Do you remember the story of Ricardo and the definition of accounting from previous chapter “Introduction to accounting”? Let’s reproduce the definition of accounting here:
Accounting is the process of recording business transactions in an organized manner in order to retrieve this financial information and present it in a useful manner in the form of various reports representing the financial performance and financial position of the business.
The definition of accounting starts with recording business transactions, but what is a business transaction?
Generally, any instance of buying and selling anything is considered as a business transaction, which is true, but half true. Business transaction is a broader term which includes buying and selling. We can define business transaction as any event or activity that influences either the financial position or financial performance of the business.
To make it clearer, let’s go through some of the transactions that Ricardo’s business entered into when he started his business of premium quality clothing.
- Initially, Ricardo introduced initial funds to start the business. This injection of capital is a business transaction which is recorded as equity/capital.
- To set up a factory for stitching the dresses, a building was acquired, and relevant machinery was purchased. These are also business transactions which are recorded as assets (property and equipment).
- Ricardo hired some staff to work at the factory and an Accountant for the office. He paid them monthly salaries. These are also business transactions and are recorded as business expenses.
- After successfully completing the dresses, these were sold to the customers. These sales are also business transactions and recorded as revenue/income of the business.
So, a business transaction is not just buying and selling, it is in fact any event or activity that has an economic substance and that effects the business financially.