What it means
Businesses do dozens of things every day, and only some of them belong in the accounts. An accounting event, sometimes called a transaction or economic event, is one that can be measured reliably in money and that alters at least two items in the accounting equation.
Everything else is business activity that leaves no trace in the ledger until it produces such a change. Events split into external and internal.
External events involve another party, such as selling to a customer, borrowing from a bank or paying a supplier, while internal events happen entirely inside the business, such as recording depreciation, using raw materials in production or writing off obsolete stock. The double entry system is built around the idea that every event has at least two effects that keep the accounting equation in balance.
Buying stock on credit increases assets and increases liabilities; paying a wage decreases cash and decreases equity through the expense. If you can only see one effect, you have not finished analysing the event.
Timing is where the concept becomes commercially interesting. Under accrual accounting the event that triggers revenue is the transfer of goods or services, not the receipt of cash, so a business can recognise a large sale in one month and collect the money three months later.
Managers who confuse the two end up surprised by a profitable month with an empty bank account. Some occurrences sit on the boundary and need judgement.
A customer verbally promising a big order is not an event, a signed contract with no performance yet is usually not one either, but a supplier's price rise that makes existing inventory unsaleable at cost certainly is, because it changes the value of an asset you already hold.
In practice
Real-world examples.
Example
A dental practice orders $9,000 of chairs in March, receives them in April and pays in June. The accounting event is the April delivery, which creates both the asset and the payable, while the March order and the June payment are, respectively, no event and a settlement event.
Example
A brewery discovers that a 4,000 litre batch has spoiled and must be destroyed. No money changes hands and no external party is involved, but the internal event reduces inventory and increases cost of sales by the batch's carrying value of $11,000.
Example
A software firm signs a three year support contract worth $180,000 with no work performed yet. Signing is not an accounting event on its own, and revenue is recognised at $5,000 a month as the service is actually delivered.
Formula
Calculation
Every accounting event must preserve the accounting equation:
Assets = Liabilities + Equity
A joinery business starts the day with assets of $620,000, liabilities of $240,000 and equity of $380,000. Check: $240,000 + $380,000 = $620,000, so the equation holds.
It then buys a computer numerical control machine for $45,000, paying $15,000 from the bank and financing the remaining $30,000 with an equipment loan.
Effect on assets = +$45,000 (machine) - $15,000 (cash) = +$30,000, so assets become $620,000 + $30,000 = $650,000.
Effect on liabilities = +$30,000, so liabilities become $240,000 + $30,000 = $270,000.
Equity is unchanged at $380,000.
Check: $270,000 + $380,000 = $650,000, which equals the new asset total, so the event has been recorded correctly. Note that profit has not moved at all, because buying an asset is not an expense; only the depreciation recognised in later periods will reduce equity.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Tavistock Modular, an invented builder of prefabricated classrooms, treated the signing of a contract as the trigger for recording revenue. In one quarter the sales team signed $3,200,000 of orders, and the management accounts showed a record result that the board celebrated.
None of those buildings had been designed, built or delivered. When the external accountants reviewed the year, they explained that a signature creates an obligation rather than a completed sale, and that the accounting event is the transfer of the finished units. The quarter was restated to the $840,000 of classrooms actually delivered.
The fictional company changed its internal reporting to track three separate measures: orders signed, work completed and cash collected. Nothing about the underlying business changed, but the board stopped mistaking a pipeline for performance, and the production team gained a schedule that finally matched what had been promised to customers.
Watch out
Common mistakes.
- Recording revenue when a contract is signed rather than when goods or services are actually delivered to the customer.
- Ignoring internal events such as depreciation, stock obsolescence and accruals, which are real changes in financial position even though no cash moves.
- Analysing only one side of an event, which leaves the books out of balance or the effect on profit misstated.
Questions
People also ask.
Is every business activity an accounting event?
No, only those that change assets, liabilities or equity and can be measured reliably in money, so hiring a candidate is not an event but paying their first wage is.
What is the difference between an event and a transaction?
A transaction is an event involving an outside party, while the wider term event also covers internal changes such as depreciation or a write-down.
Does an accounting event always affect profit?
No, many events such as buying equipment for cash or drawing down a loan change only the balance sheet, with the profit effect arriving later or not at all.
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