Why business transactions and personal transactions should be recorded separately?

Why business transactions and personal transactions should be recorded separately?

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Any financial transaction, from a bank deposit to a bill payment, needs to be recorded in your general ledger. Learn the different ways to record your accounting transactions and why it’s important.

Whether you run your business from your dining room table or have numerous locations scattered across town, recording business transactions is part of the accounting process. This includes everything from recording your latest electric bill in your general ledger for future payment to recording depreciation expenses as an adjusting entry.

Because recording transactions is part of the accounting process -- whether you record those transactions using accounting software or an accounting logbook or other transaction book -- they must be recorded timely and accurately.

If you’re using accounting software, any time you record a bill to be paid in the future, or a payment received from a customer, or pay your employees, you’re recording transactions into your general ledger.

Recording accounting transactions becomes more time-consuming if you’re using a manual accounting system. That’s because each transaction will need to be recorded in the appropriate subsidiary ledger, which will later impact your general ledger. Subsidiary ledgers include the following:

  • Cash receipts journal
  • Cash disbursements journal
  • Sales journal
  • Purchases journal

The most efficient way to record your accounting transactions is to follow the accounting cycle, which is a process used by bookkeepers and accountants to make sure that all accounting transactions are recorded properly. The accounting cycle also provides a handy reminder of the necessary steps that need to be followed, which can be beneficial for those new to the accounting process.

The steps in the accounting cycle are:

  1. Organize transactions
  2. Record journal entries
  3. Post journal entries to the general ledger
  4. Run an unadjusted trial balance
  5. Make adjusting entries
  6. Prepare an adjusted trial balance
  7. Run financial statements
  8. Close the books for the month
  9. Begin the next cycle

Types of transactions

The first thing you’ll need to do before entering transactions is to determine if an entry is a debit or a credit. Debits and credits are used in double-entry accounting and make sure that for every debit transaction recorded, there is a corresponding credit transaction recorded as well. For example, if you pay your electric bill, you would make the following journal entry:

Date Account Debit Credit
11-1-2020 Utility Expense $100
11-1-2020 Cash $100

This entry records your payment by debiting your utility expense account and crediting cash. Using double-entry accounting, this process will need to be completed for each transaction that you record.

The following are the most common types of accounting transactions that you’ll need to enter for your small business.

1. Accounts payable

Any time you pay a vendor or supplier for goods and services that they’ve supplied to your business, you have two choices. You can either pay the bill immediately, expensing it to the appropriate account, or you can record it in accounts payable to pay at a later date.

For example, let’s say your business receives a bill for $75 for office cleaning that is due at the end of the month. You would record the expense in the appropriate month and record the amount due in accounts payable.

Date Account Debit Credit
11-1-2020 Office Expense $75
11-1-2020 Accounts Payable $75

If you pay the bill immediately or pay cash for an item, all you need to do is record the expense and the reduction in cash in the appropriate accounts, as we did with the utility expense. If you’re not using accounting software, you’ll need to record this entry in the purchases journal.

2. Accounts receivable

Accounts receivable follows the same premise as accounts payable, only accounts receivable is used to record money that is owed to you by customers who are paying by credit. Again, if your customer pays immediately, there’s no need to record anything in accounts receivable. You would simply record the increase in cash and the amount of the sale.

However, every time you invoice a customer, you automatically record an accounts receivable entry. For example, let’s say that you just invoiced a customer for $208.

Why business transactions and personal transactions should be recorded separately?

Any time you create an invoice, a corresponding entry should be made in accounts receivable. Image source: Author

This is how you would need to record the entry in accounts receivable. Remember, if you’re using accounting software, this process is completed automatically when the invoice is created.

Date Account Debit Credit
4-5-2020 Accounts Receivable $208
4-5-2020 Sales $200
4-5-2020 Sales Tax $8

If you’re not using accounting software, you would need to record this entry in your sales journal.

3. Bill payment

When you’re ready to pay a bill, whether it’s the accounts payable bill you recorded earlier or a bill you wish to pay immediately, you would record it as follows. As an example, we’ll go ahead and pay the office cleaning bill that we recorded earlier in accounts payable.

Date Account Debit Credit
11-1-2020 Accounts Payable $75
11-1-2020 Cash $75

The entry above reduces the accounts payable balance and also reduces the cash balance. If you need to record this manually, it would be recorded in the cash disbursements journal.

4. Payments received

Payments received are recorded when your customers pay you for goods and services. This can include cash transactions, such as when a customer purchases a print cartridge from your office supply store. It also includes the payment received on an invoice for goods and services purchased on credit.

For example, let’s say we received a payment of $208 from Johnson Fabrics to pay the invoice referenced earlier. Here’s how to properly record that payment.

Date Account Debit Credit
5-1-2020 Cash $208
5-1-2020 Accounts Receivable $208

If you’re recording transactions manually, this should be recorded in your cash receipts journal.

5. Payroll entries

If you have employees, you’ll be entering payroll transactions. There are typically two sets of payroll transactions that you’ll need to record: the initial entry after payroll has been processed and the cash entry when your employees are paid. Payroll journal entries can be complicated at times, which is why it’s highly recommended that you use payroll software or a payroll service to process payroll.

The first payroll transactions recorded should include gross wages as well as any payroll taxes that need to be paid.

Date Account Debit Credit
11-1-2020 Gross Wages $1,000
11-1-2020 Federal Income Tax Withholding $ 100
11-1-2020 FICA (Employee) Withholding $   77
11-1-2020 State Income Tax Withholding $   40
11-1-2020 Wages Payable $ 779

The next set of payroll transactions you’ll record will be simpler, notating how much your employee wages are after payroll tax deductions.

Date Account Debit Credit
11-10-2020 Wages Payable $779
11-10-2020 Cash $779

Another set of payroll transactions will also need to be entered when tax payments are remitted. If you’re using a manual bookkeeping or accounting system, you can record these entries directly into your general journal.

6. Journal entries

With the use of accounting software, the need to enter multiple journal entries has been reduced dramatically, but there are still instances when they are a necessity.

For example, adjusting entries, such as depreciation, amortization, and payroll accruals, would all be posted as adjusting journal entries. You may also have additional entries, such as bank fees and interest earned, that will need to be posted before running financial statements.

Recording transactions properly is a necessity for all businesses

As a business owner, one of the most important things you or your bookkeeper need to do is to record all of your accounting transactions. Any transaction, no matter how small, will impact your business and needs to be properly accounted for.

Recording accounting transactions will provide you with an accurate account record of all your business activity, giving you a true representation of your business finances while helping to ensure that your financial statements are accurate.

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Why is it important to separate personal and business?

Keeping your business assets separate from your personal finances can be a liability and help protect your assets in the case of any legal actions. Nobody ever wants to think about hard times that may hit their business, such as the need to dissolve it or to be entangled in legal issues.

What is business transactions are recorded separately from personal transactions?

The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner.

Why is business treated as a separate entity for accounting purposes?

You can legally set up any type of business, but the primary reason for setting up a separate entity is to separate the liability of the business from the liability of the individual owner(s). A business or individual can have liability for debts and also for lawsuits for negligenceor illegal actions.

Is right to record the personal transactions of the business owner in the company's accounting book?

The concept states that the enterprise should record transaction separately for those of the business and the owner. It is because of this concept capital is treated as liability and drawings as an asset.

Why does business transactions need to be recorded?

The main purpose of recording transactions is to provide accurate and up-to-date information about the financial position of a company as well as maintain accurate and complete records of financial transactions.

Which accounting concept tells us to record the transactions of the company and its owners separately?

Business entity concept This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate.