Understanding and Analyzing Business Transactions

An accounting system must record all business transactions to ensure complete and reliable information
when the financial statements are prepared.
Before going to the recording process, let us understand and analyze business transactions first.

What is a business transaction?

A business transaction is an activity or event that can be measured in terms of money and which affects
the financial position or operations of the business entity. In other words, it has an effect on any of the
accounting elements assets, liabilities, capital, income, and expense.
Transactions may be classified as exchange and non-exchange. Exchange transactions involve physical
exchange such as purchasing, selling, collection of receivables, and payment of accounts.
Non-exchange transactions are events that do not involve physical exchanges but where changes in
monetary values are determinable, e.g. wear and tear of equipment, fire loss, typhoon loss, etc.
To qualify as an accountable/recordable business transaction, the activity or event must:

1. Be a transaction involving the business entity

The separate entity concept or accounting entity assumption clearly establishes a distinction between
transactions of the business and those of its owner/s.
If Mr. Bright, owner of Bright Productions, buys a car for personal use using his own money, it will not be
reflected in the books of the company. Why? Because it does not have anything to do with the business.
Now if the company purchases a delivery truck, then that would be a business transaction of the
company.
If Mr. Grim invests $20,000 into the company, would that be recorded in the books of the business? Ask
this: Does it have anything to do with the company? Yes. Then, that would be a recordable business
transaction.
In any case, always remember that a business is treated as an individual entity, separate and distinct
from its owners.

2. Be of a financial character (in a certain amount of money)

Transactions must involve monetary values, meaning a certain amount of money must be assigned to the
elements or accounts affected.

For example, Bright Productions renders video coverage services and expects to collect $10,000 after 10
days. In this case, it's explicit. The income and receivable can be measured reliably at the $10,000.
Fire, typhoon and other losses may be estimated and assigned with monetary values.
The mere request (order) of a customer is not a recordable business transaction. There should be an
actual sale or performance of service first to give the company a right over the income or revenue.

3. Have a dual or "two-fold" effect on the accounting elements

Every transaction has a dual or two-fold effect. For every value received, there is a value given; or for
every debit, there is a credit. This is the concept of double-entry accounting.
For example, Bright Productions purchased tables and chairs for $6,000. The company received tables
and chairs thereby increasing its assets (increase in Office Equipment). In return, the company paid cash;
thus, there is an equal decrease in assets (decrease in Cash). For more illustration and examples, check
out the lesson about the Accounting Equation here.

4. Be supported by a source document

As part of good accounting and internal control practice, business transactions must be supported by
source documents. The source documents serve as bases in recording transactions in the journal.
Examples of source documents are: Official Receipt issued whenever cash is received, Sales Invoice for
sales transactions, Cash Voucher for payment in cash, Statement of Account from suppliers, Vendor's
Invoice, Promissory Notes, and other business documents.
The first step in the accounting process is actually to prepare the source document and determine the
effects of the business transaction to the accounts of the company. After which, the accountant records
the transaction through a journal entry.
Examples of business transactions will be given and explained in detail as you go through the lessons in
this chapter. To see how business transactions are actually analyzed, you may jump to Accounting
Equation, Journal Entries, and More Journal Entry Examples. The next lessons will discuss the rules of
debit and credit, and chart of accounts first.