You have probably heard the term "accounting transaction" but might not know its meaning. Accounting transactions are transactions between two parties. One person can't conduct a transaction alone, so, for example, a sales department cannot buy a car for the HR department.
In most cases, though, the two departments are in the same organisation. The basic concept of an accounting transaction is to balance an equation. You will need to understand what these terms mean before properly reporting your business's financials.
Did You Know?
If a buyer purchases something using a credit card, it is immediately registered as a transaction when the seller employs the accrual accounting method.
Also Read: What is Double Entry System of Accounting
What is meant by Transaction in Accounting?
An accounting transaction is any business activity that has an economic effect on a company's financial statements. It is important to record each transaction to ensure accuracy.
Fraudulent accounting transactions can be made up by management and accounting staff but can be prevented with a comprehensive system of controls. The following are typical accounting transactions:
- Selling a product to a customer
- Buying supplies from a supplier
- Borrowing money from a lender
Assets are another element of an accounting transaction. Assets can provide a future financial benefit. Examples of assets include cash, vehicles, land, equipment, etc.
Billable expenses are incurred in performing duties, providing supplies, and performing services. Debtors are also assets but are classified as accounts receivable. In both cases, the company will record the assets it has received and can report them in the form of an accounting transaction.
Examples of Accounting Transactions
Neha has a florist shop. She spends ₹2,00,000 on buying a second-hand delivery van to expand the reach of her business. She paid this amount to the seller in cash. So, the entries in her accounts book would be like this:
A financial analyst in an industry must keep track of the accounting of plant machinery using the depreciation calculated as one lac in the past five years. He lists the following details before making the final entry:
- The plant machinery can be considered an asset, and depreciation is a cost classified as a non-cash expenditure.
- If he writes an entry in his journal for this transaction, he credits the plant machinery with Rs1 lac and debits the account for depreciation by the same sum.
- Take note that plant machinery accounts are asset accounts that are debited from the date of purchase.
Different Types of Accounting Transactions Are Based on the Exchange of Cash
After knowing about accounting transaction definition, lets know its types. In the context of exchanges for cash, there are three kinds of accounting transactions:
1) Cash Transactions
They are the most frequent types of transactions that can be described as those performed using cash. For instance, the case where a business purchases office equipment and then makes the payment for them using cash or using a debit card or a check is an actual cash transaction.
2) Credit Transactions
These are cash transactions that are deferred since the payment is promised to be completed on a later date. Businesses often offer credit terms for payments for some time, like 30-days, 60-days and 90 days, based on the item or service they provide or their industry norms.
3) Transactions That Are Not in Cash
They are not related to transactions stating whether cash has been paid for or will become payable shortly. For example, suppose company X buys a machine from Company Y and discovers that it's defective.
In that case, the machine's return will not result in any cash being spent and therefore falls under the category of non-cash transactions. Transactions that do not involve credit or cash are considered non-cash transactions.
Different Types of Accounting Transactions Based on the Objective
There are three kinds of accounting transactions based on objectives, specifically non-business, business and personal.
Types of Accounting Transactions
1. Business Transactions
These everyday operations keep the company running, like rental offices, ads, purchases, sales, and other expenditures.
2. Personal Transactions
Personal transactions are used for personal reasons like anniversary celebrations.
3. Non-business Transactions
These transactions do not necessarily involve a purchase or sale but could involve donations and social responsibilities.
Impact of the Accounting Equation on Accounting Transactions
Each accounting transaction must adhere to the accounting guidelines, which say that any deal must produce assets equal to liabilities and equity of shareholders. Examples:
- A sale to a client leads to increased revenue (indirectly increasing equity of stockholders) and an increase in the number of accounts payable (asset).
- Receiving cash from a customer results in reduced accounts payable (asset) and an increased amount of cash (asset).
- A purchase made from suppliers results in a reduction in the amount of cash (asset) and an increase in the cost of goods and services (indirectly reducing shareholders' equity).
- The borrowing of funds from the lender will increase the number of loans due (liability) and increase the amount of cash (asset).
Therefore, each accounting transaction produces a perfectly balanced accounting equation.
How to Record an Accounting Transaction
When running a business, you'll need to know how to record an accounting transaction in an Accounting Cycle Process. Accounting transactions can come in many forms and must be recorded properly to produce accurate financial statements. You'll need to gather all the relevant paperwork, including invoices from suppliers, utility bills, checks issued and credit memos for customers.
Each of these items needs to be approved before entering into the system. The transaction can be recorded in different accounts, including a sales account for purchases made by customers, a vendor account for payments made to vendors and an expense account for all other business transactions.
A cash transaction is the most common type of accounting transaction. It involves an exchange of cash for goods or services. These transactions are necessary for credit purchases and sales.
They also involve future payments. If Mr Vijay invests ₹15,000 into a landscaping business, this transaction will increase the company's assets. This means that Mr Vijay is now an owner. His equity has increased. The accounting process begins by analysing each transaction.
All accounting transactions can be categorised. A debit transaction will appear on the debit side of the journal, while a credit transaction will appear in the credit column.
For example, a customer pays a ₹500 electric bill for goods and services. The electric bill would be recorded in the Debit column of Accounts Payable and a credit transaction in cash. For this example, it is assumed that Johnson Fabrics paid the invoice in July.
How to Keep Track of These Transactions
If you're in your finance division, you could be accountable for recording and overseeing the business accounting transactions. The top management team usually sets out procedures and processes.
If you're working at an emerging company or want to make your existing procedures more efficient, here are a few methods to do it:
- Issuance of an invoice: With the help of accounting software, you can automate the creation of journal entries each time you issue an invoice. Include pertinent information, such as the cost of the item or service you offered and the amount per unit and taxes on sales. Send this invoice to your clients, and the information will be transferred to the company's accounts receivables account.
- Journal entries: Journal entries are the most popular method of recording transactions because you just have to record the credit or debit for every transaction in the journal. It could be a printed ledger or journal, but numerous companies depend upon digital versions to speed up their accounting processes.
- Payrolls: Since the cost of paying employees is a huge regular expense, it is important to track the distribution of the paychecks. Input the employee's pay rates, hours of work and deductions into the payroll account.
- Receipt of an invoice: If receiving an invoice by a vendor or other business, you should record the information in your accounting payable or expense account. Keep copies of both invoices to keep for your records.
- Accounting Voucher: An accounting voucher can be a written backup document for payments made to suppliers or creditors in any organisation for work done with the party. This paper is crucial at the beginning of the liability clearance process. This is also a part of the accounting transaction record.
It is important to take the time to understand how to calculate the equation of accounting. Recognising the two aspects of each transaction will assist you in understanding the basics of accounting. If you're not sure about the accounts that will be affected by a specific transaction, it is sometimes useful to focus on only one account that might be affected, such as cash (asset).
Use your understanding of the accounting equation to figure out the other. Whatever the case, the transaction will always balance the accounting equation.
In accounting, you might face so many calculations. To save time, you can sign up for platforms like Khatabook, which proves to be highly time-saving by providing you with all your business's debit and credit calculations.
Now keep track of your cash flow and manage your incomes and expenses with ease by using the Cashbook app by Khatabook.