A transaction is an event which has a financial impact on the enterprise and requires recording. In other words, transactions typically involve an exchange of resources between the company and other parties. It acts as the raw materials for the financial accounting process. For instance, purchasing goods with cash or on credit is a transaction to be recorded in financial accounting to reflect its impact on financial statements.
The financial accounting process consists of following steps;
- Identify and categories each economic event to reflect their type or nature,
- Assign monetary values to the event,
- Record the effect of these events on the three elements of the basic accounting equation, and
- Summarizing those economic events
Luca Pacioli developed the double-entry system in 1494. In double-entry bookkeeping each transaction is entered twice, to show where the money comes from and where it’s going. This is known as the fundamental rule of accounting. In other words, according to this rule, every transaction has equal and opposite effects in at least two different accounts.
This concept satisfy following basic accounting equation:
Assets = Liabilities + Equity
This basic equation is the foundation of the double-entry bookkeeping system.
Since in double-entry, debit to one account offset by credit to another, the sum total of all debits and credits must tally. Debit refers to the debit/left side of the ledger and credit refers to the credit/right side of the ledger.
Please note, debit does not mean that it’s always an increase and credit doesn’t mean it’s always a decrease. A debit for a transaction can increase one account and for another transaction, it may decrease another account. To be in balance, debit and credit for all transactions must be equal.
Account is a place where you record amounts of money involved in a financial transaction. At the year end or at a particular date, you can easily find out the amount of money you have spent for a particular account. It’s also known as a T account, the left side is called debit and the right side is known as credit.
To understand the double-entry bookkeeping system, let’s say you have paid Rs 25,000 towards office rent for using a building as your administrative office. In this transaction, two accounts are involved.
First one is an expense, which can be named as “office rent” and the second one is “cash/bank” based on how you paid the amount to the house owner.
In this illustration, you will be recording rent paid by debiting “office rent” and crediting “cash/bank”. This means, in the T account maintained for “office rent”, you need to record Rs. 25,000 as office rent on the debit side and in the T account of “cash/bank”, same transaction to be entered on the credit side.
Transactions recording in ERP or in accounting software
In accounting software or in ERP packages, transactions are recorded automatically based on selection of T-accounts on the entry screen and the configuration done at the back-end of the software or ERP packages.
You need not manually enter each and every transaction as it used to be in the manual system.
However, to understand the whole concept of accounting and how these software and ERP packages are working, you need to understand the basics of accounting to know how financial statements are prepared in an organization.In a computerized accounting system, you can easily access the income statement and balance sheet for any period of time by simply entering your required parameters in the report menu. You need not prepare these reports as it used to be in a manual system of accounting, as the system automatically takes each and every transaction to the respective account and prepares reports based on the inputs.
