Every organization performs various activities that ensure its continuity and success in the selected market niche. Accounting transactions are an integral part of business activities. But how can you differentiate accounting transactions from other forms of business transactions?
Accounting transactions include every form of business transaction that directly affects the business’s financial position and statements. All accounting transactions have monetary implications on the financial statement of a business. If a transaction does not have monetary implications on the financial statement, then it does not qualify as an accounting transaction.
Forms of Accounting transactions
Accounting transactions may come in different forms. Businesses are daily involved in transactions that have monetary implications on their operations. Some of these transactions include:
- Cash and credit sales of products
- Cash received from customers
- Purchase of raw materials for production purposes.
- Transportations of both raw materials and finished products
- Paid adverts for product promotion
- Salary paid to employees
- Purchase of machinery
- Renovation of company building
- Funds borrowed from creditors
Classification of Accounting transactions
Accounting transactions can be classified using different parameters. These parameters include:
- Existing institutional relationships
- Cash trade-off, and
- Objectives of the transaction
#1. Classification of Accounting Transactions based on Institutional Relationship
Accounting transactions are classified based on the relationship that exists in the institution. No business exists in a vacuum. Financial transactions carried out could be within the business. It could also be from a business to an individual or another business. Based on this classification, the following accounting transactions exist:
- Internal accounting transactions: this includes all transactions that do not involve the sale of the company’s products or services. Transactions such as determining the remuneration of the employees and the calculation of depreciation on company assets are examples of internal transactions.
- External transactions: this on the other hand involves the sale of the goods and services between the business and other individuals or businesses. External transactions are also known as cash business transactions as it involves a business or individuals offering products or services on one hand, and another purchasing the products or services. For instance, if company X gets its raw materials from company Y, such a transaction is external. When a customer purchases a company’s product, it is also an external transaction.
#2. Classification of Accounting Transactions based on the objectives of the transactions.
Different financial transactions are initiated for different purposes and to achieve a specified objective. Accounting transactions are therefore grouped into two based on the objective of such transactions. They include:
- Business transactions: some transactions aid the manager in the day-to-day running of the business. These transactions are known as business transactions. They include product marketing, purchases and sales, fueling cost, electricity bills, and rent.
- Non-business transactions: these transactions have no direct impact on the production and sale of goods and services. Common transactions in this category include money spent on carrying out community social responsibility.
- Individual transactions: individual transactions comprise all transactions that are carried out for personal purposes and may include costs incurred in celebrating birthdays and wedding anniversaries in the organization.
#3. Classification of Accounting Transactions based on cash trade-off
Accounting transactions may be classified based on the movement of money from one end to another. Using this classification, transactions are grouped into three namely cash, credit, and non-cash transactions.
- Credit transactions: these are transactions that are carried out with payment deferred to a later date. Credit transactions are a normal part of business transactions. Most businesses offer credit to their customers for a fixed period ranging between 30 to 90 days. The credit limit depends on the company and the type of service or product it is offering.
- Cash transactions: this is the commonest form of accounting transactions in most businesses. Cash transactions include all forms or purchases or sales made by the business which involve the movement of cash from one end to another. Cash transactions also include payments made through bank transfers, as well as credit and debit cards. When a businesses sells their products to a customers who pays on the spot, a cash transfer has taken place. If a business purchases machinery from and pays immediately, out is recorded as a cash transaction.
- Non-cash transactions: the transaction does not involve either cash or credit. There are no clear distinctions as to whether cash is paid immediately or if the payment was deferred for the future. For instance, if a customer returns a defective product, the transaction is neither a cash nor credit transaction.
How the principle of double-entry applies in Accounting Transactions
The double entry principle is an integral part of bookkeeping. This principle also applies while recording accounting transactions. The double entry principle states that to produce a balanced account, each entry must be duplicated in another account as a contrary entry. Entries made on the credit side of an account will invariably appear on the debit side of another account. The double entry ensures that entries made on the credit side do not exceed those on the debit side.
Examples of Accounting Transactions
Example number 1
James runs a cosmetics shop that specializes in the production of anti-aging cream that will slow down the aging process. In the last quarter, the business made so much profit that James decided to invest $20,000 into a real estate firm. How will this reflect on the accounting transaction?
Considering the money was taken out from the business to invest there will be an increase in the asset value and a decrease in equity. If however, he took a $5,000 loan from the bank to invest in the real estate business, his liability will increase as a result of the loan. There will also be an increase in assets as the loan was invested.
Example number 2
A manufacturing company’s accountant calculates a $7,000 depreciation on the company’s delivery Van. How will this transaction be recorded? A delivery Van is an asset, and depreciation on a Van is a non-cash expense. Therefore, a journal entry account will debit the depreciation account and credit the delivery Van account by $7,000 to balance the entries.
Why Accounting Transactions are important
Accounting transactions are vital for the operations of any business. Some of the benefits associated with accounting transactions are listed below
- Accounting transactions help in the proper evaluation of financial reports and statements.
- Accounting transactions encourage the maintenance of records for all business transactions.
- It provides businesses with relevant information necessary for making informed decisions.
- With the aid of accounting transactions, errors, omissions as well as fraud can be easily detected.
- Through accounting transactions, the financial standing of the business can be determined.
- It acts as evidence if a legal issue ever arises between the business and any of its customers.
- Accounting transactions provide relevant data for the determination of a business’s tax obligations
Through accounting transactions, businesses can have access to relevant data needed for the preparation of financial reports and statements. These recording techniques make accurate data available for both business and non-business transactions. Through accounting transactions, the monetary implications of every business activity can be calculated.