A transaction is an agreement between a buyer and seller about a deal. The deal will involve cash for a product or service.
- Think of a transaction as an agreement between two people to exchange a good or service for money.
- For example, Tom sells Sally an Apple in exchange for $2. The agreement to buy and sell the apple is a transaction.
- The date of transaction can either be the date of cash inflow or outflow, or the date of agreement. This depends on whether a company uses accrual accounting or cash accounting.
What is a transaction?
A transaction is a buyer handing over cash in exchange for a product or service. But this isn’t always the case.
A transaction is an agreement between a buyer and seller. It is the exchange a product or service in exchange for money. In an agreement, one can deliver the product or service at a later date. Likewise, one can make the payment later.
The tricky part of a transaction in accounting is the date that a transaction gets recorded at. In general, people complete transactions within the same date. For example, say you are at the supermarket and buy an apple. You hand over $2 and leave the store with your apple. The date of payment and date of receival of goods and service would be the same.
But there are many instances where this might not be the case. For instance:
- You buy a washing machine by 12-month installations
- You buy a huge piece of machinery and promise to make payment within 90 days
Thus the date of a transaction depends on whether you’re using accrual or cash accounting.
Accrual accounting vs cash accounting
Accrual and cash accounting are both accounting methods.
Accrual accounting is where you record a transaction at the date when cash pays out or received. It is the date when the money goes in or leave your bank account.
For example, a toy retailer purchases inventory from a toy manufacturer on 1 Jan 2022. The toy retailer promises to make payment by the end of the month and makes payment on 28 Jan 2022. The toy retailer records the inventory order transaction on 28 Jan 2022. This is the date of the cash outflow.
Accrual accounting is a method of accounting that only looks at a company’s cash and bank statements. If you don’t receive cash from selling a product, you don’t record it. You only record sales and expenses once the cash inflow or outflow happens.
Cash accounting is where one records transactions at the date of the agreement. Let’s continue from our toy retailer example above. The toy retailer records the expense on 1 Jan 2022 instead of 28 Jan 2022. This is because the agreement (of the inventory order) was on 1 Jan 2022.
Cash accounting is more straightforward. It gives a company a clear picture of the cash on hand and amount of cash it needs for all its expenses. But it is difficult for the accountant to reconcile everything. The accountant must look at all invoices and orders, along with the bank statements.
What does a transaction consist of?
A transaction usually consists of the following:
- Short description
- Account (of account or debit)
- Category of transaction
- Additional notes
- Transaction type (i.e. credit or debit)
Do note that a transaction may look different in double entry accounting.