What are Journal Entries? A Beginner’s Guide to Journal Entries in Accounting
Journal entries are the recorded transactions that your business carries out. Every business activity that involves money – sales, purchases, salaries, loans, and more – will lead to at least one journal entry. It is a chronological record of how your business’s money is being spent or earned.
Understanding how to create and interpret journal entries is key to gaining a comprehensive overview of your financial health, and Brixx Software is designed to simplify this process for you. Let’s delve in and learn more about this vital accounting tool.
What is a journal entry?
A journal entry is a record of a business transaction in the company’s accounting system. Every financial activity, from sales and purchases to revenue and expenses, can be recorded as a journal entry. The system of recording transactions is known as ‘journalizing’. The ledger where these entries are first recorded is called a ‘journal’, hence the term ‘journal entry’.
What to include in your journal entry
- Date of the transaction: This is the date when the transaction occurred, not the date when the transaction was recorded.
- Accounts involved: Each journal entry involves at least two accounts – one that is debited and one that is credited. The accounts involved in the transaction will depend on the nature of the transaction.
- Debit and credit amounts: Each journal entry must indicate how much is being debited from one account and credited to another.
- Description of the transaction: While not always required, it’s often helpful to include a brief description of the transaction for future reference.
- Unique identification number: A unique number (often called a journal entry number) can help track and organize journal entries.
Remember, the details included in a journal entry can vary depending on your accounting system, business size, and specific transaction details.
Debits vs credits
Understanding the difference between debits and credits is crucial for accurate journal entries. These terms come from double-entry bookkeeping, a system that ensures every transaction affects at least two accounts and maintains the accounting equation (Assets = Liabilities + Equity).
Here’s a basic breakdown:
- Debit (Dr): This can mean different things depending on the type of account. For asset and expense accounts, a debit increases the balance. Conversely, for liability, equity, and revenue accounts, a debit decreases the balance.
- Credit (Cr): Just like with debits, the meaning of a credit depends on the account. For asset and expense accounts, a credit decreases the balance. For liability, equity, and revenue accounts, a credit increases the balance.
To maintain the balance in the accounting equation, the total amount debited in a journal entry must always equal the total amount credited.
By understanding what a journal entry is, what to include in it, and the difference between debits and credits, you can accurately record your business transactions and keep your financial records in order.
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.
Opening entries
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 $50,000 in cash contributed by the owner, your opening entries would look like this:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| Jan 1 | Cash | 50,000 | |
| 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.
Transfer entries
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 $1,000 from your cash account to a petty cash account. Your transfer entry would look like this:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| Mar 2 | Petty Cash | 1,000 | |
| Mar 2 | 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).
Closing entries
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 $100,000 for the year. Your closing entries would look like this:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| Dec 31 | Income Summary | 150,000 | |
| Dec 31 | Revenue | 150,000 | |
| Dec 31 | Expenses | 100,000 | |
| 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
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 $500 but haven’t yet been billed by the end of the period, you would record an adjusting entry as follows:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| 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.
Compound entries
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 $1,500. You would record a compound entry as follows:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| Feb 15 | Accounts Receivable | 2,000 | |
| Feb 15 | Cost of Goods Sold | 1,500 | |
| Feb 15 | Inventory | 1,500 | |
| Feb 15 | Sales | 2,000 |
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).
Reversing entries
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 $500 of utilities expense at the end of December, you would record a reversing entry as follows:
| Date | Account | Debit($) | Credit($) |
|---|---|---|---|
| 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.
Streamlined accounting with Brixx
Automated accounting revolutionizes the way businesses manage their finances, and at the heart of this transformation is Brixx. Here’s how our platform makes accounting tasks not just simpler, but also more precise and insightful:
- Professional reports, made simple: Generate Profit & Loss, Balance Sheet, and Cash Flow reports effortlessly. Our software presents these reports in a clear, professional layout.
- Detailed insights: Break down report rows to trace the origin of any number, offering a granular view of your finances.
- Efficient double entry accounting: Brixx handles the complexities of double-entry bookkeeping, ensuring each transaction is accurately recorded.
- Real-time updates: Adjust an activity, and all linked reports update automatically, ensuring your financial data is always current.
Brixx is designed to simplify your accounting tasks while providing deep insights into your business’s financial health. It’s a powerful tool for managing your finances efficiently and accurately.
