Definition
A transaction is an external exchange of something of value between two or more entities. Events include increases in asset prices during an accounting period, and allocating the cost of long-lived assets to different accounting periods.
A business transaction involves a flow of resources into, within or out of the business. To be a business transaction, the transaction must:
- Be related to the business (the business must be one of the parties)
- Involve two or more parties
Business transactions and events must be recorded because they affect assets, liabilities and equity. Under the accounting entity concept, always interpret a transaction from the business’s point of view: the business must give or receive something, otherwise there is no transaction to record.
A transaction is either on a cash basis or an accrual (credit) basis.
Cash Basis
A cash basis transaction involves an immediate exchange of money.
Examples
- A business purchases a new computer for $1,200 and pays in cash.
- A business provides a service and receives $500 cash from the customer.
Accrual Basis (Credit)
An accrual basis (credit) transaction is a business event that needs recording but does not affect the business bank account at that time. Cash is neither received nor paid yet, but there will be a cash flow (an inflow or an outflow) at a later time.
Examples
- A business purchases office stationery on credit for $300 from a supplier.
- A business invoices a customer for a $400 service provided.
Credit Terms
Credit terms are the conditions under which a seller is willing to allow the buyer to purchase goods or services on credit. These terms specify:
- Payment due date
- Discounts for early payment
- Interest or penalties for late payment
Analysis
Transaction analysis is the process of identifying the specific effects of transactions and events on the accounting equation. The equation must ALWAYS balance.
Steps:
- Read the transaction
- Identify the nature of the transaction (business or not)
- Identify the elements affected by this transaction.
- Complete the accounting equation and check the equation balances.
Once analysed, the transaction is recorded in the General Journal using the rules of debit and credit.