Rebekiah has taught college accounting and has a master's in both management and business.
Transaction analysis can be a tricky task. In this lesson, you will learn what transaction analysis is, how to analyze a transaction, and how it is related to the accounting equation.
What Is Transaction Analysis?
Did you know that millions of times a day, all over the world, transactions occur? Think about it. Any time that a bill is paid, a loan is made, a purchase is made, or a sale is made, a transaction has occurred. A transaction is any event that involves goods, services, or money changing hands. For the average person, a completed transaction simply means that something on their to-do list has been completed. To the accounting professional, a completed transaction is just the beginning of something even bigger.
It's the beginning of the accounting cycle. The accounting cycle is the series of events that begin with a transaction and end with the closing of the books for an accounting period. In this lesson, we're going to talk about the first step in the accounting cycle: transaction analysis. What is transaction analysis, you wonder? Transaction analysis is the act of examining a transaction to decide how it affects the accounting equation.
Transaction Analysis and the Accounting Equation
Now, in order to analyze a transaction, you must know what it is you're looking for. Accountants are equipped with a very special tool that they use when analyzing transactions - that tool is the accounting equation. The accounting equation states that assets = liabilities + owner's equity. An asset is something that a business owns. A liability is something that a business owes. Owner's equity is the amount of money that a business owner personally invests in the business. Every account that a business has falls into one of these three categories.
Another important thing to know before you can analyze a transaction is that accounting professionals use a double-entry accounting system. A double-entry accounting system is one that is based on the premise that for every one transaction at least two accounts will be affected.
So, what does this mean? It means that at least one account will be debited and one account will be credited. A debit is an entry on the left side of an account that signifies an increase in the balance of an asset account and a decrease in the balance of a liability or owner's equity account. A credit is an entry on the right side of an account that decreases the balance of an asset account and increases the balance of a liability or owner's equity account.
The last thing that you really need to know before you can begin transaction analysis goes back to the accounting equation. If you recall, the accounting equation states that assets are equal to the sum of the total of liabilities and owner's equity. The key to this is in the word 'equals'. The same premise applies to transaction analysis as it does to the accounting equation. The bottom line is that everything must balance.
The best way to learn about transaction analysis is to analyze transactions, so let's do a few:
1. Jeff orders $275 worth of supplies for his company from Reads Wholesale. He pays for them with a check. What accounts are affected by this transaction and how are they affected?
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Jeff bought supplies, so that means that the balance in the supplies account increases $275, so it's debited in the amount of $275. He paid for the supplies with a check, so that means that the cash account decreases $275 and is credited $275.
2. Jeff receives the utility bill for his business office. The bill is $547.
For this transaction, the two accounts that are affected are utilities expense and accounts payable. The utilities expense account increases $547. Since this account is an expense account, a debit increases the balance in that account. The credit for this transaction is to accounts payable. Since accounts payable is a liability account, its balance also increases by the credit amount of $547.
As you can see from the examples, there are always at least two accounts that are affected by a transaction. Even though one is debited and one is credited, that doesn't mean that one account will increase and one will decrease in value. It depends on what type of account that it is as to whether the account balance increases or decreases.
Transaction analysis is the act of examining a transaction to decide how it affects the accounting equation. It's also the first step in the accounting cycle. In order to properly analyze a transaction, you must know and understand a few key things.
First, you need to know what the components of the accounting equation are. Assets are things that a business owns. Liabilities are things that a business owes. And owner's equity is the amount of money that a business owner has personally invested in the business.
Second, you need to know what debits and credits are. A debit is an entry on the left side of an account that signifies an increase in the balance of an asset account and a decrease in the balance of a liability or owner's equity account. A credit is an entry on the right side of an account that decreases the balance of an asset account and increases the balance of a liability or owner's equity account.
The third thing that you need to know before you can analyze business transactions is that, no matter what, the sum of the amounts debited and credited must be equal. Once you know these concepts, transaction analysis will be a breeze!
When you have completed this lesson you should be able to:
Define transaction analysis
Recall the accounting equation and define its components
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