Business Transaction

Business Transaction

In accounting, you record, classify, summarize and report financial information, of an individual, business or organization, to interested users. The reported financial information comes from what is referred to as business transactions.

In understanding the accounting basic, you need to learn and get familiar to the starting point and core of the accounting process, which is the business transaction. For without a business transaction, there is nothing to record, classify, summarize and report.

What is Business Transaction?

When operating a business, there will be several economic activities or events that arises what we call as business transactions.

A business transaction is best defined as follow:

Business transaction is an economic activity or event which affects and changes the financial condition and performance of an individual, business or organization. It involves an exchange of values – wherein one value is received in exchange for another value given up. Furthermore, a recorded business transaction should only include activity or event that pertains to the business, and should not include those personal transactions of the owner, in compliance to the accounting principle named business entity concept – which states that the business transaction is separate and distinct from the owner or owners.

Three Important Rules in Recording Business Transactions

In order for a business transaction to be valid and recorded in the accounting books, it must meet all of the following rules and criteria:

 1. Financial in Nature

A recorded business transaction must be financial in nature. Financial refers to something with equivalent money’s worth. The money’s worth may be in a form of cash, receivable, investment, inventory, stock, property, equipment, land, building, vehicle, right, franchise, patent, payable, bond, equity, etc.

Example:

Scenario:

Joe Smith is a lawyer who’s opening his own law firm named, Joe Smith Law Consulting Firm. Joe invested $10,000 personal cash to be used in starting and operating the law consulting firm.

Analysis:

This activity or event is considered a business transaction valid for recording in the accounting books of the business, Joe Smith Law Consulting Firm. And the money’s worth amounts to $10,000 cash and capital investment.

2. Exchange of Values

In recording a valid business transaction, the next rule and criteria is that it must involve an exchange of values. The exchange means that when you receive something you give up another thing. Like when you record an increase, you must also record an equivalent decrease.

Example: We will use the same example in rule no. 1.

Scenario:

Joe Smith is a lawyer who’s opening his own law firm named, Joe Smith Law Consulting Firm. Joe invested $10,000 personal cash to be used in starting and operating the law consulting firm.

Analysis:

This sample business transaction met the first criteria, now we’ll check if it meets the second rule and criteria, which is, it must involve an exchange of value. As we can see, the business, Joe Smith Law Consulting Firm, got $10,000 cash from the owner, Joe Smith, which represents the value received. And the equivalent value given up is the ownership claim of Joe Smith to the business assets represented by capital amounting to $10,000. In exchange for the amount of cash received from the owner, Joe Smith, the business has given up its ownership and right to the business assets amounting to $10,000.

3. Business Entity Concept

Last but not the least important rule and criteria in recording business transaction is to abide with the business entity concept, which mandates that recorded information in the business accounting books should be treated separately from the owner. It means any personal transaction of the owner should not be included in the records of the business, and vice versa.

Example: We will still use the same example in rule no. 1 and 2

Scenario:

Joe Smith is a lawyer who’s opening his own law firm named, Joe Smith Law Consulting Firm. Joe invested $10,000 personal cash to be used in starting and operating the law consulting firm.

Analysis:

This is sample business transaction has met the first and second criteria, now we’ll check if it meets the last third rule and criteria, which is, the transaction must pertain to the business and not for the owner. The $10,000 cash received from the owner, Joe Smith, is a valid business transaction to be recorded in the accounting books because the cash will be used in starting and operating the business.

This is the end of this article. By now, you were able to gain understanding on what business transaction is and how it affects the recording process in accounting. Feel free to share your thoughts, additional information, questions or concerns via comment box below.

Comments

  1. salifu yunush says:

    Why is Accounting defined as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and event which are in part at least of a financial character and interpreting the results thereof

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  4. Mark D Butaoh-Malawi says:

    Please help, how do I treat long term loan and its interests annually, during annuall financial comprehensive statement?

    Mark Butao

  5. Mark D Butaoh-Malawi says:

    How will Drawings affect owner’s equity annually?

    Mark Butao

  6. business economic activities arises.

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