What is a Transaction?

Case break down: Movie New York:

The scene that you saw shows how Sam (played by John Abrahim) is entering a shop to buy ‘New York’s best brown bread’. He is given the bread and charged $3.45. He pays and receives the balance amount and receipt in return.

In this blog, Learning Perspectives will explore the meaning of a transaction.

What is a Transaction?

A transaction is a completed arrangement between the buyer and the seller. Similar to the scene that you saw, Sam (buyer) buys the bread and then there is an implicit agreement between him and the shopkeeper that he needs to pay. Thereafter, he willingly pays the cash and he is given a receipt for the same.

How are Transactions Recorded?

The scene that you saw will be considered a straight forward transaction. That means there is no time gap between receiving the product and payment for the goods or service. While in a business, there will be thousands of transactions in which payment would be received later or goods/services will be delivered at a later date. This is quite common to happen.

For example, a business orders cleaning services for which it has to make the payment now but the services would be availed by the business at a later date.

or when a business hosts a corporate event and engages planners, caterers, waiters etc. A business might make half the payment to the staff at the beginning and half after the event is over.

Herein two systems of accounting are taken into consideration.

1. Accrual basis of Accounting
2. Cash basis of Accounting

Accrual basis of accounting:

It states that a transaction is recorded in the books when it occurs even though cash doesn’t change hands. For example: If a company sells a machine on credit, the transaction is recorded immediately. Even though the customer would pay 2 months later. It is recorded in the books under accounts receivables. When cash comes in after two months journal entry recorded earlier changes and cash is debited.

Cash basis of accounting:

As the name suggests, it states that the transaction is recorded when cash changes hand. Many small businesses follow cash basis of accounting. For example a company sells tickets for a cruise to be held in April 2021. Many people buy tickets in January 2021. Company operating under cash basis of accounting will recognizes sale in January 2021, as company receives cash.

While under accrual basis of accounting, sale would be recognized in April 2021. This is because the company would be providing services during that time.