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What is Transactional Analysis?

What is transactional analysis

Overview

Starting from one of the basic concepts of accounting - the dual aspect - which implies that every business transaction has two effects, i.e, it impacts two accounts & hence the accounting makes two entries when recording that transaction.

Scope:

  • Accounting Equation
  • Transaction Analysis
  • Application of Accounting Equation
  • Closing Summary

As previously discussed, the balance sheet essentially depicts the financial position of the business & explains what the business owns & owes.

What the business owns are resources or assets which help in generating revenue. To acquire these resources, the business needs funds which are either invested by the owners (owners’ capital) or borrowed from outsiders (liabilities of the business). 

These two parties can ask for their funds back at any time in future, implying that they have a claim against these resources. Thus, according to the dual aspect (or double entry system) of accounting, business resources are always equal to the claim against those resources.

Transactional resourcesTransactional assets

Transaction analysis

Every business transaction has at least two effects on the accounting equation. Analysing each transaction using the accounting equation implies performing a transaction analysis.

Steps to be followed in transaction analysis:

  • Identify the transaction and which two accounts it affects
  • Adjust i.e., increase or decrease the balance of accounts so affected
  • Calculate the totals of all accounts and the total of both sides of the equation.

Notably, the total balances of both sides of the equation should match.

Application of Accounting Equation

Ranveer starts a popcorn business on 1 March 2022 by investing Rs. 2,00,000. However, he feels that this amount is not sufficient for starting the operations of his business & thus takes a loan of Rs. 2,00,000 on 2 March 2022 and promises to pay it back at a certain interest rate after 5 years.

With this money in his business account, he buys a machine for making popcorn at Rs. 50,000 in cash on 3 March 2022. He bought the initial inventory of raw materials i.e., popcorn seeds for Rs. 20,000 on 4 March 2022. He did not pay for the raw material upfront. He promised to pay the supplier after a month. With this, starts preparation of his initial stock of finished goods i.e., popcorn. 

As an accountant, you need to analyze the transactions of Ranveer’s business. You can use transactional analysis, wherein we make use of the accounting equation to see whether what the company owns, or controls is equal to what it owes.

From the example above:

  • Transaction 1: Ranveer starts a popcorn business on 1 March 2022 by investing Rs. 200,000.

    Explanation: The first aspect of this transaction is simply the cash received from the owner. Hence, the business cash increases by 2,00,000. Further, Ranveer and the business are two separate entities and therefore, he can claim back his money from the business at any time in future. Thus, we say that he has a claim over the assets of the business i.e., the owner’s claim. Thus, the other aspect of this transaction is the increase in the Owners’ equity by Rs. 2,00,000.

  • Transaction 2: He takes a loan of Rs. 2,00,000 on 2 March 2022 for the business.

    Explanation: Firstly, the loan is taken for the business and therefore, it is not a personal loan. The loan amount received reflects the cash for the business has further increased by Rs. 2,00,000. However, the business owes this back to the bank after a period of 5 years. Therefore, the business has generated a liability i.e., notes payable to the bank worth Rs. 2,00,000.

  • Transaction 3: He buys machinery for making popcorn at Rs. 50,000 in cash on 3 March 2022.

    Explanation: Machinery is a resource for the business that will be used to make popcorn and help in generating revenue for the business. Hence, a new asset i.e., machinery is generated under the assets by a value of Rs. 50,000. However, as the machinery is bought in cash. The business cash comes down by Rs. 50,000.

  • Transaction 4: He bought the initial inventory of raw materials for Rs. 20,000 on 4 March 2022.

    Explanation: Inventory of raw materials is yet another resource for the business which will help in generating revenues for the business. Hence, a new asset i.e., inventory is generated under the assets by a value of Rs. 20,000. However, the raw material is bought on credit as the business will pay it in future. Thus, the business has generated a new liability of Rs. 20,000 (creditors).

Transaction Analysis

Application of accounting equation

Notably, after analysing all the transactions, we see that the equation is balanced.

Closing summary

Transaction analysis is at the heart of the accounting system and we will be using the same for understanding the preparation of financial statements.


The subsequent chapter discusses the first step of the accounting process i.e., recording of business transactions in the books of accounts.