What is a 'Transaction'

A transaction is an agreement between a buyer and a seller to exchange goods, services or financial instruments.

In accounting, the events that affect the finances of a business must be recorded on the books, and an accounting transaction will be recorded differently if the company uses accrual accounting rather than cash accounting. Accrual accounting records transactions when revenues or expenses are realized or incurred, while cash accounting records transactions when the business actually spends or receives money.

Breaking Down the 'Transaction'

Transactions in terms of sales between buyers and sellers are relatively straightforward. Person A gives person B a certain amount of money for a good, service, or financial product. . 

Transactions can become more complex in the accounting world since businesses may sometimes make deals today which won't be settled till a future date, or they may have revenues or expenses that are known but not yet due. Whether a business records income and expense transactions using the accrual method of accounting or the cash method of accounting affects the company’s financial and tax reporting.

Recording Transactions With Accrual Accounting

In accrual accounting, a company records income when completing a service or when shipping and delivering goods. If inventory is required when accounting for a company’s income, and the company typically has gross receipts over $1 million annually, the company normally uses the accrual method of accounting for sales and purchases.

Accrual accounting focuses on when income is earned and expenses are incurred. All transactions are recorded regardless of when cash is exchanged. For example, a company selling merchandise to a customer on store credit in October records the transaction immediately as an item in accounts receivable (AR) until receiving payment. Even if the customer does not make a cash payment on the merchandise until December, the transaction is recorded as income for October.

The same concept applies to goods or services the company buys on credit. Business expenses are recorded when receiving the products or services. For example, supplies purchased on credit in April are recorded as expenses for April, even if the business does not make a cash payment on the supplies until May.

Recording Transactions With Cash Accounting

Most small businesses, especially sole proprietorships and partnerships, use the cash accounting method. Income is recorded when cash, checks, or credit card payments are received from customers. For example, a business sells $10,000 of widgets to a customer in March. The customer pays the invoice in April. The company recognizes the sale when the cash is received in April. Likewise, expenses are recorded when vendors and employees are paid. For example, a business purchases $500 of office supplies in May and pays for them in June. The business recognizes the purchase when it pays the bill in June.

The cash basis of accounting is available only if a company has less than $1 million in sales annually. Because no complex accounting transactions, such as accruals and deferrals, are necessary, the cash basis is easier than the accrual basis for recording transactions. However, the typically random timing of cash receipts and expenditures means reported results may vary between unusually high and low profits from month to month.

RELATED TERMS
  1. Accrual Accounting

    Accrual accounting is an accounting method that measures the ...
  2. Cash Accounting

    Cash accounting is an accounting method in which revenues and ...
  3. Cash Cost

    Cash cost is a term used in cash basis accounting (as opposed ...
  4. Cash Basis

    Cash basis is a major accounting method by which revenues and ...
  5. Modified Cash Basis

    The modified cash basis method combines elements of the two major ...
  6. Accrue

    "Accrue" is a term used to describe the ability of something ...
Related Articles
  1. Investing

    How To Decipher Accrual Accounting

    Accrual accounting is an important method of measuring the performance and position of a company. Learn more on how its used.
  2. Small Business

    Best Checking Accounts For Small Businesses

    What you need to know to choose the best checking account for your small business – and where to look.
  3. Investing

    How to use Excel as a general accounting ledger

    Follow these steps to set up a general ledger accounting system in Excel. A small business can use Excel as a substitute for expensive accounting software.
  4. Investing

    Corporate Cash Flow: Understanding the Essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself. Learn how to read the cash flow statement.
  5. Personal Finance

    Handling High-Yield Savings Accounts

    Is a high-yield savings account right for you? Read on to find out what they have to offer.
  6. Investing

    Best Checking Accounts for Small Businesses

    Accounts with big banks offer frills, such as mobile and text-based banking but for smaller businesses, local banks and credit unions can save money.
  7. Taxes

    Deferred Tax Liability

    Deferred tax liability is a tax that has been assessed or is due for the current period, but has not yet been paid. The deferral arises because of timing differences between the accrual of the ...
RELATED FAQS
  1. What is the difference between accrual accounting and cash accounting?

    Understand the differences between the two basic methods of accounting commonly used by businesses: cash accounting and accrual ... Read Answer >>
  2. What is accrual accounting in SAP?

    See how accrual accounting practices are handled through the Statutory Accounting Principles and the Systems, Applications ... Read Answer >>
  3. Why Is Deferred Revenue Treated As A Liability?

    Deferred revenue is listed as a liability on the balance sheet because, under accrual accounting, the revenue recognition ... Read Answer >>
  4. What is the difference between deferred revenue and accrued expense?

    Understand the differences between deferred revenue and accrued expenses. Learn how each is recognized on the balance sheet ... Read Answer >>
  5. How should investors interpret accounts receivable information on a company's balance ...

    Analyze accounts receivable information on a company's balance sheet carefully. Receivables offer confidence of future cash ... Read Answer >>
  6. What's the difference between cash-on-delivery differ and delivery against payment?

    Find out more about cash on delivery and delivery versus payment transactions and the difference between these two types ... Read Answer >>
Trading Center