How to Identify and Analyze Transactions in Accounting
Sandrene is an ACCA candidate pursuing a B.C degree in accounting and finance with 5 years of experience in financial services/accounting.
What is a transaction?
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Accounting Isn't Easy
In accounting, we identify and analyze transactions by doing some simple assessments. To "identify a transaction" is to determine if a transaction actually exists and whether or not it is relevant to the business. After a transaction has been identified, it is then analyzed. This analysis decides which accounts of the business will be affected and how they will be affected.
But, to do this, one has to know what qualifies as a transaction.
A Transaction for Accounting Purposes Can Be One of Two Things:
- An exchange of goods/services for money or other goods/services carried out by or on behalf of the business
- An event/activity/process that immediately/directly changes the financial position of the business.
I have created a chart to help readers identify whether a statement qualifies as a transaction or not. See below. All you have to do is look at the information presented to you and follow the arrows!
Transaction chart
Identifying Transactions: Examples
Example 1
Statement: Bob owns a restaurant. He buys two stoves so that the staff can prepare more meals in less time.
By following the chart, we would identify this statement as a transaction because it is an exchange. Bob buying two stoves is an exchange of money for goods (stoves).
Example 2
Statement: A couple of months later, one of the stoves stops working, and Bob throws it out.
By following the chart, we would identify this statement as a transaction because even though it is not an exchange, it is an event: an event that will directly cause the financial position of the business to change. Bob throwing out the stove means that the business will have fewer assets than it did before.
Example 3
Statement: Bob is considering hiring some more employees.
By following the chart, we would not identify this as a transaction because it does not have an immediate or direct effect on the business's financial position.
Any statement that is neither an event nor an exchange should be ignored.
How Is a Transaction Analyzed?
This is done by asking two simple questions:
- Which accounts will be affected?
- How will they be affected?
Before being able to determine which accounts will be affected, one has to know the six categories of accounts and the various accounts that fall under each category. The table below gives a quick synopsis.
Six Categories of Accounts
| Drawings | Expenses | Assets |
|---|---|---|
Cash Withdrawals done by Owner | Purchases, Carriage Inwards, Insurance | Land, Building, Machinery, Equipment, Motor Vehicle |
Dividends Paid to Shareholders | Rent, Utilities, Salary, Stationery | Cash, Bank Account, Debtors, Inventory |
Assets taken by Owner | Advertising, Carriage Outward, Discount Allowed | Goodwill, Patents, Copyright |
| Liabilities | Equity | Revenue |
|---|---|---|
Mortgages, Long Term Loans | Start-up Capital, Regular Capital, Shares, | Sales, Commissions, Discount Received |
Creditors, Credit Card Blaances, Bank Overdrafts, Short Term Loans | Profit, Retained Earnings | Interest Received, Rent Received |
What does this mean for businesses?
Examples of Analyzing Transactions
Example 1
Alicia starts a business with $100,000 cash.
- Which accounts will be affected? Cash and Capital.
- How will they be affected? Cash will increase because the owner is investing money into the business, and Capital will increase because an investment is made by the owner.
Example 2
Alicia buys a motor vehicle with cash to be used in the business.
- Which accounts will be affected? Motor Vehicle and Cash
- How will they be affected? The Motor Vehicle account will increase because a new one is being bought and the Cash account will decrease (as cash was used to purchase the vehicle).
Example 3
Alicia bought some clothes costing $10,000 cash which she intends to resell at a profit.
- Which accounts will be affected? Purchases and Cash.
- How will they be affected? Purchases will increase since goods have been bought for resale, and Cash will decrease because it was used to buy the goods.
The Importance of Identifying and Analyzing Transactions
Identifying and Analyzing transactions is the first step in the Accounting Cycle/Process. It is the step that determines which transactions are selected to be recorded. Any errors that occur at this stage could be carried right through to the end of the cycle, resulting in erroneous accounting reports and records. It is therefore extremely essential for it to be done with attention to detail and accuracy.
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.
© 2021 Sandrene Morris