The raison d'etre of accounting is to present a concise, timely, accurate narrative of an organization’s fiscal standing. Business leaders look to their finance teams for reality checks: Can we afford to hire a new engineer? How much runway do we have? Are we spending too much on operating expenses?
Journal entries are the fundamental building blocks that provide the answers to those and other questions. Journal entries list vital data, such as how much was credited and debited, when and from which accounts. Each journal entry corresponds to one discrete business transaction and is eventually posted to the general ledger.
The validity of all financial reports is affected by the accuracy — or inaccuracy — of the information entered at this level.
What Is a Journal Entry in Accounting?
Each journal entry contains the data significant to a single business transaction, including the date, the amount to be credited and debited, a brief description of the transaction and the accounts affected. Depending on the company, it may list affected subsidiaries, tax details and other information.
It’s crucial to accurately enter complete journal data so that the general ledger and financial reports based on this information are also accurate and complete. With modern accounting software, recurring journal entries may be templatized and automatically executed, minimizing the potential for error.
Journal entries are made in chronological order and follow the double-entry accounting system, meaning each will have both a credit and a debit column. Even when debits and credits are linked to multiple accounts, the amounts in both columns must be equal. For example, say a company spends $277.50 catering lunch for employees. The expenses account increases by that amount, while the cash account, which is an asset, decreases by $277.50 because that money is now spent.
- A journal is a concise record of all transactions a business conducts; journal entries detail how transactions affect accounts and balances.
- All financial reporting is based on the data contained in journal entries, and there are various types to meet business needs.
- Adjusting journal entries, for example, are used to accrue or defer revenue and expenses, change or correct previous entries or estimate non-cash transactions, like allowances for debt that has been written off.
What Are Debits and Credits?
Debits add to expense and asset accounts and subtract from liability, revenue and equity balances, while credits subtract from expense and asset balances and add to liability, revenue and equity accounts.
In accounting, the basic principle is the same: An adjusting journal entry to account for the accruing interest on a bank loan will debit the Interest Expense account and credit the Accrued Interest Payable account.
What Is the Purpose of a Journal Entry?
The purpose of a journal entry is to physically or digitally record every business transaction properly and accurately. If a transaction affects multiple accounts, the journal entry will detail that information as well.
For example, say our catering purchase incurs both state and local taxes. That compound journal entry might look like this:
Thus, the journal enables the caterer to accurately account for taxes owed to multiple jurisdictions.
Journal entries are the foundation of effective record-keeping. They are sorted into various charts of accounts and, once verified for accuracy, posted to the general ledger, which then feeds information to the financial reports that business decision-makers depend on.
Accurate and complete journals are also essential in the auditing process, as journal entries provide detailed accounts of every transaction. Auditors, both internal and external, will look for entries or adjustments that lack the proper documentation, explanations or approvals or that are outside the norm for the business.
What Is Included in a Journal Entry?
Journal entries may contain multiple data points but generally include:
- A header, which is a descriptor of the entry type, and the date entered in the journal;
- A unique numerical identifier or reference number;
- One or more accounts and amounts that will be debited by the transaction and the date(s) these debits are made;
- One or more accounts and amounts the transaction will credit and the date(s) these credits are made; and
- A brief description of the transaction.
Journal entries may also include data specific to the business, such as the subsidiary or subsidiaries involved in the transaction and the currency or currencies used.
How Do You Write a Journal Entry?
MyToys Manufacturing Co. buys $100,000 worth of raw materials. It pays $10,000 in cash and uses credit for the balance. The company would record a debit, or increase, of $100,000 in raw materials. The Cash account would show a credit, or decrease, of $10,000 because that was the amount paid in this transaction. The Accounts Payable Account would show an increase, or credit, of $90,000 as it now owes that amount to a vendor on a future date or dates.
As MyToys makes payments over time on this purchase, the Cash Account will show a corresponding credit (less cash is available) and the Accounts Payable a corresponding debit as less money is owed by the company.
Further, as the raw materials are used to produce finished products — toys, in this case — a credit is applied to the Raw Materials account to reflect a decline in value as raw materials are consumed, and the Finished Goods account is debited to reflect an increase in the amount of inventory on hand.
6 Types of Journal Entries
There are six types of journal entries, or seven if you count the archaic, vague and seldom-used single entry. The single journal entry is not used in standard accounting, which is double-entry based. It is more suited to checkbook balancing than to business accounting, which involves many accounts.
Each of the primary six entry types has a specific function in accounting. Together they present a balanced, accurate and objective statement of the company’s financial standing.
These entries carry over the ending balance from the previous accounting period as the beginning balance for the current accounting period. For example: The ending balance of the Cash account on the balance sheet from the previous accounting period was $11,000 after all liabilities were paid for the period. That balance of $11,000 is now the opening entry for the current accounting period.
Transfer entries move, or allocate, an expense or income from one account to another. For example, MyToys Manufacturing transfers cash from its main account to a subsidiary. A transfer journal entry accounts for the transfer of the money from one account to another. No third party is involved in these entries, and transfers must always net zero.
These entries mark the end of an accounting period at a balance that can then be transferred from a temporary account to a permanent one, or from one accounting period to the next. In the case of temporary accounts, the closing entry zeros out the account, and any balance above that is transferred to another, more permanent account. The temporary account is then closed.
Examples of temporary accounts include expense and loss accounts; revenue, income and gain accounts; income summary accounts; and dividend or withdrawal accounts. In the case of accounting periods, the closing entry reflects the ending balance for that account at the end of that accounting period. That value is then transferred as the opening entry for the next accounting period. In that case, it is the accounting period for that account, which is closed.
Adjusting entries are entries that record changes to accounts that are not otherwise accounted for in the journal, in compliance with the accrual method of accounting. These entries are entered in the general ledger at the end of an accounting period as per matching and revenue recognition principles. Common examples are accruals, deferrals and estimates.
An expense accrual refers to an expense reported in an accounting period before it is actually paid. An example is electricity used by a plant in the month before the utility issues a bill for the company to pay.
A revenue accrual relates to work that has been performed or products that have been delivered but for which the customer has not been invoiced.
An expense deferral occurs when a payment is made in an accounting period prior to when the expense is actually incurred. An example is a payment made now for insurance that covers the following six-month period. Deferred revenue applies when a company receives payments in advance for services or products that are to be delivered in the future.
These entries record more than one account to be debited or more than one account to be credited. The rule of journal entry requires the total of debits and credits to be equal, but the number of credits and debits do not have to be equal. For example, there may be one debit but two or more credits, or one credit and two or more debits, or even two or more credits and debits. For example, Payroll may entail a large number of journal entries, which can be simplified into compounded form as a summary.
Reversing entries are made at the beginning of a new accounting period and serve to reverse, or undo, an adjusting entry made at the end of the previous accounting period. This option provides a significant reduction in accounting errors due to double-counting expenses or income and increases efficiency in processing actual invoices in the new accounting period. In other words, they are used to simplify bookkeeping. For example, an accrued expense reported in the previous accounting period can be reversed so the expense can be accounted for in the accounting period in which it was paid, without worrying about reporting the expense twice.
How to Prepare Journal Entries for Your Business
It’s important to prepare journal entries properly to ensure transactions are accurately recorded. Begin by deciding what transaction must be entered where. If you use accounting software, you’ll need to make fewer journal entries because automation embedded in the software will flow relevant data to other accounts and reports as needed.
If you are doing bookkeeping manually, to record a transaction properly, you’ll need to figure out everything the transaction affects on the company books.
Identify the accounts that will be affected:
The first step is in identifying the accounts that the transaction affects. That can be a bit confusing if you’re unfamiliar with accounting terms and principles. But in general, you’re looking for areas of impact from the transaction: Which accounts will gain something, and which will lose something in this transaction?
Sort transactions first:
Sorting transactions by type — expenses, bank deposits, quarterly taxes — will put you on the right path to recording these transactions correctly.
Follow the money:
Now that the transaction is sorted, think about how it affects the values, in terms of debits and credits, in related accounts. Ask yourself, Where did the money come from, and where did it go? What did the transaction add to the business, and what did it take away? The physics adage that “for every action, there is an equal and opposite reaction” holds true in accounting, too. Make sure you identify all actions and reactions caused by the transaction.
Determine your account type:
Some transactions are easy to map in terms of credits and debits in various affected accounts. Others may be a bit trickier. Here are some tips to help you figure them out,
Get familiar with the basic account types: All journal entries fall into one of the basic account types: Assets, Liabilities, Expenses, Revenue and Equity. Once you recognize each of these types, it will be easier to understand what each entails, how they relate to other accounts and how different types of transactions affect them.
Use standard accounting rules to direct where to apply credits and debits: Accounting rules exist for very good reasons, one of which happens to be standardizing what goes where in financial reports and journal entries. Look to the accounting rules for the defining word on where to apply debits and credits for any given journal entry.
Prepare your journal entry:
Now that you’ve identified the transaction type and the accounts it affects, you’re ready to make your journal entry.
Enter the correct date: Every journal entry must be dated to ensure the data it contains is applied to the correct accounting period.
Assign the account name and code: Note the account name and the unique identifying general ledger code. Transactions are coded to specific accounts for reporting purposes. Account balances feed the various line items on financial statements.
Enter the debit and credit amounts: If you’re using accounting software, odds are that some of the crediting and debiting in a journal entry will be at least partially automated. If you’re keeping the company books by hand, you’ll need to double check to ensure you have entered all credits and debits accurately.
Examples of Common Journals
The accepted, standard practice is to use a double-entry accounting system, which generally entails the use of both a general ledger and a general journal. It can also include the use of special journals for frequent transactions within a specific category.
A general journal is a book of raw business transactions recorded in chronological order by date. It is the first place a transaction is recorded. The amounts are then posted to the appropriate accounts such as accounts receivables, cash accounts or asset accounts.
Special, or specialized, journals contain frequent transactions within a given category and are normally used in manual bookkeeping, to make it easier for businesses to find instances of particular types of transactions. Examples include sales and purchase journals that group sales to various customers or purchases from suppliers in one place. Modern accounting software negates the need for special journals by making it easy to sort transactions and search for granular details.
How to Track Journal Entries
To move data to the proper place in the general ledger, journal entries must be easily trackable so the information can be found and copied as needed. Multiple journal entries can be recorded and tracked in T-accounts, which help finance teams visualize entries for easier review.
Examples of Journal Entries
T-accounts are a visual representation of the general ledger account. Here are some examples, as well as additional journal entry types.
Two T-accounts: Cash and notes payable
|Cash (Asset Account)|
Increases an asset / money received
Decreases an asset / money paid
|Notes Payable (Liability Account)|
Decreases a liability / Loan paid
Increases an asset / Borrowed additional funds
|Notes Payable (Liability Account)|
Decreases a liability / Loan paid
10 Oct 20 ENTRY 10,000
Increases an asset / Borrowed additional funds
9 Oct 20 ENTRY 20,000
1 Oct 20 ENTRY 10,000
*Interest income accrued in previous month, received in current month
*Interest income accrued but not received
Using Accounting Software for Tracking Journal Entries
As accounting grows in complexity and journal entries grow in number, tracking becomes more difficult, especially in manual entry systems. Accounting software is a better solution for most companies because much of the effort around journal entry tracking, pulling and allocating to accounts can be automated.
Automation delivers increased efficiency and reduced error rates. Further, modern accounting software will greatly ease the audit process.
Journal entries are the backbone of all financial reporting. As such, transactions must be verified and the corresponding journal entries cross-checked for accuracy. Whether the books are completed manually or digitally, credits and debits on affected accounts must be allocated according to standard accounting rules.
From these simplified but exacting measures, a company can know where it stands financially and how far it can go with future plans.