Accounting Transactions in a Nutshell
A transaction, per se, is the exchange of services or goods between two groups, people or entities. Each accounting transaction signifies some form of variation to the Assets, Stockholders’ Equity, or Liabilities of the parties involved. Therefore, transactions change the fiscal position of a business as it does to a person.
These transactions are recorded by a bookkeeper to ensure that the books of accounts are updated and facilitate the accountant to produce financial reports that accurately stand for the business. Such transactions take many forms, such as:
- Advances to employees;
- Bills payments;
- Borrowing money from creditors;
- Cash withdrawals of the owner or partner in single proprietorship or partnership businesses;
- Collection from invoices sent to a customer;
- Paying borrowed money from creditors;
- Paying suppliers from an invoice received;
- Payment of dividends to stockholders or income to owners and partners;
- Purchase of movable or fixed assets;
- Accepting money or assets as a capital investment or payment of advances;
- Sales to customers in cash or credit; and,
- Many others.
It is essential to bear in mind that each transaction must show a balance amid the real and nominal accounts in accounting. And this is done through journalizing the entries by debiting and crediting affected account titles in the books of accounts. And this is because each accounting Transaction exists as an occasion that impacts the financial statements of all entities.
Doing the Most Common Basic Accounting Transactions
There are many things to consider when accounting for transactions in company books, such as:
Familiarity with the Accounting Equations and Double Entry Recording
The basic accounting equation, also known as the balance sheet or real accounts equation, is the most fundamental accounting part wherein the entire double-entry accounting system is based. And as shown below, the debit part is always equal to the credit part:
Debit = Credit
You can change it whichever way you want, provided everything balances. Examples include:
Debit = Credit
Then, there, too, is an extended accounting equation that takes up the nominal accounts shown in the Income Statement. In recording transactions in accounting, the double-entry technique is always used. Technically, this means that at hand are two sides recorded at all times, which is debit on the left and credit on the right.
These entries always tally as the books must also do so at a particular date or period covered by the financial statement. And if the balances are not the same, then it requires an investigation to make the necessary corrections to possible errors committed.
This system renders accounting much more comfortable as it makes a relationship amid the real or balance sheet and nominal or income statement accounts, especially with the help of an existing Chart of Accounts. The COA or Chart of Accounts is a directory of all financial accounts used in the books of account of a business.
It stands as an organizational device that offers a digestible listing of all financial transactions conducted by the company during an accounting period and broken down into smaller groups. So, these account entries are utilized in the books of accounts consisting of the Cash Disbursement Book, Sales Journal, Cash Receipts Book, General Ledger, and other subsidiary books.
To do accounting entries right, however, you need to know the underlying thumb rules and concepts of accounting relating to the double accounting entries at the fundamental level. Although the equation formula appears so simple, it contains lots of meaning that require more in-depth exploration, especially when you have to record complex transactions.
Overview of Basic Accounting Concepts and Principles
Accounting is tremendously popular by way of the business language. Through accounting, it is stress-free to examine the financial state and operation of a business. Understand this jargon is, however, not as easy as pie. There are numerous people who simply cannot understand the figures. Then again, there are some who can actually read the stories that the numbers are telling.
Perhaps, the reason for this difference lies in the awareness of the accounting concepts and how the underlying assumptions rule the entire process. This financial info makes sense, especially when you realize that the concepts, known as Generally Accepted Accounting Principles or GAAP, serves as the accounting foundation.
GAAP facilitates the understanding of the standard concept and rules in the realm of accounting. Hence, it is of great consequence to learn these concepts for application in real existence. Here is a list of concepts and principles that any businessman must know to operate a steady flourishing business.
This principle separates the business from its owner or owners. Thus, personal transactions of the owners must never be included in the accounting books. It follows, therefore, that the Assets of the company are solely used for the business.
If you happen to be using a technique to keep a record, it follows that you must be following the same process for everything. And this guarantees that if changes within the financial reports are made, it was because there were business operation changes. Observing consistency makes it easy to keep track of things and automatically know what has to be undertaken as the need arises.
The actual price an asset or anything bought by the company is the price taken up in the accounting entry. In the case of assets, its market value is ignored because this value alters with time. In almost all cases, purchases are scrutinized to accurately record the price at the net of tax included in the purchase transaction.
For example, when the company decides to buy a delivery van for $10,000, the receipt may show that 12% of the said price is a value-added tax. Thus, the entry would be a debit to Input Tax for $1,200, a debit to Delivery Equipment for $8,800, and a credit to Cash in Bank for $10,000.
Depending on the basic equation, as shown below, this concept puts forward the belief that resources remain belonging to the company for use in its manufacturing or production process. Accountability stands as the money the company is in debt to the stockholder or investor in contrast to the resources.
Impartiality exists as the main variance between resources and accountability. It shows what stays unsettles by the company owner or stockholders. Hence, the critical aim remains keeping these basic terms stable irrespective of the way the transactions stand made. The balances increase or decrease on equal sides.
To make sure that income is stated right at all times, proper recording of the revenues and expenses should be observed. For instance, when $3,000 was disbursed to buy raw materials, then it should be taken up in the books at the same time revenue is expected to be realized.
This is especially helpful for manufacturing companies that keep itemized inventories for Raw Materials, Work in Process, and Finished Goods. In this way, the Cost of Goods Sold is account for appropriately.
This concept makes it essential to put across the financial details in terms of momentary information. As far as accounting is concerned, small things play a fundamental part in the financial security and operation of the company.
Examples are the strike of the workers or health concerns that, although not shown in the statements, are duly notated in the report to give out a more extensive and proper image of the company within the financial reporting period.
Profits exist produced with the assistance of assets and liabilities, but earning is only made when the merchandise or service is sold. Hence, earnings should be acknowledged in the books of accounts at the moment it is sold, and not when it is produced. And this explains why accounting holds an Inventory account, which is, in reality, an asset.
As hinted by the term, this principle requires that transactions recorded in accounting books and reflected in the accounting reports should be stated within their correct period. For example, a Balance Sheet as of a specified date means that the information contained therein covers all transactions from the creation of the company until the said specified date.
Another example is an Income Statement for the first quarter of a particular year denotes a report of the operation of the company from January 1 to March 31 of the said year. Most accounting reports, however, are made monthly to facilitate compliance to required government remittances, besides providing management with timely updates on operation.
Most Common Accounting Transactions
Founded on cash movement, the most common types of transactions in accounting are:
Topping the list, this is also the most common for small companies where almost everything is under the cash basis. For example, the company sells its products only in exchange for cash, debit card, or a check. Generally, companies who transact business in this way also pay for their expenses and purchases in the same manner.
Although payment or sale may still involve the receipt or issuance of a check, the original transaction will occur with a promise for settlement at an agreed date in the future. The dates stipulated differ depending on the negotiation between the buyer and the selling company.
In certain instances and depending on the amount involved, discounts may also go with the terms. For example, a delivery on account for $1,000 may have a notation on its invoice, “5/30; n/60.” This notation means that if the buying company pays the credit extended within 30 days from receipt of delivery, the said company can avail of a five percent discount on the invoice price. Otherwise, no deduction applies when the buying company settles the amount due on 31st to the 60th day following the receipt of the delivery.
Anything not belonging purely to cash and credit transactions falls under this category. An example is a sale collectible after 30 days with a return clause wherein the product sold was returned after being found defective.
Another example is a sale transaction that requires only a down payment upon receipt of the item and the balance payable after a certain number of days. And the same applies to a company receiving an investment in exchange for a land title transfer to the company.
1. What are accounting transactions?
Accounting transactions are business activities that generate financial effects. Financial effects may be in the form of income, expenses, assets, or liabilities.
2. What is the purpose of an accounting transaction?
The purpose of an accounting transaction is to generate, increase, decrease, or eliminate financial effects. This is done in order to properly reflect the financial position of a business.
3. What are some common types of accounting transactions?
The most common types of accounting transactions are cash transactions, credit transactions, and other transactions. Cash transactions are those that involve the receipt or issuance of cash. Credit transactions are those that involve the receipt or issuance of a promise for settlement at an agreed date in the future. Other transactions are those that do not fit into the category of cash or credit transactions.
4. How do you record transactions?
The recording of transactions is done by debiting one account and crediting another account. This is done in order to reflect the financial effects of the business activity. For example, when a company sells products, it will debit its Sales account and credit its Accounts Receivable account. This reflects that the company has sold products but has yet to receive payment for those products.
5. When must accounting transactions be recorded?
Cash accounting requires transactions to be recorded when the cash is received or paid out. Generally, this means transactions are recorded as they occur.