Analyzing business transactions is the basis of a strong financial reporting framework. The posting of accounting transactions in the accounting record leads to changes in the business resources. For instance, buying goods with cash decreases the cash resources of the business, and goods are increased.
So, a strong financial analysis is needed to ensure the right impact of the transaction is reflected in the accounting record. On the other hand, if there is compromise on the quality of analysis, it may lead to errors and omissions in the accounting record of the business.
ALSO READ, Users of financial statement.
Steps of analyzing business transactions
1- Identify the occurrence of financial events.
Business operations lead to the occurrence of transactions. These transactions reflect financial events taking place between the parties. For instance, ABC limited purchases material A from the market, the receipt of goods is operational activity. However, ABC limited must have paid for the purchase of goods, and hence, the financial event has taken place.
2- Ascertain chart of accounts in the business transaction
At least two charts of accounts are affected by the occurrence of business/financial transactions. In this stage, we need to find all the charts f accounts affected by the business transaction under consideration. For instance, ABC limited purchased material A from the market with half payment in cash, and the other half promised to be paid after six months.
Now, we need to understand how many charts of accounts will be affected by this business transaction. First of all, goods are purchased. So, it’s our first identified chart of accounts. On the other hand, half the payment is made through cash, which means cash is our second identified chart of account. Similarly, half payment remains as payable in the accounting record. Hence, our third chart of accounts is trade payable.
So, we have identified three charts of accounts with the purchase of material half in cash and a half remaining in liability. Here are three charts of accounts in such a situation.
- Trade payable
So, it’s good if your business transaction is posted in the given chart of accounts, and otherwise, there may be some error in the accounting entry. It’s equally important to note that the business arrangements of the deal determine the chart of accounts to be used.
For instance, if the given business transaction of material purchase is carried on the cash. Only two charts of accounts are updated that include purchase and cash.
3-Determine the effects on an identified chart of account
Once the chart of accounts is identified, we need to analyze how the business transaction will impact these identified accounts. For instance, the business has purchased raw materials. So, we can expect material has increased under the ownership of the business. Similarly, the business must have paid cash to purchase the material. Hence, cash is reduced.
Overall, a control check is to analyze the effects of business transactions on the accounting equation; if there is alignment between business transactions and financial impact, it’s considered accurately posted.
Analyzing business transaction example
Suppose the business sells material-B for USD 50,000 to the cash customer. The first stage is to identify the financial event. We can understand that the business has received USD 50,000 from the customer. So, there are two charts of accounts that need an update. This chart of accounts includes purchases and cash.