In the personal, family, social, state, and economic lives of people, various activities occur constantly, each of which is an event. These events form the basis of transactions. However, not all events are transactions. For example, if a shop owner’s father gives him $500 as gift, this is not considered a transaction. A transaction is defined as an event that brings about a change in the financial position of an entity, can be measured in monetary terms, and occurs between two parties. Recording transactions in the books of accounts according to the rules is a primary and important task of accounting. Supporting documents are required to record transactions in the books of accounts.
The main task of accounting is to accurately record the financial transactions of individuals or organizations in the books of accounts and to determine the financial status at the end of the year. The process of accounting begins with recording financial transactions. Transactions are the primary and fundamental element of accounting. Just as, a production manager cannot produce anything without raw materials, accounting cannot be performed without transactions. Therefore, it is necessary to have a clear understanding of transactions. Before learning about transactions in detail, it is essential to know the concept from which transactions originate. A transaction is a financial event of an individual or organization. Therefore, to understand transactions, one must have an understanding of events.
What is Event: Generally, an event is defined as something that occurs. In people’s personal, family, social, state, and economic lives, various activities are constantly happening, each of them is an event. The events that are constantly occurring can be divided into two categories. like —
1) Non-monetary Events: Events that are not associated with money or do not alter a person’s financial position are called Non-Monetary events. Examples includes: eating, sleeping, winning a game, giving a speech at a meeting, and placing an order for goods.
2) Monetary Events: Events that are associated with money and result in a change in a person’s financial position are called Monetary events. Examples include: shopping, paying rent, and making sales.
“As per accounting terminology, only those activities that cause a change in the financial position of an individual or organization are recognized as events. Non-financial activities are not applicable here.“
“The relationship between events and transactions is very close. Transactions originate from events. Without an event occurring, a transaction cannot take place. Therefore, it can generally be said that all transactions are events, but not all events are transactions.”
In simple terms, exchange of anything is called transaction. In the context of affection and love, exchanges are also referred to as transactions. However, but in accounting, the word ‘transaction’ carries a specific meaning. For instance, the sudden departure of a skilled employee in an organization results in inevitable losses for the organization. However, the extent of this loss cannot be measured in monetary terms. This is a significant event for the organization.
On the other hand, a fire in the warehouse destroys goods worth $500. This too is an event and can be measured in monetary terms. Moreover, it has also caused a change in the organization’s financial situation.
Features of Transaction
1) Change in Financial Position: When an event must lead to a transaction, there must be a change in the financial situation of the organization. There may be two types of changes in the financial situation
(i) Quantitative or Net Change: A change that results in the total assets and total liabilities of an entity increasing or decreasing is termed as quantitative or net change. For example, purchasing $10,000 worth of machinery. As a results, on one side, the asset (equipment) increased by $10,000. On the other side, the liability (payable) increased by $10,000.
(ii) Structural or Qualitative Change: A change that affects the elements of assets and liabilities without altering their total amounts is termed as structural or qualitative change. For instance, $20,000 collected from the debtors results in no change to the total assets of the organization. However, the receivable decreases and cash increases.
2) Measurable in terms of money: Any event that is considered a transaction must necessarily be measurable in monetary terms. ‘Selling goods’ not qualifies as a transaction, but if we say ‘$20,000 worth of goods were sold’, that qualifies as a transaction.
3) Dual Aspect: For an event to be considered a transaction, it will affect at least two accounts at the same time. This duality in transactions is evident, for example, when purchasing a machine with cash; in this case, both cash and the machine’s account are affected simultaneously.
4) Self-sufficient and Independent: Any transaction must be complete and independent to be considered as such. For example, even if money is received in the evening after selling goods in the morning, two transactions will be considered to have occurred.
5) Visible or invisible events: Transactions can occur whether they are visible or invisible. For instance, purchasing $5,000 worth of office furniture is considered a visible transaction. Conversely, if the furniture is depreciated at 10% for use throughout the year, it will be treated as an intangible event.
6) Past and Future Event: Generally, after an event occurs, accountant classify it as a transaction, after that accounting starts. Therefore, transactions occur first then the accountant begins recording. For example, purchasing $40,000 worth of goods. However, events that may occur in the future could also lead to financial changes. Therefore, such events can also be considered transactions. For example, Accrued Liabilities.
Determination of Transaction through Accounting Equation
According to the modern accounting principles, the events that change the elements of the accounting equation are called transactions.
Total assets of a business equal total liabilities. There are two types of liabilities:-
i) Owner’s due (capital) or internal liabilities.
ii) Liability to third parties are called external liabilities.
- Starting a business with $50,000 cash. In this transaction, assets (cash) increase by $50,000 and capital increases by $50,000. Therefore, this transaction is a business transaction.
- Purchase of inventory $10,000 on credit. In this transaction, assets (inventory) $10,000 increase and liabilities $10,000 increase. Journal entries:
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