What is Transaction in Accounting? An Easy Guide

Introduction

In accounting, a transaction is any event that impacts a company’s finances. Imagine a shop owner buying supplies. When money is paid and goods are received, a transaction happens. It’s the same when a customer makes a purchase or when rent is paid. Every time money moves in or out of the business, it’s recorded as a transaction. These transactions, whether large or small, are like pieces of a puzzle. Together, they form the bigger picture of how the business is operating, where money is coming from, and how expenses are being managed. 

In this blog, we will explore the concept of transactions, breaking down what they are and its different types. We’ll also dive into how transactions work and why they play such a vital role in financial reporting.

What is Transaction in Accounting?

A transaction in accounting refers to any financial event that impacts a company’s financial statements. It involves the exchange of goods, services, or money between two parties. For example, when a company purchases inventory, sells products, pays employees, or receives payment from customers, these are all transactions.

Types of Transactions in Accounting 

There are several types of transactions in accounting, categorized based on their nature and how they affect a company’s financials. The main types include:

1. Cash transactions

Cash transactions occur when goods or services are exchanged for immediate cash payment. These transactions are straightforward because the payment happens on the spot, meaning there is no delay in recording the inflow or outflow of cash. For example, when a customer buys a product in-store and pays with cash, the transaction is instantly recorded in the company’s books. Cash transactions provide immediate liquidity, making them easy to track and manage.

2. Credit transactions

Credit transactions happen when goods or services are exchanged, but payment is deferred to a future date. This is common in business-to-business dealings, where customers are allowed to purchase on credit and settle the bill later. For example, when a company sells products to a customer on a 30-day credit, the revenue is recorded at the time of sale, but cash will only be received after 30 days. These transactions require careful tracking to ensure that payments are collected on time and credit risks are managed.

3. Internal transactions

Internal transactions are financial activities that happen within a company without involving any external party. Examples include recording depreciation, inventory adjustments, or transferring assets between departments. These transactions don’t result in an exchange of cash but affect the company’s internal financial records. They help in accurately reflecting the business’s asset value, expenses, or other financial changes within the organization.

4. External transactions

External transactions involve interactions between a company and an outside party, such as a customer, supplier, or bank. Examples include purchasing raw materials from a vendor, selling goods to a client, or borrowing money from a financial institution. These transactions impact the company’s assets, liabilities, or equity and are the most common types recorded in accounting, as they directly affect the business’s relationship with the outside world.

5. Non-cash transactions

Non-cash transactions are those that don’t involve the direct exchange of cash at the time of the transaction. A typical example is when assets like property or equipment are bartered or when depreciation is recorded for an asset over time. These transactions impact the financial statements without the movement of cash, but they are essential for reflecting the accurate value and costs associated with a company’s resources over time.

Recording Transactions: An Overview 

Recording transactions is a fundamental process in accounting that ensures all financial activities of a business are accurately documented. Each transaction, whether it’s a cash payment, a credit sale, or an internal adjustment, is recorded in the company’s accounting system using the double-entry bookkeeping method. 

This method requires every transaction to be entered in at least two accounts: one as a debit and the other as a credit, keeping the accounting equation (Assets = Liabilities + Equity) balanced. Transactions are first recorded in a journal, also called the book of original entries, and then posted to the general ledger. Properly recording transactions is crucial for producing accurate financial statements, tracking cash flow, and maintaining compliance with financial regulations. 

Example of recording transactions in accounting

Let us understand with an example how transactions are recorded using the double-entry bookkeeping method. 

A company, GHT, makes the following transactions in a month:

• Transaction 1: The company purchased $7000 worth of office supplies. This was a cash transaction.
• Transaction 2: The company sold goods worth $10,000 on credit.

Journal entry for transaction 1

Transaction 1 impacts two asset accounts: office supplies and cash. While office supplies are debited, the cash account is credited, ensuring adherence to double-entry bookkeeping.

Date	Account	Debit	Credit
12th Sep 2024	Office Supplies	$7000
	Cash		$7000

Journal entry for transaction 2

Transaction 2 impacts two accounts: accounts receivables (asset account) and sales revenue (income account). 

Date	Account	Debit	Credit
12th Sep 2024	Accounts receivables	$10,000
	Sales Revenue		$10,000

In this way, transactions are recorded impacting at least two accounts and ensuring that the accounting equation is balanced. The transactions are first recorded as journal entries, and then they are later posted to the general ledger.

How Does Transaction Analysis Work in Accounting? 

When analyzing transactions in accounting, it’s important to follow a systematic approach to ensure accuracy and consistency. The process involves several key steps to accurately capture the impact of each transaction on a company’s financial records. Here’s a clear outline of the steps involved in transaction analysis:

Step 1: Identify the transaction

Determine what financial event has occurred. This could be a sale, purchase, payment, receipt, or any other business activity that impacts financial records.

Step 2: Determine the affected accounts

Identify which accounts are involved in the transaction. Common accounts include cash, accounts receivable, inventory, accounts payable, and various expense or revenue accounts.

Step 3: Classify the accounts

Decide whether each account affected is an asset, liability, equity, revenue, or expense. This classification helps in understanding how the transaction impacts the accounting equation.

Step 4: Analyze the impact

Assess how the transaction will affect each of the affected accounts. Determine whether each account will be debited or credited. For example, purchasing inventory with cash will debit the inventory account and credit the cash account.

Step 5: Record the transaction

Make the appropriate journal entries based on the analysis. This involves recording the debit and credit amounts in the journal, ensuring that the accounting equation remains balanced.

Step 6: Post to the general ledger

Transfer the journal entries to the general ledger, which consolidates all accounts and provides a detailed record of each account’s activity.

Step 7: Verify accuracy

Review the entries to ensure they are correct and that the accounting equation remains balanced. This step helps catch any errors or omissions before the financial statements are prepared.

How Can HighRadius Enhance Transaction Analysis? 

HighRadius’ Record-to-Report Solution streamlines the transaction analysis process, enhances accuracy, and supports better financial oversight. Here’s how: 

• HighRadius automates the extraction and integration of transaction data from multiple data sources, ERPs, and financial systems, ensuring accurate and timely recording. This reduces manual data entry errors and speeds up the month-end close processes, reducing time spent by 30%. 

• HighRadius offers real-time insights into financial transactions and their effects on accounts, allowing for the swift identification of discrepancies and more precise financial reporting. Enhanced by anomaly detection, it helps businesses resolve up to 80% of discrepancies, ensuring a higher level of accuracy and reliability in financial records.

• HighRadius facilitates automated reconciliation of transactions by matching entries against external records, such as bank statements. This helps ensure that all transactions are accounted for and correctly classified.

• With built-in validation rules and controls, HighRadius minimizes errors in transaction recording and ensures compliance with accounting standards. This leads to more reliable financial statements.

FAQs

1. What is a transaction in accounting terms?

A transaction in accounting is any financial event that affects a company’s accounts, such as a sale, purchase, or payment. It involves the exchange of money or assets and is recorded with corresponding debits and credits to ensure accurate financial statements and balance the books.

2. What are the different types of transactions in accounting?

In accounting, transactions are classified as cash, credit, internal, external, and non-cash. Cash transactions involve immediate payment, credit transactions defer payment, internal transactions occur within the company, external transactions involve outside parties, and non-cash transactions don’t involve cash directly.

3. How is a transaction recorded in accounting?

In accounting, a transaction is recorded by using double-entry bookkeeping. Each transaction is entered as both a debit and a credit in corresponding accounts to keep the accounting equation balanced. These entries are first documented in a journal and then posted to the general ledger.