Why are transaction identified analyzed and measured before recording them in the chart of accounts?

The accounting cycle begins with the analysis of transactions. The proper analysis of business transactions is important because it ensures that entries in the journal are correct.

Table of Contents Show

• What are the Steps of Transaction Analysis?
• Ascertaining the Accounts Involved
• Ascertaining the Nature of Accounts
• Determining the Effects in Terms of Increase and Decrease
• Applying the Rules of Debit and Credit
• Get to Know the Basics
• What are the steps of transaction analysis?
• How many accounts need to be involved in every business transaction?
• How do we determine the nature of accounts?
• How do we determine the effects in terms of increase and decrease?
• Six Steps of Accounting Transaction Analysis
• Accounting Transaction Analysis Table

What are the Steps of Transaction Analysis?

Analysis of business transactions involves the following four steps:

1. Ascertaining the accounts involved in the transaction
2. Ascertaining the nature of the accounts involved in the transaction
3. Determining the effects (i.e., in terms of increases and decreases in the accounts)
4. Applying the rules of debit and credit

Ascertaining the Accounts Involved

Every business transaction involves two or more accounts. The process of analyzing a business transaction starts with identifying these accounts.

For example, suppose that Mr. John starts a business with cash amounting to $25,000. This is a transaction that involves two accounts: namely, the cash account and the capital account.

Ascertaining the Nature of Accounts

The second step of transaction analysis is to ascertain the nature of the accounts identified in the preceding step. In the above example, cash is an asset account and capital is an owner’s equity/capital account. Consider learning more about the classification of accounts.

Determining the Effects in Terms of Increase and Decrease

After ascertaining the nature of the accounts, it is necessary to determine which account is increasing and which one is decreasing as a result of the transaction. This is necessary for the proper application of rules of debit and credit on each account.

In the above example, the two accounts involved are the cash account and capital account, both of which are increasing.

Applying the Rules of Debit and Credit

The final step involved in transaction analysis is to apply the rules of debit and credit on accounts.

In this step, we determine which account is to be debited and which one is to be credited on the basis of the increase and decrease in accounts identified in the preceding step.

Using the same example, the cash account would be debited because, when an asset increases, its account is debited. The other account involved is John’s capital account, which would be credited. This is because the capital account is credited when capital increases.

Example

Consider the following information:

1. Mr. John started his business by investing $50,000
2. He purchased merchandise for cash, amounting to $20,000
3. He sold merchandise to Mr. Sam on credit for $5,000
4. He paid an employee’s salary amounting to $700
5. He received cash from Mr. Sam of $4,800 and allowed him a cash discount of $200

Required: Give a stepwise analysis of the above transactions.

Solution

Get to Know the Basics

Every recording of a business transaction entails that one should have an appropriate understanding of the nature of the transaction, the accounts affected, and the rules of debit and credit. Let us know how we could be of help in matters like this. Here’s a link to a financial advisor in Forest, VA who can assist you. If you live outside the place, please visit our financial advisor page for more information.

Do you want to test your knowledge about Transaction Analysis? We have prepared quizzes for you.

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

• Facebook
• LinkedIn
• Instagram
• Twitter
• YouTube

In order to continue enjoying our site, we ask that you confirm your identity as a human. Thank you very much for your cooperation.

Reading Time 4 mins

The accounting transaction analysis is the process of translating the business activities and events that have a measurable effect on the accounting equation into the accounting language and writing it in the accounting books. This is the first stage in the accounting cycle, which is the foundation of accounting, regardless of the accounting type you are interested in. Businesses analyze to ensure that the balance sheet equation stays in balance after each transaction is completed.

Six Steps of Accounting Transaction Analysis

1. Determine if the event is an accounting transaction

You first need to determine whether this transaction is a business nature transaction. An accounting also transaction has to involve a monetary amount. So if the company signed a rental contract, there is no accounting transaction. However, if it makes a payment under this contract, it will be an accounting transaction because it has a monetary amount that the company will need to record. Other examples include a purchase of equipment, sale of products, and salary payments.

2. Identify what accounts it affects

Your next step is to identify which accounts the transaction will affect. For example, Ellen invested $38,000 in cash and a used truck with a market value of $8,500 in the business in exchange for the company’s common stock. The cash and truck invested will be assets for that business, recorded under Cash account and Truck account. In exchange for that investment, Ellen will get common stock, so it will also affect the Common Stock account.

3. Determine what type of accounts they are

Every transaction leads to a measurable change in the accounting equation. Knowing whether the account belongs to assets, liabilities, or equity will allow you to determine whether the account will have a debit or credit normal balance. In the example above, we already decided that two accounts will be Asset accounts, and the Common Stock account is the Owner’s Equity type account.

4. Determine which accounts are going up or down

A business records a transaction with an entry that has a debit and credit effect. This double-entry procedure keeps the accounting equation in balance. So, when Ellen invested cash, the cash and truck accounts will increase because the company will now have more money, and it now has a truck. The Common Stock account will also increase.

5. Apply the rules of debits and credits to these accounts

One has to record each business transaction in two or more related but opposite accounts. We debit one account and credit the other Account in the same transaction amount. Accounts on the left side increase with a debit entry and decrease with a credit entry while accounts on the rise in the right side with a credit entry and decrease with a debit. So, if the Cash and Truck accounts will increase, and it is an asset account, the business will debit it. The Common Stock account is the Equity account, which increases with a credit entry. 

6. Find the transaction amount to be entered into each account

Your final step would be to determine the amount of the transaction from the business records, such as receipts, invoices, and bank statements. 

Accounting Transaction Analysis Table

When going through the six steps of the accounting analysis, it is much easier to analyze by filling out an accounting transaction analysis table, such as one below. Let’s go over the example transaction, explaining it step by step and filling the table. 

1. This is an accounting transaction because it involves a monetary amount and is a business activity.
2. The business bought supplies so that it will involve Supplies account. Since it purchased them on account and not with cash, it will use the Account Payable account. 
3. Supplies are an asset the company acquired. Accounts Payable is a liabilities account because the company still owes money for the amounts it purchased. 
4. Supplies’ account is increasing because the company has more amounts after this transaction than before. Accounts Payable is also growing because it owes more money than it did before the transaction.
5. Supplies (asset) is debited to increase it. Accounts Payable (liability) is credited to enlarge it.
6. The company will record $300 for each account as the transaction amount. 

No More Bookkeeping Stress

Keeping proper financial records is time-intensive and small mistakes can be costly. BooksTime makes sure your numbers are 100% accurate so you can focus on growing your business.

Let’s review another example and use the table to summarize our analysis.

1. This is an accounting transaction because it involves a monetary amount and is a business activity.
2. The two accounts that will be used to record this transaction are Cash and Capital.
3. The Cash account is an asset type account, while the Capital is the owner’s equity.
4. Both accounts are going up because now there is more money, and the owner made a contribution.
5. To increase the Cash (asset), the company will debit it, and to increase Capital (owner’s equity), it will credit it.
6. Both accounts will increase by $97,000.