Any transaction event that impacts your business’ finances is termed as an accounting transaction. Such transactions are recorded in the accounting records or financial statements of your company. Records for each transaction are made either by a bookkeeper or accountant to ensure accuracy and correct financial reporting.
You can predict and analyze your business’s financial health using accounting transactions.
What is an Accounting Transaction?
An accounting transaction is a business event having a monetary impact on the financial statements of a business. It is recorded in the accounting records of the business.
Examples of Accounting Transactions
Sales between a buyer and a seller are relatively straightforward examples of accounting transactions. These are characterized by the exchange of money for goods, services, or a financial product between party A and party B.
Some accounting transactions can be more involved in nature. Such include deals that are made by businesses for settlements in the future. Others may involve expenses or revenue that have been identified but have not been realized yet. This is referred to as accrued income.
There are also third parties accounting transactions that can take place. Your business’s tax and financial reporting are affected by the income or expense transactions that you record.
Some examples of accounting transactions include:
- Cash sale to your businesses customer
- Credit sale to a customer
- Invoice paid in cash by an owing customer
- Fixed or non-current assets purchased from a supplier
- Non-current asset depreciation recorded over time
- Current asset or consumable supplies purchased
- Investing in another enterprise
- Marketable securities investments
- Hedge fund engagement to mitigate the unfavorable effects of price changes
- Lender borrowing
- Dividend issue to investors
- Asset sales to third parties
There are even fraudulent accounting transactions that are fabricated by accountants or your businesses’ management. A comprehensive system of quality controls exists as a guideline for accounting transaction reporting. As such, each accounting transaction follows a special accounting equation dictate. This states that a qualifying accounting transaction must result in assets that equal liabilities or shareholders’ equity.
Methods of Recording Accounting Transaction
A business can either use the cash method or accrual method of accounting transaction reporting. This means that under the different accounting systems, each transaction is handled differently.
The cash accounting method records the making or receiving of payment as an accounting transaction. On the other hand, accrual accounting recognizes the delivery of a service or invoice as a transaction.
Accounting Transactions Recorded with the Cash Method
The cash accounting method is used by many small and medium enterprises to record transactions. Partnerships and sole proprietorship record income when customers make checks, credit cards, or cash payments.
If a customer has received goods from your business but pays the invoice two months down the line, your cash accounting system records the transaction when payment is received. As such, your expenses will also be recorded when your employees or suppliers are paid. Your business can receive office supplies from a supplier, which it pays three months later. Therefore, the transaction will be recorded as a purchase when the invoice is paid to your supplier.
If your business has less than a million dollars in total annual sales, the cash accounting method is the standard method. There are no complex transactions with the cash method, such as accounting deferrals or accruals.
This method is easier for accounting transaction recording, but it has its limitations. Due to the random timing of typical cash receipts or expenditure in many SMEs, results tend to be all over the place. You will see unusually high margins of profit or losses from one month to the next.
Accounting Transactions Recording with the Accrual Method
Accrual accounting entails the recording of a transaction when you are shipping, delivering, or completing a service for your client.
For sales and purchases where gross receipts in your business exceed $1 million every year, you’ll use the accrual method or transaction recording. This is due to the requirement for inventory when such a business’s income is being accounted for.
This method focuses on when your business earns income or when you incur expenses. Regardless of whether cash is received, all your transactions are recorded at the time of the activity.
Even when customers buy items or are proffered services on credit, your accounting transaction will be recorded at the time of purchase. These transactions are listed in the AR or Accounts Receivable segment of your ledger until payment is received. Transactions are recorded as income for the month when that transaction is made, even when payment will be made at a later month.
The accrual concept also applies to the goods or services that your business acquires on credit. Expenses are recorded when these supply transactions happen, even if payment will be completed at a later date.
Impact of the Accounting Equation on Accounting Transactions
Every accounting transaction has to follow the dictates of the accounting equation, which states that any transaction must result in assets equaling liabilities plus shareholders’ equity. For example:
- A sale to a customer results in an increase in accounts receivable (asset) and an increase in revenue (indirectly increases stockholders’ equity).
- A purchase from a supplier results in an increase in expenses (indirectly decreases shareholders’ equity) and a decrease in cash (asset).
- A receipt of cash from a customer result in an increase in cash (asset) and a decrease in accounts receivable (asset).
- Borrowing funds from a lender results in an increase in cash (asset) and an increase in loans payable (liability).
Thus, every accounting transaction results in a balanced accounting equation.
Guidelines for Making Account Transactions Records
When recording accounting transactions, the double-entry method of account entries prevails.
There will always be a debit and credit. Debit transactions are on the left; credit transactions are recorded on the right.
No matter what transaction is being recorded, the double entries must show equal value. This makes your accounting transactions journal balanced.
As mentioned earlier, every accounting transaction follows an accounting equation that dictates its qualification as a transaction.
The equation states that each transaction should result in assets or liabilities alongside an equal effect on owners or shareholder’s equity. As such, a sale, purchase or credit transaction will:
- Result in the increase of an AR or Account Receivable asset, or in revenue which indirectly increases equity
- Result in an expense increase which decreases cash assets and has an indirect detrimental effect on shareholders’ equity
- Result in cash asset increase from borrowing lender funds and an increase in liability for loan payables
The result of transacting along these guidelines is a balance accounting equation for your entries.
Entering Accounting Transaction in Automated Accounting Software
When using accounting software, each transaction can either be directly or indirectly recorded. In a manual accounting system, creating a journal entry directly involves the verification of equal sums of debits and credits.
Failure to this leads to an unbalanced transaction, unsuitable for making your business’ financial statements.
A journal entry created in an automated accounting software results in refused acceptance; until the debits can equal the credits.
If you use a module to create a journal entry in your accounting software, it will create the entry for you.
This is the indirect method. For instance, each time a customer invoice is created, a billing module will debit your AR account to credit the revenue account.
The Bottom Line on Accounting Transactions
All debit entries must have a corresponding equal entry on the credit side and so on. Your business must employ the correct system of accounting and bookkeeping.
This eliminates errors and leads to the compilation of reality-reflective financial statements. You will also be able to plan and account for contingencies with the proper accounting records.
With the right accounting transaction recording, you can make future decisions with realistic financial provisions.
Types of Accounting Transactions
Types of Accounting Transactions based on Institutional Relationship
The types of accounting transactions may be based on various points of view. The first one that we will discuss is the types of accounting transactions according to institutional relationships, namely external and internal transactions.
1. External transactions
These involve the trading of goods and services with money. Therefore, it can be said that any transaction that is entered into by two persons or two organizations with one buying and the other one selling is considered an external transaction. It is also called a business transaction.
Example: If Company A buys raw materials for its production from Company B, then this is called an external transaction.
2. Internal transactions
They don’t involve any sales but rather other processes within the organization. This may include computing the salary of the employees and estimating the depreciation value of a certain asset.
Types of Accounting Transactions based on the Exchange of Cash
Based on the exchange of cash, there are three types of accounting transactions, namely cash transactions, non-cash transactions, and credit transactions.
1. Cash transactions
They are the most common forms of transactions, which refer to those that are dealt with cash. For example, if a company purchases office supplies and pays for them with cash, a debit card, or a check, then that is a cash transaction.
2. Non-cash transactions
They are unrelated to transactions that specify if cash’s been paid or if it will be paid in the future. For example, if Company A purchases a machine from Company B and sees that it is defective, returning it will not entail any cash spent, so it falls under non-cash transactions. In other words, transactions that are not cash or credit are non-cash transactions.
3. Credit transactions
They are deferred cash transactions because payment is promised and completed at a future date. Companies often extend credit terms for payment, such as 30 days, 60 days, or 90 days, depending on the product or service being sold or industry norms.
Types of Accounting Transactions based on Objective
There are two types of accounting transactions based on objective, namely business or non-business.
1. Business transactions
These are everyday transactions that keep the business running, such as sales and purchases, rent for office space, advertisements, and other expenses.
2. Non-business transactions
These are transactions that don’t involve a sale or purchase but may involve donations and social responsibility.
3. Personal transactions
Personal transactions are those that are performed for personal purposes such as birthday expenditures.
Frequently Asked Questions
What is an accounting transaction?
An accounting transaction is a business event recording a financial impact on the financial statements of a business. It is recorded in a business’s accounting records.
What are examples of transactions?
Transactions include paying a supplier for services rendered or goods delivered, paying a seller with cash and a note in order to obtain ownership of a property formerly owned by the seller, paying an employee for hours worked, and receiving payment from a customer in exchange for goods or services delivered.
What are the types of transactions in accounting?
The four main types of financial transactions that occur in a business are sales, purchases, receipts, and payments.
How do you record transactions in accounting?
To record a transaction, accountants most commonly use journal entries, where they manually enter the account numbers and debits and credits for each individual transaction. This approach is less time-consuming than other methods but susceptible to human error, so it is often reserved for adjustments and special entries.
What are examples of transactions?
Transactions include paying a supplier for services rendered or goods delivered, paying a seller with cash and a note in exchange for ownership of property formerly owned by the seller, and paying an employee for hours worked.