How Accounting Focuses on Transactions - dummies

How Accounting Focuses on Transactions

Business accounting focuses on transactions. A good bookkeeping system unfailingly captures and records every transaction that takes place. Understanding accounting, to a large extent, means understanding how accountants record the financial effects of transactions. They also record events that have an economic impact on a business.

Counting on transactions

The immediate and future financial effects of some transactions can be difficult to determine. A business carries on economic exchanges with six basic types of persons or entities:

  • Its customers, who buy the products and services that the business sells.

  • Its employees, who provide services to the business and are paid wages and salaries and provided with benefits, such as a retirement plan, medical insurance, workers’ compensation, and unemployment insurance.

  • Its suppliers and vendors, who sell a wide range of things to the business, such as legal advice, products for resale, electricity and gas, telephone service, computers, vehicles, tools and equipment, furniture, and even audits.

  • Its debt sources of capital who loan money to the business, charge interest on the amount loaned, and are due to be repaid at definite dates in the future.

  • Its equity sources of capital, the individuals and financial institutions that invest money in the business and expect the business to earn profit on the capital they invest.

  • The government, or the federal, state, and local agencies that collect income taxes, sales taxes, payroll taxes, and property taxes from the business.

Here’s a look at the interactions between a business and the other parties in its economic exchanges.

Transactions between a business and the parties it deals with.
Transactions between a business and the parties it deals with.

Accounting for events

Even a relatively small business generates a surprisingly large number of transactions, and all transactions have to be recorded. Certain other events that have a financial impact on the business have to be recorded, as well. These are called events because they’re not based on give-and-take bargaining — unlike the something-given-for-something-received nature of economic exchanges.

Events such as the following have an economic impact on a business and are recorded:

  • A business may lose a lawsuit and be ordered to pay damages. The liability to pay the damages is recorded.

  • A business may suffer a flood loss that is uninsured. The waterlogged assets may have to be written down, meaning that the recorded values of the assets are reduced to zero if they no longer have any value to the business. For example, products that were being held for sale to customers (until they floated down the river) must be removed from the inventory asset account.

  • A business may decide to abandon a major product line and downsize its workforce, requiring that severance compensation be paid to the laid-off employees.

At the end of the year, the accountant makes a special survey to make sure that all events and developments during the year that should be recorded have been recorded, so that the financial statements and tax returns for the year are complete and correct.