We have learnt that the relationship among 5 ledger account categories used in bookkeeping is expressed by the following equation.
Assets = Liabilities + Equity + Revenues + Expenses
The transactions in terms of accounting are those business activities that affect one or more of the components of the equation. In other words, there are many activities in a business that are not business transactions, and therefore they are not recorded by accountants.
For example, the following are business activities without doubt, but they are not business transactions because they don’t affect any component of the accounting equation.
- Hiring an employee.
- Meeting with a potential client online.
- Replying to a coworker by a chat message.
However, they might lead to business transactions in the following cases.
- You have paid salary to the employee after hiring her. (Salary is an increase in expenses and paying by cash or bank transfer results in a decrease in assets)
- After meeting with the potential client, you sold goods to her and generated sales. (Sales is an increase in revenues and increase in assets (cash or accounts receivables)
- After using the chat service, you paid for the service. (A communication expense increases expenses and paying by cash or bank transfer decreases your assets)
It is important to realize that after recording transactions, the left and right side of the accounting equation must continue to be equal. For example, if assets increase, it must be matched by one of 1) decrease in other assets, 2) increase in liabilities, 3) increase in equity, 4) increase in revenues, or 5) decrease in expenses, by the same amount.