What are Journal Entries? A Beginner’s Guide to Journal Entries in Accounting
What is the purpose of a journal entry?
The primary purpose of a journal entry is to document and track all financial transactions of a business in a systematic manner. This record keeping serves several critical purposes. They are the foundation of all financial reporting. It helps businesses:
- Maintain a clear and organized record of financial transactions
- Track revenue and expenses to determine profitability
- Identify trends and irregularities in business operations
- Compile necessary information for tax preparation and audits
- Adhere to regulatory compliance and reporting standard
6 types of journal entries (with examples)
Different types of business transactions necessitate different types of journal entries. Let’s delve deeper into each type of journal entry with enhanced explanations.
At the start of an accounting period, you need to set up your accounts to reflect their beginning balances. This is where opening entries come in. For example, if your business starts on January 1 with $50,000 in cash contributed by the owner, your opening entries would look like this:
|Jan 1||Owner’s Equity||50,000|
This entry indicates that your business now possesses $50,000 in cash and this money is the owner’s equity in the business.
There are times when you might need to shift funds from one account to another for better management of resources. This is when transfer entries come in handy. For example, suppose you move $1,000 from your cash account to a petty cash account. Your transfer entry would look like this:
|Mar 2||Petty Cash||1,000|
Here, you are reducing your cash account by $1,000 (credit) and increasing your petty cash account by the same amount (debit).
At the end of an accounting period, you need to close out your income and expense accounts and shift these balances into a summary account. This is done using closing entries. For example, suppose you have a revenue of $150,000 and expenses of $100,000 for the year. Your closing entries would look like this:
|Dec 31||Income Summary||150,000|
|Dec 31||Income Summary||100,000|
These entries clear out the balances in your revenue and expense accounts and move the net income ($50,000) into the Income Summary account.
Adjusting entries are necessary to ensure that your financial statements reflect the revenues earned and expenses incurred during an accounting period. For instance, if you have used utilities worth $500 but haven’t yet been billed by the end of the period, you would record an adjusting entry as follows:
|Dec 31||Utilities Expense||500|
|Dec 31||Utilities Payable||500|
This entry increases your expenses for the period and recognizes the liability you have for the unpaid utilities.
There are situations where a single transaction impacts more than two accounts. In such cases, you make a compound journal entry. Suppose you sell goods worth $2,000 on credit and the cost of the goods sold is $1,500. You would record a compound entry as follows:
|Feb 15||Accounts Receivable||2,000|
|Feb 15||Cost of Goods Sold||1,500|
This entry records the sale (increasing Accounts Receivable and Sales) and also records the cost of the items sold (increasing Cost of Goods Sold and decreasing Inventory).
Sometimes, to simplify accounting, you may want to reverse the adjusting entries you made at the end of the previous period. These are known as reversing entries. For instance, if you recorded an adjusting entry for $500 of utilities expense at the end of December, you would record a reversing entry as follows:
|Jan 1||Utilities Payable||500|
|Jan 1||Utilities Expense||500|
This entry cancels out the previous adjusting entry and simplifies the recording of the actual utility payment later in January.
How to record accounting journal entries for your business?
The process of recording journal entries in accounting involves several steps. It begins with identifying the transaction and ends with making an entry in the journal. Here’s a step-by-step guide:
- Identify the transaction: Start by figuring out what business activity needs to be recorded. It could be a purchase, sale, payment, receipt, or any other business transaction.
- Analyze the transaction: Figure out what accounts are affected by this transaction. Does it increase or decrease your assets, liabilities, equity, revenues, or expenses?
- Determine the amount: Find out the monetary value of the transaction. How much money was received, paid, or committed?
- Decide on debit and credit: Based on your analysis, decide which account should be debited and which one should be credited. Remember, in double-entry bookkeeping, every transaction is recorded in two accounts, and the total debit amount should always equal the total credit amount.
- Create the journal entry: Write down the date, the names of the accounts, and the amounts to be debited and credited. You should also include a brief description of the transaction.
- Ensure debits equal credits: Check your entry to make sure that the total debit amount equals the total credit amount. This step helps maintain the balance of the accounting equation.
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