An organization’s accounting system records a business transaction through a journal entry. Journal entries form the foundation of the double-entry accounting method, which has maintained financial records for centuries. They allow businesses to track resource usage and origin.
The double-entry accounting method necessitates that every transaction be recorded in at least two accounts. For example, when a business buys supplies using currency, it records the transaction in both the cash account and the supplies account. Before proceeding, we must establish the fundamentals.
The Purpose of a Journal Entry
In the era of automated accounting software, it is easy to overlook the significance of the humble journal entry. Before automation, people painstakingly entered entries into journals, which were once physical books of paper similar to a journal but could also be Excel sheets.
To document financial transactions, the accounting system uses accounting journal entries. The accounting system relocates these entries from the journals and posts them to the general ledger. Although the majority of this process occurs in the background of contemporary accounting software, it is crucial to be aware of the process. There may be instances in which manual entries are necessary to rectify or alter account balances after an accounting period.
What should go into a journal entry?
A critical aspect of journal entries is that they must include sufficient information to accurately represent the actual transaction. In this manner, rather than relying solely on account balances, we can review journal entries to determine the actual events and determine whether any errors were made.
The following are the components of a journal entry:
- The date of the transaction.
- Each account’s identity and number were affected.
- The total quantity of credit and debit.
- The transaction is identified by a unique reference number.
- A detailed account of the transaction.
Debits and Credits: What Are They?
According to the double-entry bookkeeping procedure, debits and credits in a journal entry must be equivalent. The general accounting equation that describes the balance statement must also be consistent with journal entries.
Assets = liabilities + ownership equity
This equation accounts for debits on the left and credits on the right. This implies that debiting an asset account on the left side of the equation increases that account. Debiting a liability or equity account on the right side of the equation will reduce its balance.
Credit quantity produces the opposite effect. Crediting an asset account reduces the balance while crediting a liability or equity account increases it. On the income statement, credits augment revenue accounts, while debits augment expense accounts.
The accounting equation and the actions of debiting or crediting an account result in the typical existence of either a debit balance or a credit balance in the various categories of accounts. The accompanying flowchart illustrates this.
A Journal Entry: How Is It Made?
Let us examine a few examples. On January 10, 2024, Walmart received an order from Lucy for $238.87 in office supplies. When Walmart delivers the supplies, she also receives invoice number 4987. She needs to settle the invoice within 14 days.
The journal entry that documents the supply receipt and associated payables is as follows:
Reference number: 4396
January 10, 2024
Office supplies (account 6390): $238.87 Accounts Payable (account 2100) I am documenting the payable for invoice 4987 from Walmart.
Two weeks later, Lucy pays the invoice.
Reference number: 1547 Accounts Date: 1/24/2024 Payable $238.87
Cash (account: 1010) $238.87
To document the payment for invoice 4987 from Walmart
Invoice number 21095 for $2,560.00 is issued by Lucy on January 12, following the completion of a consulting assignment for Ace Design, Inc.
Reference number: 2401
Accounts Date: January 12, 20/24 Accounts Receivables (account 2100): $2,560.00 Revenue (account 4101): $2,560.00 I need to record invoice 21095 for Ace Design, Inc.
She received payment for the invoice two days later.
Reference number: 2489
Date: January 25, 2024
Cash (account: 1010) $2,560.00 Accounts Receivable (account 2100): $2,560.00
We need to record the payment for Ace Design, Inc.’s invoice 21095.
Importing data into the general ledger
For centuries, people conducted bookkeeping using paper and a stylus. Businesses employed specialized journals, or ledgers, to document business transactions. For example, a payroll journal would document payroll, while a sales journal would record sales. Periodically, the accounting cycle posted a summary of those transactions to the appropriate general ledger account. Data could only be entered into financial records using journal-entry accounting.
However, during the creation of invoices, the processing of customer payments, and the payment of bills, accounting software automatically records transactions like those mentioned above in the appropriate accounts. This implies that accountants generate relatively few journal entries at present. Accounting software also enables small business proprietors to conduct their bookkeeping.
The remaining journal entries primarily pertain to accruals at the end of a period or the transition to GAAP-based accounting. Journal entries may also be necessary for non-cash transactions, such as amortization and depreciation.
The speciality journals of the past are available as modules in today’s accounting software. For example, a payroll module enables employee payments and simplifies the generation of payroll tax reports. Nevertheless, these distinct modules are largely imperceptible to users; all transactions will appear as if they were entered into the general ledger.
What Kinds of Journal Entries Are Most Common?
Depending on their format and role within the accounting cycle, journal entries come in a variety of flavors. You can employ them to modify or reverse an existing entry or account balance or to directly input information like depreciation or amortization that accumulates throughout the month. Here are a few examples of the various types, as well as their appearances:
Journal entry examples
Instead of processing invoices or cash receipts automatically or through a specialized module, the general ledger directly records general journal entries. For instance, take the following entry:
Reference number: 8806
December 31, 2024
Depreciation expense (account 6401): $10,500.00
Accumulated depreciation (account 1515). $10,500.00
To document the annual depreciation expenditure
Compound journal entries are complex and capture transactions that affect more than two accounts. The following is a straightforward compound entry to document the acquisition of machinery with a cash down payment and a bank loan:
Reference number: 4352
April 12, 2024
Machinery (account 1510): $275,000
$25,000.00 in cash (account 1010)
$250,000.00 bank loan (account (2358)) I am documenting the acquisition of new machinery.
Generally, GAAP-based financial statements employ adjusting journal entries to allocate income or expenses to the appropriate period. Adjusting entries aligns incurred expenses with the appropriate period when the last day of the month deviates from the payroll period. For instance, suppose that payroll expenses totalled $3,000 as of December 31st.
Reference number: 5953.
December 31, 2024
Payroll expense (account 6780): three thousand dollars
The accrued payroll for account 2780 is three thousand dollars. three thousand dollars
To document the accrued payroll for the year’s conclusion
To accrue income or expenses, reversing journal entries reverses one or more adjustments made in the immediately preceding period. These can streamline the accounting process while guaranteeing the recording of income or expenses in the correct periods. We would reverse the adjusting journal to accrue payroll expenses the following year.
Reference number:7103
Date: January 1, 2024
The accrued payroll for account 2780 is three thousand dollars. three thousand dollars
Payroll expense (account 6780): three thousand dollars
To reverse the payroll accrued on 12/31/24,
Monitoring journal entries
When creating journal entries manually, it is necessary to monitor which entries are associated with which transactions as you post items to the general ledger. This is the sole dependable method for identifying the source of an error and verifying a number to guarantee precise financial reporting.
T-accounts are frequently useful for monitoring. They display the account in question in the shape of a T, with the account name in the masthead above the horizontal line of the T and the vertical line splitting the credit and debit columns left and right. It is a straightforward template that enables you to visualize the transaction.
For example, if you obtain a $10,000 loan, the Notes Payable t-account will show a $10,000 credit in the payable account and a $10,000 debit, designated as cash.
We would then manually post each of these journal entries to the general ledger. If you believe that this sounds like a significant amount of work and a lot of opportunities for errors, you are correct. We employ technology to simplify our tasks in this situation.
Fewer journal entries due to automation
The provided examples are straightforward, but imagine the ease with which errors could occur if manual journal entry accounting was the only method of transferring data into the general ledger. Errors in addition and subtraction occur due to the transposition of numbers. Additionally, it is virtually impossible to identify these errors.
By utilizing bank inputs and imports from a variety of applications, accountants and bookkeepers can enhance accuracy and save time by fully utilizing the automation in contemporary accounting systems. This expedites the offshore accounting cycle and allows small business proprietors to provide financial statements that are both precise and comprehensive in nearly real-time.
At Velan, we are consistently in favour of automation that enables accountants to complete their tasks more efficiently and with greater precision.
Our Bookkeeping Experts are here to help.