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Understanding and Analyzing Business Transactions

Introduction

An accounting system must be able to record all business transactions to ensure complete and reliable information when the financial statements are prepared. This lesson aims to help you understand business transactions better.

In a Nutshell

What is a business transaction?
A business transaction is an activity or event that has an effect on a company's financial position or performance, and which can be measured in terms of money.

Business Transaction

A business transaction has an effect on any of the accounting elements – assets, liabilities, capital, income, and expense.

Transactions may be classified as exchange and non-exchange. Exchange transactions involve physical exchange such as purchasing, selling, collection of receivables, and payment of accounts.

Non-exchange transactions are events that do not involve physical exchanges but where changes in monetary values are determinable, e.g., wear and tear of equipment, fire loss, typhoon loss, etc.

To qualify as a recordable business transaction, the activity or event must:

1. Be a transaction involving the business entity

The separate entity concept or accounting entity assumption clearly establishes a distinction between transactions of the business and those of its owner/s.

If Mr. Bright, owner of Bright Productions, buys a car for personal use using his own money, it will not be reflected in the books of the company. Why? Because it does not have anything to do with the business. Now if the company purchases a truck for its deliveries, then that would be a business transaction of the company.

If Mr. Grim invests $20,000 into the company, would that be recorded in the books of the business? Just ask this: Does it have anything to do with the company? Yes. Then, that would be a recordable business transaction.

In any case, always remember that a business is treated as an individual entity, separate and distinct from its owners.

2. Be of a financial character (in a certain amount of money)

Transactions must involve monetary values, meaning a certain amount of money must be assigned to the elements or accounts affected.

For example, Bright Productions renders video coverage services and expects to collect $10,000 in 10 days. In this case, it's explicit. The income and receivable can be measured reliably at the $10,000.

Losses from fire, typhoon and other calamities may be estimated and assigned with monetary values.

The mere request or an order by a customer is not a recordable business transaction. There should be an actual sale or performance of service first to give the company a right over the income or revenue.

3. Have a dual or "two-fold" effect on the accounting elements

Every transaction has a dual or two-fold effect. For every value received, there is a value given; or for every debit, there is a credit. This is the concept of double-entry accounting.

For example, Bright Productions purchased tables and chairs for $6,000. The company received tables and chairs thereby increasing its assets (increase in Office Equipment). In return, the company paid cash; thus, there is an equal decrease in assets (decrease in Cash). For more illustration and examples, check out the lesson about the Accounting Equation here.

4. Be supported by a source document

As part of good accounting and internal control practice, business transactions must be supported by source documents. The source documents serve as bases in recording transactions in the journal.

Examples of source documents are: Official Receipt issued whenever cash is received, Sales Invoice for sales transactions, Cash Voucher for payment in cash, Statement of Account from suppliers, Vendor's Invoice, Promissory Notes, and other business documents.

The first step in the accounting process is actually to prepare the source document and determine the effects of the business transaction to the accounts of the company. After which, the accountant records the transaction through a journal entry.

Examples of business transactions will be given and explained in detail as you go through the lessons in this chapter. To see how business transactions are actually analyzed, you may jump to Accounting Equation, Journal Entries, and More Journal Entry Examples. The next lessons will discuss the rules of debit and credit, and chart of accounts first.

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