Question 2

A transaction is a completed agreement between a buyer and a seller to

exchange goods, services, or financial assets in return for money.

In business bookkeeping, this plain definition of "transaction" can get tricky. A

transaction may be recorded by a company earlier or later depending on
whether it uses accrual accounting or cash accounting.

KEY TAKEAWAYS

 A transaction involves a monetary exchange for a good or service.

 Accrual accounting recognizes a transaction immediately after it is
finalized, regardless of when payment is received or made.
 By contrast, cash accounting, used mostly by smaller businesses,
records a transaction only when money is received or paid out.
Understanding Transactions
A sales transaction between a buyer and a seller is relatively straightforward.
Person A pays person B in exchange for a product or service. When they
agree on the terms, money is exchanged for the good or service and the
transaction is complete.

Transactions can be more complex in the accounting world because

businesses may make a deal today which won't be settled until a future date.
Or, they may have revenues or expenses that are known but not yet
due. Third-party transactions can also complicate the process.

Whether a business records income and expense transactions using the

accrual method of accounting or the cash method of accounting affects the
company’s financial and tax reporting.

 The accrual accounting method requires a transaction to be recorded

when it occurs, regardless of when the money is received or the
expenses are paid.
 The cash accounting method records a transaction only when the
money is received or the expenses are paid. This may require a letter of
intent or a memorandum of understanding.

 
Whereas accrual accounting is used most often by businesses with gross
receipts above $5 million a year, cash accounting is used primarily by small
businesses.1

Transactions Using Accrual Accounting

When accrual accounting is used, a company records income when
completing a service or delivering goods. If inventory is required when
accounting for a company’s income, and the company
has gross receipts above $5 million a year, the company normally uses the
accrual method of accounting for sales and purchases.1

Examples of Accrual Accounting

For example, a company selling merchandise to a customer on store credit in
October records the transaction immediately as an item in accounts receivable
(AR). Even if the customer does not make a cash payment on the
merchandise until December or pays in installments, the transaction is
recorded as income for October.

 
If a customer buys something on credit, it will immediately be recorded as a
transaction if the company selling the good uses the accrual accounting
method.

The same goes for goods or services the company purchases. Business
expenses are recorded when the products or services are received. Supplies
purchased on credit in April are recorded as expenses for April, even if the
business does not make a cash payment on the supplies until May.

Transactions Using Cash Accounting

Most small businesses, especially sole proprietorships and partnerships, use
the cash accounting method. Income is recorded when cash, checks, or credit
card payments are received from customers.

Examples of Cash Accounting

Let's say a business sells $10,000 of widgets to a customer in March. The
customer pays the invoice in April. The company recognizes the sale only
after the cash is received in April.

Meanwhile, expenses are recorded only when a payment is made. A business

may purchase $500 of office supplies in May, for example, and pay for them in
June. The business recognizes the purchase when it pays the bill in June.

For tax reasons, the cash basis of accounting is available only if a company
has less than $5 million in annual sales. The cash basis is easier than the
accrual basis for recording transactions because no complex accounting
transactions, such as accruals and deferrals, are necessary. Its drawback is
that the profit of the business may vary wildly from month to month, at least on
paper.
Payment Options
As a small business owner, you’ll need to decide what types of payment
you’ll accept from customers.

You might offer customers the choice to pay with:

 Cash
 Checks
 Debit cards
 Credit cards
 Mobile payments
 Electronic bank transfers

Offering more than one option could help you attract a wider variety of
customers and allow your customers to make larger purchases. However, there
are advantages, disadvantages and costs associated with each payment type.

Pros and cons of different payment types

Where you open your business and the types of items you sell could play an
important role in deciding which payments systems to offer customers.

If you expect to make a large portion of your sales online, accepting electronic
payments will be a must. Similarly, if your products or services are expensive,
customers might not feel comfortable carrying that much cash to your store to
make a purchase — checks, cards or mobile payment could be better options.

On the other hand, if you sell inexpensive items from a physical store, your
customers may prefer to pay with cash. Customers may also expect you to
accept cash if you open a shop in an area where many people don’t have bank
accounts or where card processing networks, the companies that send and
verify information when someone makes a purchase with a card, frequently go
offline.

No matter which payment type(s) you offer, there will be advantages and
disadvantages to each. Here are some of the pros and cons of the main payment
types:
 Payment Type Advantages Disadvantages

Cash One of the most common and Customers might not want to
easiest forms of payment. make large purchases with cash.

Many customers will expect you Storing cash at your place of

to accept cash. business or home, or
transporting it to the bank, can
You won’t have to pay any fees be dangerous.
to accept cash.
Ensuring your register is stocked
with bills to make change can tie
up money you could use for
other business purposes.

Counting money at the end of

each day is time-consuming.

Checks May lead customers to make After depositing a check, you’ll

more frequent or larger need to wait for the bank to
purchases. process the check and put the
money in your account.
Allows customers to safely make
large purchases. There’s a risk that someone will
try to pay with a fake check, or
You won’t have to keep as much that a check will “bounce” if the
cash in your store. customer doesn't have enough
money and you won’t receive the
You won’t have to pay any fees payment.
to accept checks.

Debit, Credit and May lead customers to make
Prepaid Cards more frequent or larger
purchases.
Allows customers to safely make and three days.
large purchases.
Can be quicker and more
convenient for customers at
checkout than cash or checks.
You’ll have to wait for the
transaction to process before
getting money in your account.
This usually takes between one
You may have to pay transaction
fees, a small percentage of the
transaction. Debit cards generally
have lower fees.

You won’t have to keep as much You will need to purchase or rent
cash in your store. a device to accept payment
(called a point-of-sale device).
 Payment Type Advantages Disadvantages

You don’t have to worry about

bad checks or fake cash. You may be responsible if a
customer uses a fake or stolen
Allows foreign travelers to more card to make a purchase.
easily make purchases.
If a customer disputes a charge
(i.e., initiates a “chargeback”),
the transaction may be reversed
and you won’t receive a
payment.

Mobile Payments May lead customers to make You’ll have to wait for the
more frequent or larger transaction to process before
purchases. getting money in your account.
This usually takes between one
Allows customers to safely make and three days.
large purchases.
You may have to pay transaction
Can be quicker and more fees, which is usually a small
convenient than accepting cash percentage of the transaction.
or checks.
You will need to purchase or rent
You won’t have to keep as much a device to accept payment
cash in your store. (called a point-of-sale device).

You don’t have to worry about You may be responsible if a

bad checks or fake cash. customer uses a fake or stolen
payment information to make a
Mobile payments may be more purchase.
reliable than card-based
transactions in some areas. If a customer disputes a charge
(i.e., initiates a “chargeback”),
If you sell items at markets, the transaction may be reversed
conferences or trade shows, you and you won’t receive a
can bring your mobile payment payment.
system with you.

Allows foreign travelers to more

easily make purchases.

Electronic Bank Allow you to receive large Non-business customers might

Transfers payments without paying fees. not feel comfortable transferring
money directly from their bank
 Payment Type Advantages Disadvantages

Allows customers to safely make account to your business.

large purchases.
You’ll have to wait for the
Can be quicker and more transaction to process before
convenient than accepting cash getting money in your account.
or checks.
You may need to set up this type
You won’t have to keep as much of transaction with your bank and
cash in your store. the customer’s bank, which isn’t
always easy.
You don’t have to worry about
bad checks or fake cash.

Could be a good option if you sell

products or services to other
businesses.

As a small business owner, especially if you hire employees, you’ll also want to
consider the time and effort associated with each type of payment.