Introduction to Transaction Analysis

To understand every aspect of bookkeeping is to understand transaction analysis first and foremost. To not understand this core level is to be incapable of fault finding an account. Transaction analysis is the foundation to getting it right.

"Debit" refers to the left side of a general ledger account, while "Credit" refers to the right side. Due to the proliferation of bookkeeping and accounting computer software, it is now common for Debits to be mistaken as positive values and Credits to be mistaken as negative values. Positive and negative values allow for mathematical calculations in software programs, not ledger accounting.

Debit vs. Credit

Using both the ALORE acronym and ledger accounts you will better understand debits and credits by utilising what is called a transaction analysis table. This is not used in daily accounting, instead used as a training aid to understand the full detail of a transaction. Master this and your ledger accounting falls into place.

Bank Accounts

Much confusion stems from misinterpretation of bank debits and credits when viewed to a business accounts debit and credits. If your bank account is a general savings account type, in that you only have access to your money, then this account is created as a "debit account" (Accounts Receivable) from the banks viewpoint. When you deposit money the bank "debit" the bank’s ledger account and "credit" your ledger account.

When you withdraw money the bank "credit" the bank’s ledger account and "debit" your ledger account. If you utilised the banks money, that account would be created as a "credit account" (Accounts Payable) type from the banks viewpoint. When you deposit money to that account the bank would "credit" the bank’s ledger account and "debit" your ledger account. When you withdraw money the bank would "debit" the bank’s ledger account and "credit" your ledger account.

Here comes the confusion; you only see half the debit and credit transaction upon your statement, per transaction. The bank provide you a statement of your "ledger account" held with them, they do not provide you the other half of the transaction which would be upon the statement of their ledger account. This is why a person can often confuse a credit on their bank statement with the meaning they must credit their business ledger account, when in fact it is the opposite, being a debit, just as the bank do. Again, you only view one-half the total transaction that occurs from banking; you view all when looking upon your own ledger accounts.

Ledger Account Rules

• Every transaction must affect two or more accounts,
• Double Entry - total debit amounts equal total credit amounts per transaction, and
• Rule of thumb, you debit before credit.

Transaction Analysis Preparation

To analyse transactions into their debit and credit elements you should complete the following steps:

1. Determine what ledger accounts are involved for these transactions,
2. Determine what type of account each transaction is (asset, liability, etc),
3. Determine the nature of the account (Look under heading "Accounts" - asset(dr), etc.),
4. Determine whether the account is increasing or decreasing in value,
5. Determine which side of the account is affected (debit or credit), and
6. Calculate the amount.

Transaction Analysis Table - Example Time

The following is a transaction analysis table

• Date - Straight forward,
• Transaction - Outlines the transaction detail (eg. J. Blow injects $25,000 into the business),
• Accounts Involved - Using the above transaction it would be "Cash at Bank" and "Capital" ledger accounts,
• Type of Account - Is the ledger account a debit or credit (eg. Cash at Bank is a debit, Capital is a credit type account),
• Inc / Dec - Does the transaction "Increase" or "Decrease" the monetary amount,
• Dr / Cr - Debit goes before Credit, remembering ledger rules above "total debit amounts equal total credit amounts per transaction", and
• Amount - The dollar figure.

Remaining with our basic three account types, Assets, Liabilities and Owner's Equity, we will derive the following Balance Sheet:

The above balance sheet contains five basic accounts, being; accounts receivable, accounts payable, cash at bank, furniture and capital. For each of these accounts you would have your own ledger account, either T-Format or Columnar Format. To assist in the learning of debits and credits correctly, we will use the T-Format here.

If we had the following basic transactions, we would then use the above transaction analysis preparation rules to determine all requirements:

1. Jun 01 - J. Blow injects $25,000 into the business
2. Jun 02 - J. Blow purchases a computer for $3200 cash
3. Jun 02 - J. Blow purchases a printer for $950 cash

Applying our above rules to these transactions we would derive the following analysis for understanding:

• 1. $25,000 capital is injected which must go into the "Cash at Bank" ledger account; this account type is an "Asset"; an asset account is a "debit" type in nature; putting $25,000 into this ledger account "increases" the monetary value in that account; which if posted onto the T-Format ledger account "Cash at Bank" would be entered on the "debit" side because it is a "debit" account and the business is adding to it.
• 1a. $25,000 capital is now owned by the company, however; now the company "owes" the owner that money so the same transaction must now be "credited" to the ledger account "Capital" as that is where all monies owed to the owner belongs; the type of account is "Owners Equity"; the nature of which is a "credit" type account, the entry "increases" the monetary value in that ledger account; which if posted onto the T-Format ledger account "Capital" would be entered on the "credit" side because its a "credit" account the business is adding to that and "owes" the owner that money, the business as an entity is in credit to the owner.
• 2. $3,200 cash is used to buy a computer, a computer is an item of business "furniture"; the furniture account is an "asset" type; and of a "debit" nature; the computer is added to the furniture account "increasing" monetary value in that account; which if posted onto the T-Format ledger account "Furniture" would be entered on the "debit" side as the business is increasing its furniture asset.
• 2a. $3,200 cash is used to buy a computer, the cash is contained within the "Cash at Bank" account; which is an "asset" type account and is of a "debit" nature; the monetary value is being "decreased" in that account; which if posted onto the T-Ledger format account "Cash at Bank" would be entered on the "credit" side as the business is reducing its cash asset.
• 3. $950 cash is used to buy a printer, a printer is an item of business "furniture"; the furniture account is an "asset" type; and of a "debit" nature; the printer is added to the furniture account "increasing" monetary value in that account; which if posted onto the T-Format ledger account "Furniture" would be entered on the "debit" side as the business is increasing its furniture asset.
• 3a. $950 cash is used to buy a printer, the cash is contained within the "Cash at Bank" account; which is an "asset" type account and is of a "debit" nature; the monetary value is being "decreased" in that account; which if posted onto the T-Ledger format account "Cash at Bank" would be entered on the "credit" side as the business is reducing its cash asset.

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Conclusion

Remember that this is a basic outline to transaction analysis, and it goes much deeper than what is mentioned here. Further topics will cover detailed aspects where you have more realistic accounts and transactions, including GST, profit and loss values, etc. You have learnt basics here that must be known to understand where a transaction correctly resides within your ledger accounts, whether manual or computerised, data entry is where the mistakes are created. If you do not understand and clearly identify the difference between debit and credit transactions vs. debit and credit account types, then you could realistically never fault find your own account as you would look a fault in the eye and believe it to be a correct entry; in fact it could be the culprit to your balance sheet failing. Look forward to more advanced and realistic scenarios. Learn first though!