What is a Transaction Analysis?

The transaction analysis is done with the help of the accounting equation. The basic accounting equation is alternatively known as the balance sheet equation is based on the double-entry system which says that for each transaction happening in a business, at least two accounts should be affected I.e. both the debit side and the credit side should be equal. The Accounting Equation is

Total Assets = Total Liabilities + Owner’s Equity

A transaction is analyzed with the help of the above equation given that it should have a monetary value. The above equation needs to be satisfied by any transaction happening where both sides of the equation need to be balanced. Both sides of the equation won't balance if the double-entry system is not followed in the books of accounts

Transaction Analysis based on the above equation means reconciling the differences of either side of the equation with each financial transaction happening.

Let’s look at some examples to have a better understanding

 A company purchased an item of furniture worth $ 5000 on credit.

Total Assets = Total Liabilities + Owner’s Equity

   $ 5000       =        $ 5000          +        $ 0

Explanation: This transaction is a business transaction because it has monetary value involved and it comprises a business activity. Here, Credit would act as a liability for the company and the furniture would be an asset worth $ 5000.

  An Owner invested $ 75000 cash in the company.

Total Assets = Total Liabilities + Owner’s Equity

    $ 75000     =        $ 0     +     $ 75000

Explanation: This transaction is a business transaction because it has monetary value involved and it comprises a business activity. The investment made by the owner adds to the owner’s equity while increasing cash would be an increase in the assets of the company.

Here is an example that would affect only the asset side and still the equation will be left balanced

 Purchased office furniture for $ 4600

Total Assets = Total Liabilities + Owner’s Equity

-       $ 4600           =        $ 0                +        $0

+   $ 4600

Explanation: This transaction is a business transaction because it has monetary value involved and it comprises a business activity. Here both the accounts in the transaction fall under the category of asset and therefore an asset will increase i.e. furniture and the other would decrease i.e. cash and therefore it will nullify the effect.

The Process of Financial Transaction Analysis

• Determining the Financial Transaction: The first and foremost step is to find out whether the transaction is financial or not. The condition that needs to be satisfied for this is that the transaction should involve a monetary value in the absence of which the transaction would not be considered financial. For instance, the signing of a rental agreement does not form a financial transaction as it does not involve any monetary value.

• Identifying the effect on the accounts: Each business transaction affects a minimum of two accounts in the books of the company. The second step is to identify which accounts affect the transaction. For example, Computer purchased in cash would impact both the cash and computer account.

• Determine the types of account: Determining the type means to categorize the account as an asset, liability, or owner's equity. This will help us to determine whether the account would be having a debit balance or a credit balance. An example of the same would be, if the owner has invested cash in the business, the owner's equity would increase and cash would increase on the asset side. So, these are the two types of accounts involved i.e. Asset and Owner's Equity.

•  Determining the Increase or Decrease in account balances: The next step in the process is to analyze which account balance decreases and the balance of which account is to increase as an effect of the transaction. For instance, when we talk about the transaction of purchasing a computer the asset would increase and the cash account will decrease as a result of payment of cash against the purchase made.

• Apply the debit and credit rules: The accounts involved would be debited and credited with the same amount as per their type and as an effect of the transaction.

• Finding the transaction amount: The final step in this process is to check what amount needs to be entered with the transaction based on the supporting documents of the transaction like the receipts etc. Like if you have purchased a computer you will get a receipt supporting the transaction with the amount of purchase done.

Advantages of Financial Transaction Analysis

• This analysis shows the impact of each transaction on the Assets, Liabilities, and the owner's Equity.
•  It helps in getting a clear picture of the financial health of a business.
• While analyzing the financial transaction we can easily find out the third component of the accounting equation if two of them are provided.
• It is an easy way to check the accuracy of the bookkeeping done at any organization.
• The accounting equation forms a basis of decision-making for potential investors and money lenders.

Conclusion

Analyzing the financial transaction is a key step in the process of accounting. It lets us know what effects of the transaction have been recorded in the books and how it has affected the financial health of a company.

There is a standard set for the ratio of assets and liabilities a company should have failing which could mean risk on the financial part of the business and also the money lenders and investors are the ones who are mostly interested in the financial statements of the company apart from the management and if there is an excess in the amount of liability the lenders could drop the idea of investing.

Analyzing the financial transactions from time to time helps us keep a check on the assets and liabilities of the company and ensure the soundness of the financial performance.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for     

• BBA
• Bachelor of Commerce
• Master of Commerce