Track 1 · What accounting does
Transactions and economic events
Which events go into the accounts and which don't: exchanges, other economic events, promises, and the business entity concept.
You will be able to
- Decide whether an event is recorded in the accounts.
- Tell exchanges apart from other economic events.
- Apply the business entity concept.
- Explain why some important events aren't recorded.
Builds on
Plenty happens in a business every day, but only some of it goes into the accounts. Ask two questions about any event:
- Has it changed the business's assets, liabilities or equity — right now?
- Can the change be measured reliably in money?
If both answers are yes, record it. If either is no, it stays out of the ledger (though it may still matter to managers, and sometimes needs a note in the statements).
Terminology: "measured reliably" is the classic beginner's test. The IASB's 2018 Conceptual Framework (chapter 5) puts it more precisely: an item is recognised when doing so gives relevant information and a faithful representation of it — very high measurement uncertainty is one reason recognition can fail.
Exchanges and other economic events
Most recorded events are exchanges (transactions with another party): buying, selling, borrowing, paying, collecting. Something is given and something is received.
Some recorded events involve no other party at all. These other economic events still change what the business controls: equipment destroyed in a fire, stock that is stolen, a customer going bankrupt so a receivable will never be collected. Nothing was exchanged, but the business is poorer, so the loss is recorded.
What isn't recorded (yet)
- Promises that neither side has started to perform. Signing a contract for work next month, accepting an order, or hiring someone who starts next week creates no asset or liability yet — nothing has been delivered and nothing paid. The entry comes when one side performs.
- Things the business doesn't control or can't measure. A loyal team, a good reputation or a great location matter enormously, but a home-grown reputation can't be measured reliably and staff can leave.
- The owners' personal affairs. Under the business entity concept, the business is accounted for separately from its owners — even when there is only one owner. The owner's personal car repair, paid from her own account, isn't a business event. If business money is used for something personal, the business records it — as an amount owed by the owner, or as drawings or a dividend — never as a business expense.
| Event | Recorded? | Why |
|---|---|---|
| 1 Apr — pays April's studio rent, 800 | Yes — exchange | Cash down; the rent is used up in April, so an expense reduces equity. |
| 3 Apr — buys desks and chairs from Oakline Furniture on 30-day credit, 720 | Yes — exchange | Lumen controls the furniture and owes the supplier, even though no cash has moved. |
| 13 Apr — signs a six-month design retainer with Harlow Books, starting 1 May | No | Neither side has performed yet: no asset or liability until Harlow pays or Lumen works. |
| 15 Apr — Ostrander Gym pays 1,500 in advance for work in May and June | Yes — exchange | Cash up, and Lumen now owes the client the work: a liability (unearned revenue). |
| 15 Apr — Maya pays for a repair to her own car from her personal account | No | Business entity concept: it's her money, not Lumen's. |
| 17 Apr — receives a 1,100 quote for a document scanner | No | A quote is an offer. Nothing has been bought. |
| Named one of a design magazine's "studios to watch" | No | Good for reputation, but there's no asset Lumen controls that can be measured. |
| Event | Recorded? | Why |
|---|---|---|
| An uninsured workshop computer, recorded at 1,100, is destroyed in a small fire | Yes — other event | An asset is gone and nothing was received for it: assets and equity fall. |
| A demo e-bike is stolen from the shop floor and isn't insured | Yes — other event | Inventory has been lost without any exchange. |
| A trade customer owing 900 goes into liquidation with nothing left for creditors | Yes — other event | The receivable will never be collected, so an asset has been lost. |
Lumen is a few weeks old and hasn't had a loss like these, so the examples come from Fernway Bikes, an established cycle shop.
Practice
Practising as a guest — attempts aren't saved.
Exercise 1 · Classify
Lumen Design Studio Ltd is a company. Which of these April events does it record in its accounts?
Exercise 2 · Classify
For each event at Lumen or at Fernway Bikes, is it an exchange with another party, another economic event with no exchange, or not recorded at all?
Exercise 3 · Accounting equation
An uninsured workshop computer that Fernway Bikes had recorded at 1,100 is destroyed in a fire. How does this affect Fernway's accounting equation?
Exercise 4 · Accounting equation
On 15 April Ostrander Gym pays Lumen 1,500 in advance for a pack of class posters and social media templates that Lumen will produce in May and June. How does this affect the accounting equation today?
Exercise 5 · Concept check
On 23 April Maya Lind, Lumen's managing director, pays 86 for her family's groceries with the company's bank card by mistake. How should the company account for it?
Exercise 6 · Concept check
Priya runs Sparrow Tutoring as a sole trader — there is no company, just her business. She transfers 300 from the business bank account to pay her home electricity bill. How is this recorded in the business's books?
Exercise 7 · Concept check
Clients choose Lumen because Maya and Theo are highly skilled. Why doesn't that skill appear as an asset in Lumen's accounts?
Exercise 8 · Calculate
Here is everything that happened at Lumen in the week of Monday 13 to Friday 17 April. By how much did Lumen's total assets change over the week? (Enter a decrease as a negative number.)
Key points
- Record events that change assets, liabilities or equity and can be measured reliably.
- Exchanges involve another party; fires, thefts and customer failures are recorded too, without one.
- Unperformed promises (orders, contracts, hiring) aren't recorded until someone performs or pays.
- The business is accounted for separately from its owners — personal items are never business expenses.
Content review: answers and figures are checked by automated tests against the accounting engine, and the text has had an internal review against the standards; independent review by a qualified accountant is pending.