A company engages in a variety of transactions daily. These include buying equipment, buying inventory, manufacturing, advertising, selling goods and services, etc. The accounting process starts with identifying the activities of a company that need to be recorded in its accounting system.

Any activity that has a financial impact on the company is a financial transaction that needs to be recorded in the company’s accounting system. A financial impact is created by an event or activity that involves the exchange of value between two or more parties. Examples of transactions include the purchase of an asset, the sale of goods or services, the use of a service such as a recruitment service, running an advertisement, etc.

An activity that has a financial impact on the company need not be a payment or receipt of cash. An activity or transaction could be creating a current or future financial obligation such as a payable in the future even if there is no payment of cash now. An example of such a transaction is the use of a contractor’s services today for which a payment will be made a few weeks from now.

Internal Transactions Or External Transactions

Transactions could be internal transactions or external transactions: Internal transactions are transactions that occur within the organization and do not involve external parties. Examples of internal transactions include recording employee wages, depreciation expenses of the company’s assets, inventory obsolescence, etc.

External transactions are transactions that the company engages with external parties such as customers, suppliers, lenders, and investors. Examples of external transactions are sales to customers, buying inventory, borrowing money, etc.

Activities That Do Not Have A Financial Impact On The Company

Some activities do not have a financial impact on the company. These activities do not need to be recorded in the accounting system. (Some of these may need to be disclosed in the notes to the financial statement.)

Examples of activities that do not have a financial impact on the company and so do not need to be recorded in the accounting system include:

• Entering a contract to supply goods at a future point in time. We do not record a transaction as we have not collected cash nor have we supplied goods (yet). No asset or liability has been created yet.
• Entering a letter of credit agreement with a bank where the bank assures our company’s client that, if our company fails to make the payment, then the bank will do so. Here, we do not record this in our accounting system as we have not created an asset or liability (yet). This becomes a liability to the bank only if our company fails to make a payment and we owe the bank money.
• Entering a credit/loan facility, where a bank agrees to lend the company on a future date if required. This transaction is not recorded on the company’s books because the company has not borrowed money (as yet).

Illustration of Identifying Transactions

Mark started a new business on January 1^st. Here is a list of activities for the month of January. Which of the activities listed below has a financial impact on the company? Which of these activities needs to be recorded in the accounting system?

1. Mark invested $20,000 to start a business in exchange for 1,000 shares on January 1^st.
2. The business borrowed $30,000 from ABC bank at an interest rate of 10% per year on January 2^nd.
3. Equipment worth $25,000 was purchased and paid for immediately on January 4^th.
4. On January 6^th, inventory worth $40,000 was purchased by the company on a 60 days credit note.
5. Three customers walked into the store to enquire about prices and products on January 12^th.
6. $10,000 worth of inventory was sold for $30,000 in revenue on 30 day credit on January 15^th.
7. $5,000 of wages were paid on January 31^st.
8. The rent for January was $2,000 and was paid on January 31^st.
9. On January 31^st, $10,000 of accounts receivable was collected from the customer related to sales made on Jan 15^th.
10. The equipment would last for 5 years. The straight-line depreciation method is used to account for depreciation expenses.

Take a few minutes to think through the above transactions. Please identify which transactions have a financial impact on your company and need to be recorded in the accounting system. Please do this before you look at the answers provided below.

1. Mark invested $20,000 to start a business in exchange for 1,000 shares on January 1^st.
   • Yes, there is a financial impact.
     • Cash received.
     • Shares issued.
2. The business borrowed $30,000 from ABC bank at an interest rate of 10% per year on January 1^st.
   • Yes, there is a financial impact.
     • Cash received.
     • Debt created.
3. Equipment worth $25,000 was purchased by the company in exchange for cash on January 4^th.
   • Yes, there is a financial impact.
     • Equipment received.
     • Cash paid.
4. Inventory worth $10,000 of inventory was purchased by the company on 60 days credit on January 6^th.
   • Yes, there is a financial impact.
     • Inventory received.
     • Payable created.
5. Three customers walked into the store to enquire about prices and products on January 12^th.
   • No Financial Impact.
6. The company sold $20,000 worth of inventory for $30,000 on 30 day credit on January 15^th.
   • Yes, there is a financial impact.
     • Inventory given.
     • Receivables created.
7. The company paid wages of $5,000 on January 31^st.
   • Yes, there is a financial impact.
     • Wages recorded.
     • Cash paid.
8. The companies rent for the month was $2,000 was paid on January 31^st.
   • Yes, there is a financial impact.
     • Rent expenses recorded.
     • Cash paid.
9. On January 31^st, $10,000 of accounts receivable was collected from the customer related to sales made on Jan 15^th.
   • Yes, there is a financial impact.
     • Cash received.
     • Accounts receivable goes down.
10. The company’s equipment would live for 5 years and used the straight-line depreciation method to account for depreciation expenses.
    • Yes, there is a financial impact.
      • Depreciation expenses recorded.
      • Accumulated depreciation increases.