.

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The official website of the Federal Trade Commission, protecting America's consumers for over 100 years.

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Key Takeaways

How Simple Interest Works

Simple interest is a way of measuring interest that does not account for multiple periods of interest payments or charges. The interest rate will only apply to the principal amount of the loan or investment-accrued interest doesn't affect it.

Understanding simple interest is one of the most fundamental concepts for mastering your finances. It involves some simple math, but calculators can do the work for you if you prefer. With an understanding of how interest works, you become empowered to make better financial decisions that save you money.

Interest can affect you in various aspects of your financial life:

When borrowing money: You must repay the amount you borrowed and include payments for interest, which represents the cost of borrowing.

When lending money: Lenders typically set a rate and earn interest income in exchange for making money available to other people.

When depositing money: Interest-bearing accounts, such as savings accounts, pay interest income because you are making your money available to the bank to lend to others.

Simple Interest Formula

To calculate simple interest, multiply the principal amount by the interest rate and the time. The formula written out is "Simple Interest = Principal x Interest Rate x Time."

This equation is the simplest way of calculating interest. Once you understand how to calculate simple interest, you can move on to other calculations, such as annual percentage yield (APY), annual percentage rate (APR), and compound interest.

Example of Simple Interest

For example, say you invest $100 (the principal) at a 5% annual rate for one year. The simple interest calculation is:

$100 x .05 interest x 1 year = $5 simple interest earned after one year

Note that the interest rate (5%) appears as a decimal (.05). To do your own calculations, you will need to convert percentages to decimals. For example, to convert 5% into a decimal, divide five by 100 to get .05.

Tip

If you want to calculate simple interest over more than one year, calculate the interest earnings using the principal from the first year, multiplied by the interest rate and the total number of years.

$100 x .05 interest rate x 3 years = $15 simple interest for three years

Simple Interest vs. Compound Interest

For loans such as 30-year mortgages, for example, simple interest calculations aren't an entirely accurate way to compute your costs since they don't account for closing costs. Those costs are included in your APR, which is typically higher than your interest rate.

Note

The effects of compounding become more pronounced over time, and that's another reason why a 30-year mortgage is a bad candidate for simple interest calculations. Throughout the 30-year life of the loan, the interest costs will add significantly to the total cost paid by the borrower.

When you start accounting for compounding, you need to use more complex interest calculations that measure "compounding frequency," or how often the interest is compounded. This could be daily, monthly, yearly, or some other frequency. Each frequency would give different results.

For example, when you borrow funds with a credit card, you might estimate how much interest you pay using simple interest. However, most credit cards quote an annual percentage rate (APR) to customers, but they actually charge interest daily, and each day's total of principal and interest becomes the basis for the next interest charge. As a result, you accumulate a lot more in interest charges than you would tally with a simple interest calculation.

Limitations of Simple Interest

The simple interest calculation provides a very basic way of looking at interest. It's an introduction to the concept of interest in general. In the real world, your interest-whether you're paying it or earning it-is usually calculated using more complex methods.

There may also be other costs factored into a loan than just interest. These costs will affect the total amount that you spend on the loan throughout the year, but they may not be included in the interest rate given to you by the lender.

Frequently Asked Questions (FAQs)

Is simple interest a good thing?

Generally speaking, simple interest is a good thing when you're borrowing. It means your interest costs will be lower than what you'd pay if the lender was charging you compounding interest. However, if you're investing or saving your money, simple interest isn't as good as compounding interest.

Who benefits from simple interest?

Banks offering accounts with interest can benefit from simple interest because they don't have to pay out as much interest over time as accounts with compounding interest. On the consumer side, borrowing money that charges simple interest benefits you because it will cost you less than compound interest.

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Simple interest is a way of measuring interest that does not account for multiple periods of interest payments or charges. The interest rate will only apply to the principal amount of the loan or investment-accrued interest doesn't affect it. Understanding simple interest is one of the most fundamental concepts for mastering your finances.