Every business transaction affects the accounting equation (Assets = Liabilities + Equity) by altering at least two accounts. These transactions impact financial statements and must be recorded using the double-entry bookkeeping system to maintain balance. This article explores common business transactions and their effects on assets, liabilities, and equity.
1. Cash Transactions
A. Receiving Cash from Customers
- Increases cash (asset) and increases revenue (which increases equity).
- Journal Entry:
- Debit: Cash
- Credit: Sales Revenue
- Example: A business receiving $5,000 in cash for a product sale.
B. Paying Expenses in Cash
- Decreases cash (asset) and increases expenses (which decreases equity).
- Journal Entry:
- Debit: Expense Account (e.g., Rent, Utilities)
- Credit: Cash
- Example: A business paying $1,000 in rent.
2. Credit Transactions
A. Purchasing Inventory on Credit
- Increases inventory (asset) and increases accounts payable (liability).
- Journal Entry:
- Debit: Inventory
- Credit: Accounts Payable
- Example: A business purchasing $3,000 worth of goods on credit.
B. Paying Off Accounts Payable
- Decreases cash (asset) and decreases accounts payable (liability).
- Journal Entry:
- Debit: Accounts Payable
- Credit: Cash
- Example: A business paying off a $2,500 supplier invoice.
3. Loan Transactions
A. Taking a Loan from a Bank
- Increases cash (asset) and increases loan payable (liability).
- Journal Entry:
- Debit: Cash
- Credit: Loan Payable
- Example: A business taking a $20,000 bank loan.
B. Repaying a Loan
- Decreases cash (asset) and decreases loan payable (liability).
- Journal Entry:
- Debit: Loan Payable
- Credit: Cash
- Example: A business repaying $5,000 of a bank loan.
4. Owner’s Equity Transactions
A. Owner Investment
- Increases cash (asset) and increases owner’s equity.
- Journal Entry:
- Debit: Cash
- Credit: Owner’s Equity (or Common Stock for corporations)
- Example: A business owner investing $10,000 into the company.
B. Owner’s Withdrawals (Drawings)
- Decreases cash (asset) and decreases owner’s equity.
- Journal Entry:
- Debit: Owner’s Drawings
- Credit: Cash
- Example: An owner withdrawing $3,000 for personal use.
5. Revenue and Expense Transactions
A. Earning Revenue on Credit (Accounts Receivable)
- Increases accounts receivable (asset) and increases revenue (which increases equity).
- Journal Entry:
- Debit: Accounts Receivable
- Credit: Sales Revenue
- Example: A company completing a $7,000 project but receiving payment later.
B. Collecting Accounts Receivable
- Increases cash (asset) and decreases accounts receivable (asset).
- Journal Entry:
- Debit: Cash
- Credit: Accounts Receivable
- Example: A business receiving $7,000 from a customer.
C. Incurring an Expense on Credit (Accounts Payable)
- Increases an expense (which decreases equity) and increases accounts payable (liability).
- Journal Entry:
- Debit: Expense Account
- Credit: Accounts Payable
- Example: A company receiving a $2,000 electricity bill payable next month.
D. Paying an Expense
- Decreases cash (asset) and increases an expense (which decreases equity).
- Journal Entry:
- Debit: Expense Account
- Credit: Cash
- Example: A business paying $500 in advertising expenses.
6. Asset Disposal Transactions
A. Selling an Asset
- Increases cash (asset) and decreases the sold asset.
- Any gain or loss affects equity.
- Journal Entry:
- Debit: Cash
- Debit: Accumulated Depreciation (if applicable)
- Credit: Asset Account
- Credit: Gain on Sale (if applicable)
- Example: A business selling a company vehicle for $10,000.
B. Writing Off an Uncollectible Debt
- Decreases accounts receivable (asset) and increases bad debt expense (which decreases equity).
- Journal Entry:
- Debit: Bad Debt Expense
- Credit: Accounts Receivable
- Example: A company writing off $1,200 of unpaid invoices.
7. Maintaining Balance in the Accounting Equation
Each business transaction affects at least two accounts, ensuring that the accounting equation remains balanced. By properly recording transactions using double-entry bookkeeping, businesses maintain financial accuracy, generate reliable financial statements, and support sound decision-making for long-term growth.