Lesson Business Transactions and their Analysis as

5 Applied to the Accounting Cycle of a Service

Business

INTRODUCTION

Accounting cycle is the financial process starting with recording business

transactions up to the preparation of financial statements. This process demonstrates
the purpose of financial accounting, i.e., to create useful financial information in the
form of general-purpose financial statements. In other words, the sole purpose of
recording transactions and keeping track of expenses and revenues is to turn this
data into meaning financial information by presenting it in the form of a balance
sheet, income statement, statement of owner’s equity, and statement of cash flows

LEARNING TARGETS

After going through this lesson, you are expected to:

1. Give examples of business transactions;

2. Describe the nature and give examples of business transactions;
3. Identify the different types of business documents;
4. Analyze common business transactions using the rules of debit and credit;
and
5. Solve simple problems and exercises in the analyses of business
transaction.

MOST ESSENTIAL CONCEPTS AND IDEAS

Business Transactions

In accounting, the business transaction (also known as financial

transaction) is an event that must be measurable in terms of money and that
essentially impacts the financial position of the business. For example, in a
merchandising business, selling some goods to a customer for P25,000 cash, is an
event that can be measured in terms of money and that impacts the financial position
of the business so it is a transaction. Similarly, the payment of P4,000 cash to
salesman as payment of salary is also a transaction because it has a monetary
value of P4,000.00 and it has a financial impact in the business. Only those events
that can be measured in monetary terms are included in accounting records of the
business.
 However, there may be numerous events related to a business that cannot be
reliably assigned a peso value. Such conditions or events cannot be called business
or financial transactions. For example, the CEO of a company delivers a motivational
lecture to the employees. This event may be of great benefit for the company’s
business but assigning a monetary value to it is not possible, so it is not a business
transaction and therefore cannot become a part of accounting records.

Characteristics of a Business Transaction

The following are the five important characteristics of a valid business

transaction that every bookkeeper or accountant must take care of before entering
the transaction in the journal.

1. It is a monetary event.
2. It affects the financial position of the business.
3. It belongs to the business not to the owner or any other person managing the
business.
4. It is initiated by an authorized person.
5. It is supported by a source document.

Types of Business Transactions

In accounting, the transactions may be classified as:

1. Cash transactions and credit transactions

A transaction in which cash is paid or received immediately at the time

when transaction occurs is known as cash transaction.

Example:

Selling some goods to Mr. Cruz for P500.00 and Mr. Cruz immediately
pays P500.00 cash for the goods purchased. It is a cash transaction because
the business immediately received cash for the goods sold to the customer.
Similarly, buying furniture for the company for P7,500.00 will require payment
immediately of P7,500.00 cash to the supplier and in return the company
have the possession of furniture. It is also a cash transaction.

In today’s modem business world, cash transactions are not limited

to the use of currency notes or coins for making or receiving payments, all
transactions made using debit or credit cards issued by financial institutions
are also categorized as cash transactions.

In a credit transaction, the cash does not change the hands

immediately at the time when transaction occurs. In other words, the cash is
received or paid at a future date.
Example:

Buying some merchandise from vendor for P1,000. Upon request,

the vendor agrees to receive the payment of P1,000 for goods sold next
week. The possession of the goods was transferred and transported to the buyer.

It is a credit transaction because payment was not made immediately

in cash immediately at the time of purchase of goods. Similarly, selling some
goods to Mr. Sam for P1.500. Mr. Sam requested to receive the payment of
P1,500 next month. Upon agreement, Mr. Sam takes the goods for use. This
is also a credit transaction because payment has not been received in cash
at the time of sale of goods to Mr. Sam.

In today’s business world, goods are mostly purchased and sold on

credit.

2. Internal transactions and External transactions

Internal transactions (also known as non-exchange transactions)

are those transactions in which no external parties are involved. These
transactions do not involve the exchange of values between two parties but
the event constituting the transaction is measurable in monetary terms and
impacts the financial position of the business. Examples of such transactions
include recording depreciation of fixed assets and realizing the loss of assets
caused by fire etc.

External transactions (also known as exchange transactions) are transactions

in which a business exchanges value with external parties. Normally, all transactions
other than internal transactions are external transactions. These are the usual
transactions that a business performs on daily basis. Examples of external
transactions include purchase of goods from suppliers, sale of goods to customers,
purchase of fixed assets for business use, payment of rent to owner, payment of gas,
electricity or water bills, payment of salary to employees etc. Normally, a large
portion of transactions performed by any business consists of external transactions.

Business Documents

Each transaction is recorded by making a journal entry by a bookkeeper or

accountant. Since each transaction impacts financial position of the business, the
bookkeeper or accountant must make sure that it has been authorized by a
responsible person and is properly supported by one or more source documents
before recording it in the journal.
A source document is a document that provides basic information needed to
record a transaction in the journal. Usual examples of source documents include sales
invoices, purchase invoices, cash receipts, payment vouchers, statement of accounts,
bills of exchange, promissory notes and any other document containing the basic
transaction details which can be presented as a proof of valid transaction.
Summary of Rules of Debit and Credit

Debit means Credit means Normal Balance

Increase in Asset Decrease in Asset Debit

Decrease in Liability Increase in Liability Credit

Decrease in Owner’s Equity Increase in Owner’s Equity Credit

Decrease in Income Increase in Income Credit

Increase in Expense Decrease in Expense Debit

Sample of Transactions

Example 1:

Jan 1 Juan Cruz invested cash of P100,000 in his business, Cruz Company.

Analysis:

a. The transaction is to be analyzed from the point of view of the business.

So, what accounts of the business are affected by the transaction?
b. Asset, Cash and Capital, Juan Cruz, Capital are the account titles affected.
c. Cash increased by P100,000 and Juan Cruz, Capital increased by P100,000.
d. So, in the analysis, both account titles increased.
e. Apply the rules of debit and credit:
Cash + ------> debit
Juan Cruz, Capital + ------> credit
f. The amount is P100,000 for each account.
g. So, the entry is:
Debit Cash P100,000
Credit Juan Cruz, Capital P100,000
h. The debit amount, P100,000 is equal to the credit amount, P100,000.

Example 2:

Jan 3 The business bought a computer costing P60,000 paying P40,000 down
payment and the balance to be paid on February 15.

Analysis:

a. Assets - Cash and Equipment, and Liability – Accounts Payable, are the
account titles affected.
b. Cash decreased P40,000
Equipment increased P60,000
Accounts Payable increased P20,000
 c. Apply the rules of debit and credit:
Cash - ------> credit 40,000
Equipment - ------> debit 60,000
Accounts Payable + ------> credit 20,000
d. So, in the entry there are two credit titles and one debit title.
e. So, the entry is:
Debit Equipment P60,000
Credit Cash 40,000
Credit Accounts Payable 20,000
f. The debit amount of P60,000 is equal to the total credit amount of P40,000
and P20,000.

The following are the steps or procedures in journalizing transactions in a 2-

column journal, assuming a manual accounting system.

1. Date Column
• The date has 2 columns. Write the year in small figures on top of the
first line of the first column. The month is written below the year on the
first line
• The day is written on the first line of the second column.
• The year and the month are not written again on the same page unless
the month changes.
• The day of each transaction is written regardless of the number of
transactions completed on the same date.
2. Description Column
• The title of the account debited is written on the first line on the extreme
left of the description column.
• The title of the account credited is written on the second line indented
by about one-half inch from the debit.
• A brief explanation of the transaction is written on the next line indented
again by about one-half inch from the credit.
3. Posting reference column
• The account numbers of the account titles debited and credited are
written on this column. However, this column is filled up only during the
posting stage.
4. Debit Column
• The amount of the debit account title is written in the debit column.
5. Credit Column
• The amount of the credit account title is written in the credit column.

Additional points to be remembered when recording using the two-column

journal.

a. Peso signs are not used.

b. Leave one space after each journal entry.
 c. When there are no centavos, a dash is usually placed in the centavo
column.
d. When money columns are used, comma or period is omitted in the
amount columns of the journal.

LET’S PRACTICE

Identify each of the following accounts of Servico, Inc. as asset,

liability, owner’s equity, revenue or expense, and state in each case whether
the normal balance is a debit or a credit.

CLASSIFICATION NORMAL BALANCE

_______________ ________________1. Accounts Payable

_______________ ________________2. Accounts Receivable
_______________ ________________3. Cash
_______________ ________________4. Calma, Capital
_______________ ________________5. Calma, Drawing
_______________ ________________6. Equipment
_______________ ________________7. Rent Expense
_______________ ________________8. Salary Expense
_______________ ________________9. Service Revenue
_______________ ________________10. Supplies
_______________ ________________11. Notes Payable
_______________ ________________12. Unearned Rent
_______________ ________________13. Supplies Expense
_______________ ________________14. Prepaid Rent
_______________ ________________15. Insurance Expense