What is Business Transaction?
A business transaction is an accounting term that relates to the events that occur with third parties (i.e., customers, vendors, etc.), having monetary value and have tangible economic value to the economy of the company as well as impacting the financial position of the company.
In simpler terms, business transactions are defined as the event occurring with any third party, which is measurable in monetary considerations and having a financial effect on the company. For example, in the case of a manufacturing company, the company needs to buy raw materials to be used in the production of finished goods. For the same, the company will enter into a transaction with the vendor, which will have a monetary value; this will affect the financials of the company.
- These transactions are measurable in monetary terms.
- It involves an event occurring between the organization and a third party.
- The transaction is entered for the entity, not for any individual purpose.
- They are supported by the authorized and legitimate documents related to the event or transaction entered, e.g., in case of a sale, sale order & invoice will be considered as legal documents for supporting the deal.
Examples of Business Transaction
#1 – Borrowing from Bank
This transaction will affect two accounts one is Cash/bank Account (Assets) and the second is Loan Account (Liability)
#2 – Purchase Goods from Vendor on Credit Basis
This transaction will have an effect on two accounts one is Purchase Account, and the second is Vendor Account (Liability), this transaction will also affect the inventory as the inventory stock will increase (Assets).
#3 – Rent and Electricity of Premises Paid
This transaction will affect two accounts, one is Cash/bank Account (Assets), and the second is Rent and electricity Account (Expense).
#4 – Cash Sale of Goods
This transaction will affect two accounts; one is Cash/bank Account (Assets) and the second is Sale Account (Income), this transaction will also affect inventory as inventory stock will decrease (Assets).
#5 – Interest Paid
This transaction will affect two accounts, one is Cash/bank Account (Assets), and the second is interest Account (Expense).
Types of Business Transaction
These transactions can be classified on two bases. These bases are described as follows:
#1 – Cash Transaction and Credit Transaction
- Cash Transaction: A transaction in which cash is involved means payment is received or paid at the time of occurrence of the deal. For example, Mr. A paid Rs.10000 as the rent of his premises in cash. This is a cash transaction because it involves cash payment at the time of the transaction. Similarly, Mr. A bought stationery for Rs. 5000 and paid cash as consideration.
- Credit Transaction: In credit transactions, cash is not involved at the time of the transaction; instead, the consideration paid is after a particular time (termed as credit period). For example, Mr. A sold goods to a customer on a credit basis and provided him a credit period of 30 days. So in this transaction, cash is not involved at the time of sale, but the customer will pay it after a credit period of 30 days.
#2 – Internal Transaction and External Transaction
- Internal Transaction: In an internal transaction, there is no external party involved. These transactions do not involve any exchange in value with the other external party, but it has monetary terms or value, i.e., impairment of fixed asset. It reduces the value of fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples..
- External Transaction: In an external transaction, there are two or more parties involved in the transaction. They are the usual transactions that occur daily. For example, purchasing goods, sale, rent expenses, electricity expenses paid, etc.
They are day to day transactions, and they may occur once in a year or more than once in a year. But while running a business, it is bound to be multiple times. Because, if there will be no transaction, then it means that the entity is not working & it is in an obsolete level and will shut down eventually. So having these transactions implies the entity is working.
It also depends on transactions that whether the entity is a downside or growing. If there are few transactions in the entity, it means it is working, but if there are lots of transactions in the entity, it means it is growing. So these transactions keep the company in existence and larger & frequently the transactions that may relate to more competitive business practices and business interaction with the external and internal environment of the business.
Business Transactions vs. Investment Transactions
- Business Transactions are usually the transactions that are entered in by the organization and are like trade, commerce, or manufacture. Investment transactions are entered into for the sale or purchase of marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it. and other assets that may or may not be connected directly to the business.
- Business transactions generate income, which is termed as the company’s income and is taxable under the “Profit & Gain from the Business property.” In contrast, Investment transactions generate a capital gain, which is taxable under the head “Income from Capital Gains.”
- If purchase & sale of an asset is as same as the general trading business of the assessee, then these transactions will be considered as business transactions, whereas if the purchase & sale of an asset is an independent activity against the ordinary course of business. The transactions will be considered as an investment transaction.
- In general, the frequency of these transactions is huge in numbers as they are entered in the course of business comparing to the investment transactions entered as they are independent transactions.
- Recording of these transactions helps in evaluating the effectiveness of business and profit generation by the entity during the respective period.
- The transaction recording helps in bifurcating the income produce from the business activities from the other incomes, which may be clubbed with a capital gain, lottery income, salary income, etc.
- They are recorded, and in the year-end or for a specified period, Final Accounts are prepared through them for determining the financial position of the assessee.
- It helps the assessee to record and file his income tax returns as per statutory norms with a proper bifurcation of his income & expenditure into the appropriate heads.
Business transactions are the transactions entered by the assessee for the business purpose with the third party; measured into monetary consideration; recorded in the books of accounts of the assessee. The recording of these transactions into the books of accounts of the assessee depends upon the documents related to the event, which provide proper support to justify the transactions. Business transaction recording helps the assessed to evaluate his business income separate from other incomes. The bifurcation helps the assessee to file his income tax returns (ITR) for the required period as per the statutory norms.
This has been a guide to what is Business Transaction and its definition. Here we discuss types and examples of the business transactions along with benefits. You may learn more about our articles below on accounting –