Financial Accounting: Chapter 2 – Transaction Analysis

Transaction Analysis in Financial Accounting

Introduction

Transaction analysis is a foundational concept in financial accounting, focusing on identifying, classifying, and recording business transactions. This process ensures that all financial events are accurately reflected in a company's accounting records, supporting the preparation of reliable financial statements.

Learning Objective 1: Recognizing Business Transactions and Account Types

Definition of a Business Transaction

• Business Transaction: Any event that has a financial impact on a business and can be measured reliably.

• Transactions provide objective information about the financial impact of an exchange.

• Each transaction involves two sides:

  • Something is given

  • Something is received in return

• Accounting records both sides of every transaction (the double-entry system).

The Accounting Equation

• The accounting equation expresses the basic relationship in accounting:

$\text{Assets} = \text{Liabilities} + \text{Stockholders' Equity}$

• Account: The record of all changes in a particular asset, liability, or stockholders’ equity item during a period.

Types of Accounts

Assets

Assets are economic resources that provide future benefits to a business.

• Cash: Money including bank account balances, paper currency, coins, certificates of deposit, and checks.

• Accounts Receivable: Promises for future cash for goods or services provided.

• Notes Receivable: Amounts other parties must pay to the business because they signed a promissory note.

• Inventory: Goods the company sells to customers.

• Prepaid Expenses: Expenses paid in advance, such as insurance or rent.

• Investments: Long-term assets purchased with the intention of generating income and/or strategic control.

• Property, Plant & Equipment (PPE): Long-term assets such as land, buildings, and equipment used in operations to earn revenue. Most PPE assets are depreciated over time.

Liabilities

Liabilities are debts or obligations payable to outsiders.

• Accounts Payable: Promises to pay debts arising from purchases on credit.

• Notes Payable: Signed notes promising to pay a future amount (borrowings).

• Accrued Liabilities: Liabilities for expenses that have been incurred but not yet paid (e.g., wages payable, interest payable).

Stockholders’ Equity

Stockholders’ equity represents the owners’ claims to the assets of the company.

• Common Stock: Owners’ investment in the corporation through stock issuance.

• Retained Earnings: Cumulative net income minus net losses and dividends over the company’s life.

• Dividends: Distributions of the company’s earnings to shareholders.

• Revenues: Increases in stockholders’ equity from delivering goods or services to customers.

• Expenses: Decreases in stockholders’ equity due to the cost of operating the business.

Summary Table: Major Account Types

Account Type	Examples	Normal Balance
Assets	Cash, Accounts Receivable, Inventory, PPE	Debit
Liabilities	Accounts Payable, Notes Payable, Accrued Liabilities	Credit
Stockholders’ Equity	Common Stock, Retained Earnings, Dividends	Credit (except Dividends: Debit)
Revenues	Service Revenue, Sales Revenue	Credit
Expenses	Rent Expense, Salary Expense, Utilities Expense	Debit

Example: Transaction Analysis

• If a company purchases equipment for cash, both the Equipment (asset) and Cash (asset) accounts are affected. Equipment increases, Cash decreases, but total assets remain unchanged.