Accounting Transaction Definition
Accounting Transaction is a business activity or transaction which will have a monetary impact on the firm’s financial statement. This is based on basic and fundamental accounting equation which is the following:
Asset = Liabilities +Equity
Hence, we need to remember that if we are adding any accounting entry in our books, then a counter entry also needs to be entered to balance out the above equation. To keep track of these statements, accountants do ledger or journal accounting for each transaction. If an asset is increased, then it goes down as debt, while an increase in an asset is known as a credit in liability.
Types of Accounting Transactions
These transactions get a place in thousands of forms depends on the nature of the business, for example:
- If a firm is selling goods/services to customers on cash or credit.
- A firm is buying assets using cash.
- Taking a loan from creditors.
- Paying off debt to creditors.
- Paying cash to suppliers upon receiving an invoice from them.
External and Internal Accounting Transactions Categories
- External Transactions: These kinds of transactions occur between two companies or organizations. Since this is an intercompany transaction; hence, it involves monetary or asset exchange. Buying a good or raising debt from creditors is a kind of example for External Transactions.
- Internal Transactions: These involve the process within the organizations, for example, by reducing the value of an asset by depreciating it year on year.
In capital budgeting, if a company buys a fixed asset, usually, it does not account for the total value of an asset as an expense even though the company has bought that asset in cash upfront. Below will be accounting for an asset that has been purchased upfront.
The above journal entry is an external accounting transaction example. Here we can see that the firm has not put the entry of the expense of assets in the income statement. It will depreciate the value of an asset in each period, and only that depreciation amount will be treated as an expense in the income statement. So after one-year journal entry of that Asset depreciation will be like below:
This $10,000 will flow into the income statement before EBIT as an expense. Since this entry is only an accounting entry but not the actual money transfer, hence it is known as Internal Transaction.
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Accounting Journalizing Transactions
We need to record these accounting transactions in our books and need to ascertain that if we are recording an entry, then we also need to put a counter entry to balance the statement.
Also, if an asset is increased, it is known as ‘Debit’ entry in books, while if liabilities increase, then it is known as credit.
For example, let us say your firm is a cloth manufacturing company. Recently you have received the order of $5,000 from your customer, and they have paid in cash for that order. So, on the asset side, your cash has been increased by $5,000 while your Sales have increased, which will flow into your net Income and finally to the equity. That means the equity of your firm will also get increased by $1,000. So below will be accounting will be book entry of your accounting transaction:
We can see here that our overall equation is at balance.
Let’s take another example in which your firm needs new machinery for upgrading your system. This machine will cost $10,000, and your firm is going to buy it using cash. So, on the asset side, your fixed asset will increase(debit) by $10,000 while the current asset will decrease (credit) by $10,000. So ultimately, there won’t be any change in both asset and liability position for your firm.
We will take a simple example of Infosys Ltd. Buyback that happened in Dec. 2017. Infosys had announced that it would buyback Rs. 13,000 cr. In FY 18. The transaction of this deal occurred in Dec’ 17. Now please look below the balance sheet ‘Cash’ and ‘Equity’ item of Infosys in JAS’17 and OND ’17 quarter below.
As we can see that since buyback happened in Dec’17 quarter hence as per Accounting transactions, Cash should get credit(reduced) from books. And the same way, common equity also should get reduced(debit) form the accounts.
Now, if you compare “Cash and equivalents” between Sep’17 and OND’17 above, “Cash and Equivalents” are down by Rs. 2,728 crores, and Equity went down by Rs. 11,396 cr. Of course, there are other transactions that could get involved in that period for Cash and equity that we don’t know. That’s why we won’t see exactly Rs.13,000 crore reduction in cash and Equity here. This example is just to give an indication of how these transactions are recorded in books.
- These transactions are the core of the business. Business or firms run because of these transactions.
- By keeping the journal entries of these transactions, it would be easier to understand these transactions and year-end recordkeeping.
In business, every event that business deals with, a transaction. Out of those, accounting transaction makes business running. A firm should be careful to record these and review these transactions from time to time. Because in a combined way, these transactions convey to us how the business is running and how its future holds.
This has been a guide to what is Accounting Transaction and its definition. Here we discuss Accounting Journalizing Transaction, its Types and Categories, and its advantages. You can learn more about from the following articles –