Transaction, debit, credit, Assets, Liabilities, Capital, Drawings, Goods

25/12/2020 1 By indiafreenotes

Transaction

An accounting transaction is a business event having a monetary impact on the financial statements of a business. It is recorded in the accounting records of the business. Examples of accounting transactions are:

  • Sale in cash to a customer
  • Sale on credit to a customer
  • Receive cash in payment of an invoice owed by a customer
  • Purchase fixed assets from a supplier
  • Record the depreciation of a fixed asset over time
  • Purchase consumable supplies from a supplier
  • Investment in another business
  • Investment in marketable securities
  • Engaging in a hedge to mitigate the effects of an unfavorable price change
  • Borrow funds from a lender
  • Issue a dividend to investors
  • Sale of assets to a third party

A high-volume transaction, such as a billing to a customer, may be recorded in a specialized journal, which is then summarized and posted to the general ledger. Alternatively, lower-volume transactions are posted directly to the general ledger.

When the cash basis of accounting is being used, a transaction is recorded when cash is spent or received. Alternatively, under the accrual basis of accounting, a transaction is recorded when revenue is realized or when an expense is incurred, irrespective of the flow of cash.

Debit, Credit

Business transactions are events that have a monetary impact on the financial statements of an organization. When accounting for these transactions, we record numbers in two accounts, where the debit column is on the left and the credit column is on the right.

  • A debit is an accounting entry that either increases an asset or expense account, or decreases a liability or equity account. It is positioned to the left in an accounting entry.
  • A credit is an accounting entry that either increases a liability or equity account, or decreases an asset or expense account. It is positioned to the right in an accounting entry.

Debit and Credit Rules

  • The rules governing the use of debits and credits are as follows:
  • All accounts that normally contain a debit balance will increase in amount when a debit (left column) is added to them, and reduced when a credit (right column) is added to them. The types of accounts to which this rule applies are expenses, assets, and dividends.
  • All accounts that normally contain a credit balance will increase in amount when a credit (right column) is added to them, and reduced when a debit (left column) is added to them. The types of accounts to which this rule applies are liabilities, revenues, and equity.
  • The total amount of debits must equal the total amount of credits in a transaction. Otherwise, an accounting transaction is said to be unbalanced, and will not be accepted by the accounting software.

Debits and Credits in Common Accounting Transactions

  • Sale for cash: Debit the cash account | Credit the revenue account
  • Sale on credit: Debit the accounts receivable account | Credit the revenue account
  • Receive cash in payment of an account receivable: Debit the cash account | Credit the accounts receivable account
  • Purchase supplies from supplier for cash: Debit the supplies expense account | Credit the cash account
  • Purchase supplies from supplier on credit: Debit the supplies expense account | Credit the accounts payable account
  • Purchase inventory from supplier for cash: Debit the inventory account | Credit the cash account
  • Purchase inventory from supplier on credit: Debit the inventory account | Credit the accounts payable account
  • Pay employees: Debit the wages expense and payroll tax accounts | Credit the cash account
  • Take out a loan: Debit cash account | Credit loans payable account
  • Repay a loan: Debit loans payable account | Credit cash account

Assets, Liabilities

An asset is a resource that owned or controlled by a company and will provide a benefit in current and future periods for the business. In other words, it’s something that a company owns or controls and can use to generate profits today and in the future.

The two important things to remember about this definition are that an asset is owned or controlled by a company and it can be used to benefit future accounting periods. Not all assets are owned by the company that reports them on their balance sheet. For example, a leased vehicle is not technically owned by the lessee, but it still reports the vehicle as an asset. Likewise, the company doesn’t necessarily have to benefit future periods, but it has to have to ability to benefit them. Cash may only benefit the company in the current period because it is received and spent in the current period. However, cash can be saved and spent in future periods.

Classification of Assets

Assets are generally classified in three ways:

  1. Convertibility: Classifying assets based on how easy it is to convert them into cash.
  2. Physical Existence: Classifying assets based on their physical existence (in other words, tangible vs. intangible assets).
  3. Usage:  Classifying assets based on their business operation usage/purpose.

Classification of Assets: Convertibility

If assets are classified based on their convertibility into cash, assets are classified as either current assets or fixed assets. An alternative expression of this concept is short-term vs. long-term assets.

  1. Current Assets

Current assets are assets that can be easily converted into cash and cash equivalents (typically within a year). Current assets are also termed liquid assets and examples of such are:

  • Cash
  • Cash equivalents
  • Short-term deposits
  • Accounts receivables
  • Inventory
  • Marketable securities
  • Office supplies
  1. Fixed or Non-Current Assets

Non-current assets are assets that cannot be easily and readily converted into cash and cash equivalents. Non-current assets are also termed fixed assets, long-term assets, or hard assets. Examples of non-current or fixed assets include:

  • Land
  • Building
  • Machinery
  • Equipment
  • Patents
  • Trademarks

Classification of Assets: Physical Existence

If assets are classified based on their physical existence, assets are classified as either tangible assets or intangible assets.

  1. Tangible Assets

Tangible assets are assets with physical existence (we can touch, feel, and see them). Examples of tangible assets include:

  • Land
  • Building
  • Machinery
  • Equipment
  • Cash
  • Office supplies
  • Inventory
  • Marketable securities
  1. Intangible Assets

Intangible assets are assets that lack physical existence. Examples of intangible assets include:

  • Goodwill
  • Patents
  • Brand
  • Copyrights
  • Trademarks
  • Trade secrets
  • Licenses and permits
  • Corporate intellectual property

Classification of Assets: Usage

If assets are classified based on their usage or purpose, assets are classified as either operating assets or non-operating assets.

  1. Operating Assets

Operating assets are assets that are required in the daily operation of a business. In other words, operating assets are used to generate revenue from a company’s core business activities.  Examples of operating assets include:

  • Cash
  • Accounts receivable
  • Inventory
  • Building
  • Machinery
  • Equipment
  • Patents
  • Copyrights
  • Goodwill
  1. Non-Operating Assets

Non-operating assets are assets that are not required for daily business operations but can still generate revenue. Examples of non-operating assets include:

  • Short-term investments
  • Marketable securities
  • Vacant land
  • Interest income from a fixed deposit

A liability is a financial obligation of a company that results in the company’s future sacrifices of economic benefits to other entities or businesses. A liability can be an alternative to equity as a source of a company’s financing. Moreover, some liabilities, such as accounts payable or income taxes payable, are essential parts of day-to-day business operations.

Accounting Reporting of Liabilities

A company reports its liabilities on its balance sheet. According to the accounting equation, the total amount of the liabilities must be equal to the difference between the total amount of the assets and the total amount of the equity.

Assets = Liabilities + Equity

Liabilities = Assets – Equity

Liabilities must be reported according to the accepted accounting principles. The most common accounting standards are the International Financial Reporting Standards (IFRS). The standards are adopted by many countries around the world. However, many countries also follow their own reporting standards such as the GAAP in the U.S. or the RAP in Russia. Although the recognition and reporting of the liabilities comply with different accounting standards, the main principles are close to the IFRS.

The most common current liabilities are:

  • Accounts payable: These are the unpaid bills to the company’s vendors. Generally, accounts payable are the largest current liability for most businesses.
  • Interest payable: Interest expenses that have already occurred but have not been paid. Interest payable should not be confused with the interest expenses. Unlike interest payable, interest expenses are expenses that have already been incurred and paid. Therefore, interest expenses are reported on the income statement, while interest payable is recorded on the balance sheet.
  • Income taxes payable: The income tax amount owed by a company to the government. The tax amount owed must be payable within one year. Otherwise, the tax owed must be classified as a long-term liability.
  • Bank account overdrafts: A type of short-term loan provided by a bank when the payment is processed with insufficient funds available in the bank account.
  • Accrued expenses: Expenses that have incurred but no supporting documentation (e.g., invoice) has been received or issued.
  • Short-term loans: Loans with a maturity of one year or less.

Long-term Liabilities

Long-term (non-current) liabilities are those that are due after more than one year. It is important that the long-term liabilities exclude the amounts that are due in the short-term, such as interest payable.

Long-term liabilities can be a source of financing, as well as refer to amounts that arise from business operations. For example, bonds or mortgages can be used to finance the company’s projects that require a large amount of financing. Liabilities are critical to understanding the overall liquidity and capital structure of a company.

Long-term liabilities include:

  • Bonds payable: The amount of outstanding bonds with a maturity of over one year issued by a company. On a balance sheet, the bonds payable account indicates the face value of the company’s outstanding bonds.
  • Notes payable: The number of promissory notes with a maturity of over one year issued by a company. Similar to bonds payable, the notes payable account on a balance sheet indicates the face value of the promissory notes.
  • Deferred tax liabilities: They arise from the difference between the recognized tax amount and the actual tax amount paid to the authorities. Essentially, it means that the company “underpays” the taxes in the current period and will “overpay” the taxes at some point in the future.
  • Mortgage payable/long-term debt: If a company takes out a mortgage or a long-term debt, it records the face value of the borrowed principal amount as a non-current liability on the balance sheet.
  • Capital lease: Capital leases are recognized as a liability when a company enters into a long-term rental agreement for equipment. The capital lease amount is a present value of the rental’s obligation.

Capital

Capital refers to the financial resources that businesses can use to fund their operations like cash, machinery, equipment and other resources. These are the assets that allow the business to produce a product or service to sell to customers.

The term ‘capital’ refers to any financial resources or assets owned by a business that are useful in furthering development and generating income.

  • Capital can refer to funds raised to support a particular business or project.
  • Capital can also represent the accumulated wealth of a business, represented by its assets less liabilities.
  • Capital can also mean stock or ownership in a company.

Drawings

Drawings are the amounts taken by the owner of a business for his personal use in anticipation of profit. Drawings are usually made in the form of cash, but there could be other assets or goods withdrawn by the owner for his personal use. On the other hand, profits earned by the business increase owner’s capital; drawings reduce the amount of capital on the other hand.

Drawings are subtracted from the amount of purchase. In balance sheet, drawings are subtracted from capital at the end of accounting period.

Goods

The things which are bought and sold by business are called goods. Goods maybe raw material work in progress of finished goods. In accounting, when goods are purchased it is written as purchases. When goods are sold it is written as sales. It is written as a stock if remain unsold at the end of the year.