We should know that accounting equation is only affected when business enters into a transaction. The term transaction is defined below:
Business transaction is an event or happening that changes financial position or earnings of a business. An event is said to be a transaction when:
- Two are more than two parties are involved.
- Transaction is measurable in terms of money.
- Transaction involves exchange of goods or services.
Categories of Business Transaction:
Transaction is the basic element of accounting that gives rise to entries in accounting records. Transactions may be categorized as:
(1) Cash Transaction, Definition:
Cash transaction occur when cash is paid or received at the time of transaction.
(2) Credit Transaction, Definition, Example and their Effect on Accounting Equation:
In credit transaction payment or receipt of cash is defined to a future date.
Let’s take an example to understand the effects of transactions on the equilibrium of the accounting equation.
Mr. Rainbow starts off with a trading business by putting his $50,000 savings in the business bank account.
Mr. Rainbow got an opportunity to have a financing from ABC bank for purchase of office furniture costing $10,000.
Mr. Rainbow acquires a suitable business premises for $20,000 paying out of the business bank account.
Mr. Rainbow brought his personal vehicle costing $4,000 within the business.
Some inventory of goods was purchased on credit from a supplier D. Ingram for $3,000.
Mr. Rainbow paid $1,000 to D. Ingram by cheque. This would reduce bank balance (asset) and capital investment of the owner.