Updated date:

How to Identify and Analyze Transactions in Accounting

Sandrene is an ACCA candidate pursuing a B.C Degree in Accounting and Finance with 5 years experience in Financial Services/Accounting.

how-to-identify-and-analyze-transactions-in-accounting

In accounting, we identify and analyze transactions by doing some simple assessments. To identify a transaction means to determine if a transaction actually exists and whether or not it is relevant to the business. After a transaction has been identified it is then analyzed. The analysis is basically deciding which accounts of the business will be affected and how they they will be affected. But, in order to do this, one has to know what a qualifies as a transaction.

A transaction for Accounting purposes can be one of two things:

  1. An exchange of goods/services for money or other goods/services carried out by or on behalf of the business
  2. An event/activity/process that immediately/directly changes the financial position of the business.

I have created a chart to help newbies to identify whether a statement qualifies as a transaction or not.

how-to-identify-and-analyze-transactions-in-accounting

Examples of Identifying Transactions

Example 1

Statement: Bob owns a restaurant. He buys two stoves so that the staff can prepare more meals in less time.

By following the chart, we would identify this statement as a transaction because it is an exchange. Bob buying two stoves is an exchange of money for goods (stoves).

Example 2

Statement: A couple months later, one of the stoves stops working and Bob throws it out.

By following the chart, we would identify this statement as a transaction because even though it is not an exchange it is an event: event that will directly cause the financial position of the business to change. Bob throwing out the stove means that the business will have less assets than it did before.

Example 3

Statement: Bob is considering hiring some more employees.

By following the chart, we would not identify this as a transaction because it does not have an immediate or direct effect on the business's financial position.

Any statement that is neither an event nor an exchange should be ignored.

How Is a Transaction Analyzed?

This is done by asking two simple questions:

  1. Which accounts will be affected?
  2. How will they be affected?

Before being able to determine which accounts will be affected, one has to know the six categories of accounts and the various accounts that fall under each category. The table below gives a quick synopsis.

Six Categories of Accounts

DrawingsExpensesAssets

Cash Withdrawals done by Owner

Purchases, Carriage Inwards, Insurance

Land, Building, Machinery, Equipment, Motor Vehicle

Dividends Paid to Shareholders

Rent, Utilities, Salary, Stationery

Cash, Bank Account, Debtors, Inventory

Assets taken by Owner

Advertising, Carriage Outward, Discount Allowed

Goodwill, Patents, Copyright

LiabilitiesEquityRevenue

Mortgages, Long Term Loans

Start-up Capital, Regular Capital, Shares,

Sales, Commissions, Discount Received

Creditors, Credit Card Blaances, Bank Overdrafts, Short Term Loans

Profit, Retained Earnings

Interest Received, Rent Received

how-to-identify-and-analyze-transactions-in-accounting

Examples of Analyzing Transactions

Example 1

Alicia starts a business with $100,000 cash.

  1. Which accounts will be affected? Cash and Capital.
  2. How will they be affected? Cash will increase because the owner is investing money into the business, and Capital will increase because an investment is made by the owner.

Example 2

Alicia buys a motor vehicle with cash to be used in the business.

  1. Which accounts will be affected? Motor Vehicle and Cash
  2. How will they be affected? The Motor Vehicle account will increase because a new one is being bought and the Cash account will decrease cash was used to purchase the vehicle.

Example 3

Alicia bought some clothes costing $10,000 cash which she intends to resell at a profit.

  1. Which accounts will be affected? Purchases and Cash.
  2. How will they be affected? Purchases will increase since goods have been bought for resale, and Cash will decrease because it was used to buy the goods.

The Importance of Identifying and Analyzing Transactions

Identifying and Analyzing transactions is the first step in the Accounting Cycle/Process. It is the step that determines which transactions are selected to be recorded. Any errors that occur at this stage could be carried right through to the end of the cycle, resulting in erroneous accounting reports and records. It is therefore extremely essential for it do be done with attention to detail and accuracy. Check out this Youtube Session on the topic.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.