Transaction

Transaction: Definition, Accounting, and Examples

What is a transaction?

A transaction is an agreement between two or more parties to exchange goods, services, or financial assets for money. In simple consumer terms, it’s complete when the buyer pays and the seller delivers. In business accounting, however, when a transaction is recorded depends on the company’s accounting method.

How transactions work in practice

• A basic transaction: buyer pays seller in exchange for a product or service.
• Business transactions can involve credit, delayed settlement, third parties, or contingent terms (e.g., letters of intent or memoranda of understanding).
• How and when a transaction is recorded affects financial statements and tax reporting.

Accrual accounting

• Definition: Records revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands.
• Typical accounts used: accounts receivable (AR) for earned but unpaid revenue; accounts payable (AP) for incurred but unpaid expenses.
• When it’s required: Companies that maintain inventory and have average gross receipts above certain regulatory thresholds (commonly cited threshold: $26 million average over the prior three years) generally must use accrual accounting for sales and purchases.
• Examples:
• A merchandise sale on store credit in October is recorded as revenue and an account receivable in October, even if cash is received in December.
• Supplies received on credit in April are recorded as an April expense, even if payment occurs in May.
• Pros/cons:
• More accurately matches revenue and expenses to the period in which they occur.
• Requires accrual and deferral entries, which add complexity.

Cash accounting

• Definition: Records revenue only when cash is received and records expenses only when cash is paid.
• Common users: Many small businesses, sole proprietorships, and partnerships.
• Eligibility for tax purposes: Cash-basis accounting is generally available to businesses with average annual gross receipts below a regulatory threshold (commonly cited: $26 million average over the prior three years).
• Examples:
• A sale made in March but paid in April is recognized in April.
• Office supplies purchased in May but paid for in June are recognized in June.
• Pros/cons:
• Simpler to maintain; no accruals/deferrals.
• Reported profit can swing significantly from month to month, since timing depends on cash flows rather than economic activity.

Third-party and special-case transactions

• Transactions routed through third parties (agents, brokers, payment processors) can complicate recognition, timing, and who records the revenue or expense.
• Agreements like letters of intent or memoranda may document obligations before cash flows occur; treatment depends on the substance of the arrangement and accounting rules.

ACH transactions

• Definition: Electronic bank-to-bank payments processed through the Automated Clearing House (ACH) network.
• Common examples: direct deposit of payroll, electronic tax refunds, online bill payments.
• ACH transactions are electronic transfers between bank accounts rather than card-based transactions.

Cancelling a pending transaction

• Pending transactions are authorized but not yet posted to your account.
• To attempt cancellation:
• Contact the merchant to request they reverse or void the authorization.
• Contact your bank or card issuer to request a reversal or stop payment.
• Once a transaction posts (moves from pending to posted), cancellation may be more difficult and could require a refund request or dispute.
• Timeframe and options depend on the merchant, payment method, and banks involved.

Key takeaways

• A transaction is an exchange of value; in accounting, timing matters.
• Accrual accounting records transactions when earned/incurred; cash accounting records them when cash changes hands.
• Small businesses often use cash accounting for simplicity; larger businesses or those with inventory commonly use accrual accounting.
• Electronic transactions like ACH are bank-to-bank transfers; pending card transactions may be cancellable before posting.

Bottom line

Transactions are the fundamental events that drive financial records. The choice between accrual and cash accounting determines when those events appear on financial statements and tax returns, so businesses should pick the method that best reflects their operations and complies with applicable rules.