Deliverable 2 - The Accounting Cycle

In accounting, we define a business transaction as a financial or economic event that impacts a company. The event must be measurable in terms of money and affect the financial position of the company. For example, a company purchases a new truck for their business for $25,000 by signing a note payable. This event can be measured in terms of money and it has an impact on the financial position of the company. It therefore must be included in the accounting records of the company. An example of an event that would NOT be included in the accounting records would be if a company hired a nationally renowned new CEO. While this may be of great benefit to the company in the long run, we cannot assign a monetary value to this event, and therefore, do not include it in the accounting records.

Business Transactions

Business transactions that have to be recorded in the accounting records also have other characteristics. We already discussed how they have to be able to be stated in a monetary value (dollars in the U.S.) and they have to impact the financial position of the company. However, there are three more important requirements:

1. The transaction is that of the company and not the owner or the employees. It is required that the records of the company must be separate from those of the owner.

2. The transaction must be authorized by someone with the authority to do so on behalf of the company.

3. There is adequate documentation of the transaction available to support the business transaction.

Documenting Transactions

One of the most critical aspects of the recording is to have adequate documentation of the transaction. Proper internal controls require appropriate electronic or paper documentation that supports the business transaction. By “supports” we mean it documents the monetary value, the effect on the company’s financial position, it was properly authorized, and it relates to the business entity.

A source document is an original record that contains the data to substantiate a transaction that is entered into the accounting system. Typically, the source documents required will fall into two categories: Internal and external documents.

INTERNAL DOCUMENTS

Examples of Internal Documents:

· order requisitions

· purchase orders

· receiving reports and disbursement requests.

EXTERNAL DOCUMENTS

Examples of External documents:

· bank statements

· invoices

· receipts

Internal documents consist of forms that are prepared by the company itself. Examples are order requisitions, purchase orders, receiving reports and disbursement requests. These forms will often contain the required authorization information.

External documents consist of forms and other documents that are prepared by third parties. External documents often offer evidence that can be considered more reliable as they are prepared independent of the company itself. Examples include bank statements, invoices and receipts.

Since the end products of business transactions are the financial statements of a company, properly accounting for each business transaction is important to reach this end result.

Every time a company enters into a business transaction, a paper or electronic trail is created. We must take steps to preserve this trail as it provides documentation and evidence of the transaction and its characteristics.