A Business Transaction is an economic event involving the movement of money, goods, or services, usually between two or more parties. These events must always be measurable in monetary terms so that the company can record them for accounting purposes. They are always recorded in a certain account. Most companies usually have five different accounts to record all business transactions accurately:
- Assets
- Liabilities
- Equity
- Expenses
- Revenues
When analysed and compared, these accounts can give us a good idea about how financially sound a company is. Some business transaction examples are: selling machines to a company for credit or cash, paying wages to an employee, and giving a loan as a financial institution.
Features of a Business Transaction
In order for an economic event to be classified as a business transaction, it needs to have certain key features. These features are as follows:
Financial Value
It must have financial value. The event must affect the financials of the company. This effect can be seen in two ways: qualitative and quantitative. A quantitative change occurs when there is a change in the assets or liabilities of the company. A qualitative change occurs when no change takes place in a company’s assets and liabilities but the financial situation of a company changes. It signals the intangible effect of transactions.
Two Parties
A business transaction requires two or more parties to be involved in making an event into a business transaction.
Done by Company
The event must be done on behalf of the company. An individual should not conduct it for their own needs.
Documentary Evidence
The event should be based on documentary evidence, for example, an invoice or a memo. The document which provides proof of the event is called a voucher or a source document. Some economic events that occur in the day-to-day operation of a business can’t be considered as business transactions. The easiest method to find out whether or not an event is a business transaction is to consider whether or not it could be added to an accounting record. If it can’t be added, likely, the event is not a business transaction.
Types of Business Transactions
The classification of business transactions can be done in two ways. The first criterion is whether or not cash is exchanged during the transaction.
Cash Transaction
They are the most common type of transaction. They refer to the transactions that are done by the company using cash. However, if a company uses a debit card or a cheque, it is still called a cash transaction.
Credit Transaction
The payments, in this case, are deferred, i.e., delayed. A company often allows deferred payments on big sales as it allows the company to cater to a wider base of customers. They also charge interest on these payments.
Non-cash Transaction
This category of transactions doesn’t specify whether money is involved. For example, a company returns a machine to its manufacturer because it was defective. There is no money involved in the transaction, but it does reduce the assets of the company or there could be an exchange that is in kind. The second criterion for classifying business transactions is whether or not the transaction happens with a third party outside the company.
External Transaction
These transactions involve the exchange of goods and/or services for money with external parties. They can range from financial activities like paying for utilities to paying the employees.
Internal Transaction
Internal transactions are an exception to the feature of requiring two parties. These transactions do not involve any outside party, and they don’t involve purchases or sales. They are instead based on internal processes, such as, the use of supplies and depreciation of assets.
Accounting for Business Transactions
Accounting of business transactions can be done in many ways. The company always has to choose whether it will operate on accrual basis accounting or cash basis accounting.
Accrual basis accounting is a way of recording transactions where revenue/expenses are recorded as and when they are incurred. This method of accounting is more accurate than cash basis accounting but is also more complex.
Cash-based accounting systems are systems where instead of recording revenues/expenses when they are incurred, they are recorded when the cash is received or paid. This system is less popular but it gives definitive information on the liquidity of a company. This is helpful as it helps companies plan expenses.
The Process of Accounting Business Transactions
- A company decides on the method of accounting.
Collect the evidence for its transactions.
Enter all transactions into a general ledger.
Use the accounting equation to prepare financial statements.
The accounting process begins with documentary evidence. This refers to the memos and invoices of all the transactions that have occurred in the accounting period. If there is no evidence due to the expense being too small, a transaction voucher is created. A transaction voucher is a piece of documentary evidence that can record transactions.The recording of transactions in the accounts is done through a basic principle called the accounting equation.
It is usually written as: Assets = Liabilities + Equity
It states that a company’s assets equal the sum of its liabilities and the shareholder’s equity.
Conclusion
The meaning of a business transaction can be described as an exchange of money, goods, or services between two or more parties. There are certain vital features that an event needs to have to be considered a business transaction. The most important of them is that the event makes a change in the financial standing of the company. A business transaction can be classified based on two different criteria into cash, non-cash, credit transactions, and external, internal transactions. Recording and analysing business transactions are based on the accounting equation: Assets = Liabilities + Equity.
