A transaction is an agreement between a buyer and seller about a deal. The deal will involve cash and a product or service being exchanged.
- 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 usually thought of as the process of 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 to exchange a product or service in exchange for money. Agreement means that the product or service can be delivered at a later date. Likewise, the payment can be made at a later point in time.
The tricky part of a transaction in accounting is usually the date that a transaction gets recorded at. In most cases, a transaction is completed within the same date. For example, if you were to head to the supermarket and buy an apple, you would 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.
However, there are many instances where this might not be the case. For instance:
- You purchase a washing machine by 12-month installations
- You purchase a huge piece of machinery and promise to make payment within 90 days
Therefore, the date that a transaction gets recorded 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 a transaction is recorded when cash is paid out or received from a cash and 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 will record the inventory purchase transaction on 28 Jan 2022 as that was the date that the cash outflow was recorded.
Simply put, accrual accounting is a method of accounting that only looks at a company’s cash and bank statements. Any revenue that hasn’t been collected or expense that hasn’t been paid isn’t recorded in the company’s accounting records.
Cash accounting is where transactions are recorded as when the agreement is made. Continuing our toy retailer example from above, the toy retailer will record the expense on 1 Jan 2022 instead of 28 Jan 2022 since the agreement (of purchase) was made on 1 Jan 2022.
Cash accounting can be more straightforward since it gives a company a clear picture of the cash on hand and amount of cash it needs for all it’s expenses. However, the disadvantage is that it may be more difficult for the accountant to reconcile everything accurately since they will need to look at all invoices and purchase orders in addition to 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 slightly different in double entry accounting.