The purpose of this post is to outline the various types of transactions in accounting. However, there’s a need to make some things clear beforehand.
Transactions, which are quite important in businesses, are events that take place consistently on a daily basis, and so they are regarded as the subject matters of accounting. Accounting, however, is a systematic way of maintaining accounts of transactions.
Meanwhile, an accounting transaction is defined as any business activity that has a direct effect on the company’s financial statements and status. It is a way of keeping a track record of certain transactions that assists in analyzing and predicting the financial status of a business. Basically, any item that has to do with the exchange of money is called an accounting transaction.
Examples of Transactions In Accounting
These transactions can, however, be documented in different ways, such as spreadsheets or invoices, in order to keep tabs on finances. Some examples of such transactions are:
- Taking out a loan from a creditor
- Clearing funds borrowed from a creditor
- Paying employees’ salaries
- Making cash payments to suppliers for goods purchased
- Getting paid in cash or in credit after selling to customers
- Acquisition of fixed and movable assets
- Financing or investing in another company
- Cash receipt from a customer via an invoice sent
- Business loans
- Dividends to shareholders
- Investing in tradable securities
As stated in the definition of a transaction, every occurrence of human life is referred to as an event, but not every event is a transaction. Events can then be grouped into two categories, which are:
- Monetary events
- Non-monetary events
Features of Accounting Transactions
For an event to be categorized as a transaction, it needs to have the following features:
- The transaction must be in terms of money. Any event that cannot be measured in terms of money is not a transaction.
- Accounting transactions should have an effect on the financial position of the company or business. This could be a net change or structural change.
A net change is a change caused by the number of assets and liabilities of a business, while a structural change is the change that occurs between liability to liability, or asset to asset, but not the change between liability to an asset, or vice versa for a particular transaction.
- Accounting transactions necessitate two parties, i.e., dual aspects because no transaction can be completed without a giver and a receiver, also known as a transaction between the creditor and the debtor.
- There has to be a transfer of property or service for it to be called a transaction. It is important to have transactions done by way of transferring services or property.
- Each transaction must show the balance of assets and liabilities, or the debit and credit.
- In order for an event to be classified as a transaction, it must be supported by documented evidence.
- To be called a transaction, an event must be self-contained and self-sufficient.
When these events occur, the transactions will then be recorded in line with the company’s policy, such as:
- Journal entries: This is the most common method of recording transactions, in which you only record debit and credit transactions in a journal.
- Issuance of an invoice: This can be generated automatically by accounting software when issuing an invoice to a customer, and it will include relevant information such as the price, unit sold, and so on.
- Invoice receipts: When an invoice is received from a supplier or another company, it should be recorded in an expense or accounts payable account.
- Paycheck Issuance: Because this is a recurring expense, it is critical to keep track of every paycheck issued.
Note that accounting transactions are either directly or indirectly recorded with a journal entry. The indirect record is created when a module in the accounting software is being used and the module creates the journal entry. For example, the billing module in the accounting software debits the receivable accounts and credits the revenue account once a customer invoice is created.
Meanwhile, if a journal entry is created directly using an accounting software package, it will not be accepted unless the debits equal the credits. If it is created directly in a manual accounting system, there is a need to ensure that the sum of all debits is the same as the sum of all credits, or else it will be an unbalanced transaction, which will make creating financial statements impossible.
3 Types of Transaction Accounting
Accounting Transactions are categorized into different types, and these are:
Accounting Transactions Based On Institutional Relationships
- External transactions
- Internal transactions
- External Transactions: This is also known as a business transaction because it involves the exchange of goods and services for money. It is a monetary transaction that takes place between two individuals or two organizations. It can, as well, be between an individual and an organization. For any transaction to be called an “external transaction,” it must be between two different entities.
- Internal Transactions: These are transactions that take place within an organization rather than with a third party. This could be an exchange of finances from one department to the other in the same company, or between the company itself and the employees; for example, the payment of employee salaries.
Although internal transactions do not involve sales like external transactions, they affect the company’s finances.
Accounting Transactions Based On Exchange Of Cash
- Cash Transactions: This is the most common type of transaction in businesses, and it involves the exchange of goods for cash, which can also be debit transactions, cheques, or bank drafts. It is the type of transaction whereby cash is paid immediately after the transaction takes place. For example, purchasing new machinery and paying cash.
- Credit Transactions: This is the polar opposite of a cash transaction in that it does not involve an immediate cash payment for the goods or services. It takes place when a supply or purchase is made and both parties agree to a payment plan that could be made in the future. This can also attract a certain amount of interest when the payment is finally made.
- Non-Cash Transactions: These are also known as “transactions in papers” or “transactions in books of accounts.” It is a transaction that does not involve either cash or credit and has no traces anywhere except in the books of accounting. A typical example of a non-cash transaction is the depreciation of fixed assets or when a company converts its bonds to another type of asset of equal value.
Accounting Transactions Based On Visibility
- Visible Transactions: These are also referred to as “real transactions” because they involve real assets. It is a kind of transaction that involves sales and purchases of physical goods.
- Invisible Transactions: These are transactions that cannot be seen, felt, or touched. They mainly intangible assets like share discounts, depreciation of fixed assets, etc.
Accounting Transactions Based On Objectivity
- Business Transactions: This is explained as a day-to-day transaction that keeps a business going. This could be the payment of wages and salary, hiring an external consultant to improve the marketing strategies of a company, advertisements, etc.
- Non-Business or Non-Trading Transactions: These are social service-oriented transactions in which a company does not sell or buy goods but instead participates in activities such as hosting a charity event, making donations, or sending employees to volunteer for a cause rather than working for a day.
- Personal Transactions: This type of transaction occurs when a person, employee, or business spends money on personal items. A typical example of this is having a birthday party for one of the employees or having a send-off celebration for an outstanding employee.
Let it be known that every accounting transaction needs to follow the dictates of the accounting equation, which says, “any transaction must result in assets equals liabilities plus shareholders’ equity.” For example,
- Selling to a customer must bring about an increase in accounts receivable (asset) and an increase in revenue, which indirectly increases stockholders’ equity.
- There is an increase in expenses, i.e., a decrease in the shareholder’s equity and a decrease in assets (cash) when a purchase is made.
- Receiving cash from a customer results in an increase in cash, also known as an asset, and a decrease in accounts receivable.
- Obtaining a loan from a lender causes an increase in cash as well as an increase in liability, i.e., loans payable.
Therefore, every accounting transaction leads to a corresponding accounting equation.
10 Importance of Accounting Transactions
Accounting transactions are also important for the following reasons:
- It aids in the resolution of tax-related issues.
- It can be used as evidence in court.
- It aids in business decision-making.
- It makes information about stakeholders and other parties available.
- It aids in the analysis of financial statements.
- It causes changes in a company’s financial position.
- It facilitates the detection of errors and omissions in business.
- It allows you to keep track of and record business transactions.
- It can be used to determine the worth of a company.
- It makes it simple to compare historical facts and data to current factual data.