What Is a Transaction? Basic Knowledge of Transactions in Business

What Is a Transaction?

A transaction is a completed agreement between a buyer and a seller to exchange goods, services, or financial assets for money. The term is also commonly used in corporate accounting. In a company's ledger, this simple definition can become complicated. A transaction can be recorded by a company sooner or later depending on whether the company uses the accrual accounting or cash accounting method.

Key Points

• A transaction involves the exchange of currency for goods or services.
• Transactions can become more complex when they involve corporate accounting.
• Accrual accounting records a transaction as soon as it is completed, regardless of when money is received or paid.
• Cash accounting is typically used by smaller businesses and only records a transaction when money is received or paid out.
• Third-party transactions can often complicate the process.

Basic Knowledge of Transactions

A sales transaction between a buyer and a seller is relatively straightforward. Person A pays person B in exchange for a product or service. Once they agree on the terms, money is exchanged for the goods or services and the transaction is complete.

Transactions can be more complex in the world of accounting because businesses may make an agreement today that won't be settled until a future date. Or they may have known revenues or expenses that are not yet due. Third-party transactions can also complicate the process.

Whether a business records income and expenses using the accrual accounting method or the cash accounting method affects the company's financial statements and taxes.

• The accrual accounting method requires a transaction to be recorded as it occurs, regardless of when cash is received or an expense is paid.
• The cash accounting method only records a transaction when cash is received or an expense is paid. This may require a letter of intent or a memorandum of understanding.

While accrual accounting is generally used by businesses with average revenue of over $26 million in the three previous years, cash accounting is primarily used by small businesses.

Transactions Using Accrual Accounting

When using accrual accounting, a company recognizes income as a service is completed or a delivery is made. If inventory is required when accounting for a company’s income and the company has an average revenue of more than $26 million in the three prior years, the company typically uses the accrual accounting method for its sales and purchases.

Accrual Accounting Example

A company that sells merchandise to a customer on credit in October would record the transaction immediately as an entry in its accounts receivable (AR). Even if the customer does not make a cash payment for the goods until December or in installments, the transaction is still recorded as income for October.

The same applies to goods or services the company buys. A business expense is recorded when the product or service is received. Supplies purchased on credit in April are recorded as an expense for April, even if the business does not make a cash payment for the supplies until May.

If a customer purchases an item on credit, the transaction is recorded immediately if the selling company uses the accrual accounting method.

Transactions Using Cash Accounting

Most small businesses, particularly sole proprietorships and partnerships, use the cash accounting method. Income is recognized when cash, a check, or a credit card payment is received from a customer.

Cash Accounting Example

Say a business sells $10,000 worth of merchandise to a customer in March. The customer pays the bill in April. The company only records the sale after it receives the cash in April.

Meanwhile, expenses are only recorded when a payment is made. A business may buy $500 of office supplies in May, for example, and pay for them in June. The business records the purchase when it pays the bill in June.

For tax reasons, the cash accounting method is only available if a company has average revenue of less than $26 million in the three previous years. The cash accounting method is easier than the accrual method for recording transactions because complex accounting transactions like accruals and deferrals are not needed. Its disadvantage is that a business's profit can swing wildly from month to month, at least on paper.

What Is an ACH Transaction? An ACH transaction is an electronic payment made between banks. They are processed through the Automated Clearing House System. Examples of ACH transactions include direct deposits like payroll or tax refunds, and bill payments made online or through your bank.

How to Cancel a Pending Transaction? Pending transactions are those that have been made but have not yet posted to your account. This includes payments, purchases, pre-authorized debits, and any other related transactions. Debit or credit card purchases are held for a certain amount of time before they are processed electronically from your bank to the recipient. The transaction date is the date of the purchase or payment. Posting the transaction to a credit card account moves it from the pending category. Contact the merchant and/or your bank to request a cancellation if, for whatever reason, you want to void the transaction.

How Are Transactions Different in Accounting? Accounting transactions are a bit different because of the way they can be recorded. In the accrual accounting method, transactions are recorded as soon as they are made. But in the cash accounting method, transactions are only recorded when money is received or paid out.

Conclusion

A transaction signals a financial agreement between two parties, where one party financially benefits by selling goods and services to the other. Put simply, a transaction is complete when goods and services change hands for money. But things get more complex when it comes to transactions in accounting. Businesses using the accrual accounting method record transactions as they are completed. In the cash method, they are recorded only when payments are made or received.