Contents
What is a Transaction in Accounting?
Transaction in accounting refers to cash and non-cash transactions related to a business that impact its financial statements.
Cash transactions occur when there is a sale of goods and services to a customer and the customer pays cash immediately. In cash transactions, there is always a physical exchange of money, be it payment of penalties, receiving loans, payment of salaries, receipt of the advance, etc.
Non-cash accounting transactions include credit sales, depreciation, valuation exercises, credit purchases, etc. In non-cash transactions, there could be an obligation to pay or receive on a future date, revaluation of goodwill, depreciation calculation to reduce the value of an asset, etc. i.e. all those transactions where cash is not exchanged.
Generally, a transaction always involves a monetary exchange, but when it comes to transaction in accounting system, then non-monetary transactions are also included in the definition of “transaction” nomenclature.
The main intent of a bookkeeping and accounting system is to record transactions by:
- Identifying transactions that are a business transaction and not a personal transaction.
- Recording and classifying transactions via a system where you record by doing journal entries and then classify them in a general ledger.
- Preparing a trial balance to check the accuracy of the transaction recording process.
- At the end of the year, a “year-end close process”, is initiated and then financial statements are created.
Need for Recording Transactions in Accounting
A company’s financial statements depict the financial health of the company, and the accuracy of these statements depends upon the accuracy with which the transactions are recorded.
Recording transactions is important to know about a company’s income and expenses, where the company is heading, the efficiency of using the resources, spotting any gaps or inefficiencies, reporting about the company’s financial position to the investors, creditors, shareholders, lenders, government, etc.
Methods for Recording Transactions
Accounting transactions are also financial transactions, that impact the accounting equation.
Accounting Equation is Assets = Liabilities + Equity
Modern day bookkeeping is recording, organizing, and classifying the transactions as per the accounting equation following GAAP guidelines and other regulatory guidelines. Accounting interpreting the transactions, compiling them into final accounts, generation financial reports for management, investors, tax authorities, banks, analysts, etc.
Bookkeeping Methods
Single Entry
Single entry is a system where accounting transactions are recorded in a manner that it affects only one account.
Double Entry
Double entry system record accounting transactions affecting atleast two parties or accounts, it uses debt and credit method.
Accounting Methods
Cash Accounting Method
In cash accounting method, accounting transactions are recorded only when the cash is received or given. Thus, cash accounting will not record transactions related to credit sales, accounts payable account, accrued expenses, etc.
Often startups, small businesses, and self employed professional do prefer cash basis accounting for its simplicity. But cash basis accounting fails to record non cash transactions and does not represent the true picture of company’s financial statements.
Accrual Accounting Method
Accrual accounting method records a transaction when there is an obligation to pay or receive money. In accrual basis accounting, recording a transaction is not depended on the cash exchanging hands. Accrual accounting method records both cash and non cash transactions.
Accrual accounting is recommended by most of the accounting bodies, governments, tax bodies, etc. Accrual method is useful as the business grows and can handle even complex accounting involving valuations, mergers and acquisitions, depreciation, currency exchange rate differences, etc.
Types of Transactions in Accounting
Cash Transactions
A financial transaction involving the exchange of money or currency. A cash transaction necessarily involves cash payment which can also be paid by hand or digitally by a payment app, debit card, etc. resulting in immediate inflow or outflow of money. All cash transactions in a business affects cash flow statements and cash account.
Non-Cash Transactions
All the transactions that do not involve money, but still impacts the accounting equation. Like, depreciation reduces the asset and are non-monetary expense shown in the income statement.
Credit Transactions
Credit transactions occur when goods or services are provided with the expectation of payment at a later date, such as a business delivering products to a client on credit.
Business Transactions
Business transactions form the core of a company’s operations, including sales, purchases, and exchanges directly related to its primary objectives, like a retail store selling merchandise to customers.
Non-Business Transactions
Non-business transactions encompass activities unrelated to the core operations of a business, like an employee buying personal items using the company’s credit card.
Internal Transactions
An internal transaction involve exchanges within the organization, such as the transfer of assets between departments, like one department transferring office equipment to another.
External Transactions
An external transaction involve interactions with entities outside the organization, such as a supplier delivering raw materials to the company.
Third-Party Transactions
Third party transactions involves middle men or facilitators like brokers, escrow company, etc. between two parties.
Accounting Transactions Examples
Cash Transactions
- A customer purchasing groceries with cash at a local supermarket.
- A business owner paying monthly rent in cash to the landlord.
- An individual withdrawing cash from an ATM for personal expenses.
Non-Cash Transactions
- A tech company acquiring a software firm through the exchange of company stocks.
- A real estate developer obtaining a prime location for a new project by offering shares in the development company.
- An energy company acquiring a competitor through a non-cash deal involving the exchange of assets.
Credit Transactions
- An advertising agency providing marketing services to a client with payment due 60 days after service delivery.
- A consulting firm extending credit terms to a corporate client for strategic planning services.
- A software company selling licenses to a startup on credit, with payment scheduled for a later date.
Business Transactions
- A retail store selling 100 units of a popular product to customers.
- A manufacturing company distributing finished goods to wholesalers.
- An e-commerce platform processing online orders and shipping products to customers.
Non-Business Transactions
- An employee using the company credit card for a business trip’s hotel accommodation.
- An executive charging dinner expenses at a business meeting to the corporate credit card.
- A team member purchasing office supplies using the company credit card.
Internal Transactions
- The IT department transferring computer equipment to the customer support department.
- The marketing team reallocating budget resources to support a new advertising campaign.
External Transactions
- A construction company buying steel and concrete from an external supplier for a new project.
- A clothing manufacturer acquiring fabric and textiles from an external supplier for production.
Process of Recording Transactions
- Identify the Transaction: Identify a financial transaction or an event that affects the company’s financial statements. Example a sale, purchase, payment, receipt, or any other business activity involving monetary value.
- Analyze the Transaction: Determine how the transaction impacts the accounting equation (Assets = Liabilities + Equity). Identifying affected accounts and increase or decrease.
- Determine Debit and Credit Entries: Based on the double-entry accounting system, every transaction affects at least two accounts. One account is debited (increased or decreased, depending on the account type), and another is credited (also increased or decreased, depending on the account type). The total debits must equal the total credits for each transaction.
- Prepare the Journal Entry: Record the transaction in the accounting journal as a journal entry that includes the date of the transaction, the accounts involved, and the amounts to be debited and credited along with a brief description.
- Post to the General Ledger: Transfer the entries from the journal to the general ledger, where transactions are categorized and recorded in individual accounts.
- Trial Balance: At the end of an accounting period (like a month or a quarter), prepare a trial balance to ensure that total debits equal total credits in the general ledger.
- Adjusting Entries: Don’t forget to make any necessary adjusting entries to account for accrued expenses, accrued revenues, prepayments, and other adjustments that need to be made before preparing financial statements.
- Prepare Financial Statements: Use the adjusted trial balance to prepare the financial statements, including the income statement, balance sheet, and cash flow statement.
- Closing Entries: After preparing the financial statements, you must closing entries to clear out temporary accounts (like revenues and expenses) and transfer their balances to permanent accounts (like retained earnings).
- Post-Closing Trial Balance: Prepare a post-closing trial balance to ensure that the accounts are balanced and ready for the next accounting period.
Conclusion
Accurately recording transactions is the backbone of your business’s financial management and helps to evaluate organization’s financial performance.
To record income, other expenses, financial transactions related to funds, loans, flow of capital, appreciation of property, and other complex issues, businesses can make use of accounting software like Akounto, that gives inbuilt option to choose and switch between accrual method and cash basis method. It handles everything from setting up charts of accounts, invoice generation, sending payment reminders, to generating financial statements.
