Business Transactions - Business Studies Form 3 Notes

• Definition
• Classification Of Business Transactions
  • Cash Transactions
  • Credit Transactions
• Effects of Transactions on the Balance Sheet
• Effects of Transactions on Balance Sheet Totals
  • Changes In Capital
• Past KCSE Questions On The Topic

Definition

• A business transaction is any dealings between two or more individuals or parties that can be assigned a monetary value.

Classification of Business Transactions

Cash Transactions

• This is where both parts of the exchange are executed immediately. That is no credit.
• Payments may either be in cash or other forms of money such as cheques, money orders, postal orders or anything that can be accepted as medium of exchange.

Credit Transactions

• This is where goods or services are bought and payment is made at a later date. Payment at a later date is also referred to as deferred payment.
• The payment can still be in cash or other forms of money.

Effects of Transactions on the Balance Sheet

• A transaction taking place in a business will have the effect of increasing or decreasing some items of the balance sheet.

Example

The balance sheet of Bigfoot communications as at 31st December 2005 and the transactions that took place between the balance sheet date and 20th January 2006 are given below. A balance sheet as at 20th January 2005 after the transaction is shown below.

Transactions that took place

1. Bought stock for cash sh 80,000 on 2nd January 2006.The effect was that the asset cash in hand decreased by sh 80,000 from sh 500,000 to sh 420,000.The asset stock increased by sh 80,000 from sh 300,000 to sh 380,000.
2. Transferred sh 100,000 from cash in hand to the bank account on 3rd January.This effect was : The asset cash at bank increased by sh 100,000 from sh 700,000 to sh 800,000 and the asset cash in hand reduced by sh 100,000 from sh 380,000 to sh 280,000.
3. Some creditors were paid sh 50,000 by cheque on 5th January .The effect was that the liability creditors reduced by sh 50,000 from sh 150,000 to sh 100,000 and the assets cash in bank also reduced by sh 50,000 from sh 800,000 to sh 750,000.
4. Bought stock on credit sh 90,000.The asset stock increased by sh 90,000 from sh 380,000 to sh 470,000 and the liability creditors increased by sh 90,000 from sh 100,000 to sh 190,000.
5. Sold stock on credit at cost sh 150,000 on 12th January .The effect was; stock was decreased by sh 150,000 from sh 470,000 to sh 350,000 and the assets debtors increased by sh 150,000 from sh 100,000 to sh 250,000.
6. Acquired a loan sh 500,000 from Keya Industrial Estates and used it to repay the bank loan on 16th January .The effect was;The liability KIE loan was created of sh 500,000 and bank loan was reduced by sh 500,000 from sh 800,000 to sh 300,000.
7. Received cash sh 100,000 from one of the debtors on 20th January .The effect was; the asset cash in hand was increased by sh 100,000 from sh 280,000 to sh 380,000 and the asset debtors reduced by sh 100,000 from sh 250,000 to sh 150,000 and the asset debtors reduced by sh 100,000 from sh 250,000 to sh 150,000.

Note

It can be observed that a transaction affects two items of the balance sheet in either of the following ways;

• An increase in an asset followed by a decreased in another assets.
• An increased in a liability followed by a decrease in another liability.( capital is included as liability).
• Both an asset and liability are affected in the same way.

In a balance sheet the totals must always be equal on both sides.So whatever is done to one side must be done on the other side.

The values on 20th January of the items affected were as follows:

• Stock: sh (300,000 + 80,000 + 90,000 – 150,000) = sh 320,000.
• Cash: sh ( 500,000 – 80,000 – 100,000 + 100,000 ) = sh 420,000.
• Bank: sh (700,000 + 100,000 – 50,000) = sh 750,000.
• Creditors: sh (150,000 – 50,000 + 90,000) = sh 190,000.
• Debtors: sh (100,000 + 150,000 – 100,000) = sh 150,000.
• Bank loan: sh (800,000 – 500,000) = sh 300,000.
• K.I.E loan: sh 500,000.

The balance sheet as at 20th junuary 2006 after all the transactions would appear as shown below;

NOTE;

• Buildings, Motor vans, Furniture and capital remained the same since they were not affected by any transaction.
• It is also possible for a transaction to affect more than two items on the balance sheet.

Example

Esha bought stock of goods and paid by cash and the balance remained to be paid later. The items affected are: cash reduced, stock increased and creditors increased.

Effects of Transactions on Balance Sheet Totals

• A transaction affecting the items of the balance sheet would in turn affect the totals of the balance sheet such that they may increase, decrease or have no change. The examples are shown below.

Changes In Capital

Capital is the owners claim from the business and it‟s referred to as the owner‟s claims or owners‟ equity .Changes in capital may be as a result of the following.

1. Drawings
   - This is refers to cash or other items taken from the business by the owner from private use. Drawing reduces a firm‟s capital.
   - To get the remaining capital we less drawings from the initial capital.
2. Additional investment
   - These are additional cash or other assets brought in by the owner from his or her personal belongings. Additional investments increase a firm‟s capital.
   - To get the new capital after additional investment we add the investments to the capital
3. Profit
   - The gains obtained after selling goods or services at a price higher than that which they were bought. The effect of profit is that it increases capital. So we add the profit to the initial capital to get the new capital.
4. Losses
   - Losses are incurred when the cost of goods or services are higher than their sales. Losses reduces the capital hence to find the new capital after loss we take away the loss from the initial capital.

Summary

Capital at the end of a given period (final capital) = Capital at the beginning of the period (initial capital) + profit + added investment – drawings.

The unknown can be found by;

CC = OC + P + I – D
I = C.C – P + D
D = O.C – C.C + I + P
P = C.C – O.C – I + D

Example

In the spaces provided, indicate with a (x) whether each of the following transactions will increase, decrease or have no effect in the balance sheet.

Solution

Example

The following balance sheet was prepared from the books of Makara traders.

The following transactions then took place in January 2012

1. Opened a bank account for the business and deposited shs 120,000 from personal sources.
2. Paid part of the bank loan shs 40,000 by cash.
3. Bought goods worth shs 50,000 on credit.
4. Sold part of the furniture worth shs 10,000 in cash

Required:
Prepare Makara traders balance sheet as at the end of January 2012

Solution

Each mark (√) 1 mark 10 x1=10 marks

Example

The following balances were extracted from the books of Mile Traders for the year ended 31^st December, 2014.

                                                         Kshs
Stock                                                100,000
Capital                                              800,000
Debtors                                              50,000
Creditors                                            80,000
Cash                                                  10,000
Net Profit                                           10,000
Bank Overdraft                                   70,000
Machines                                          600,000
Furniture                                          200,000

Required: Prepare Mile Traders balance sheet as at 31st December 2014.

Solution

Past KCSE Questions on the Topic

1. State the term that best fit each of the following description
   1. Money brought into the business by owner_______
   2. Goods bought for resale______
   3. Money borrowed by the owner of business. (4mks)
2. For each of the following transactions, indicate with a tick in the spaces provided whether the following business transaction will increase, decrease or have no effect on the balance sheet total.
   

   Transaction	Effects on the balance Sheet
   	Increase	Decrease	No effect
   a) investing more cash in the business
   b) paying creditors in cash
   c) Buying a piece of furniture in cash

3. In the spaces provided, indicate with a (x) whether each of the following transactions will increase, decrease or have no effect in the balance sheet. (4 marks)
   

   Transaction	Increase	Decrease	No effect
   a. buying stock in cash
   b. Depositing extra cash into a business account
   c. Drawing cash for personal use
   d. Buying stock on credit