Analysis of business transactions
The accounting cycle starts with the analysis of transactions. A proper analysis of business transactions is very important to make a correct journal entry.
Steps of transaction analysis
Analysis of business transactions is a mental process which includes the following four steps:
- Ascertaining the accounts involved in the transaction
- Ascertaining the nature of accounts involved in the transaction
- Determining the effects in terms of increase and decrease
- Applying the rules of debit and credit
Ascertaining the accounts involved
Every business transaction involves two or more accounts.The process of analyzing a business transaction starts with finding out these accounts. For example, Mr. John starts a business with cash $25,000. It is a transaction which includes two accounts – “cash account” and “capital account”.
Ascertaining the nature of accounts
The second step of transaction analysis is to ascertain the nature of accounts found in step 1. In above example, cash is an asset account and capital is an owner’s equity/capital account. Click here to read more about classification of accounts.
Determining the effects in terms of increase and decrease
After ascertaining the nature of accounts in step 2, we determine which account is increasing and which one is decreasing as a result of transaction being analyzed. It is necessary for the proper application of rules of debit and credit on each account. In above example, the two accounts involved are “cash account” and “capital account”, both are increasing.
Applying the rules of debit and credit
The final step of transaction analysis is to apply the rules of debit and credit on accounts. In this step, we determine which account is to be debited and which one is to be credited on the basis of increase and decrease in accounts determined in step 2. In our example, cash account would be debited because when an asset increases, its account is debited. The other account involved is John’s capital which would be credited because when capital increases, its account is credited. Click here to read more about rules of debit and credit.
- Mr. John started business by investing $50,000.
- Purchased merchandise for cash $20,000.
- Sold merchandise to Mr. Sam on credit for $5,000.
- Paid salary to an employee $700.
- Received cash from Mr. Sam $4,800 and allowed him a cash discount of $200.
Required: Give stepwise analysis of the above transactions.