How do you apply journal entries in real-world scenarios for bookkeeping and accounting purposes? Do you understand their meaning? Proper comprehension of journal entries is essential for maintaining precise financial records and producing trustworthy financial statements. In this blog post, we will explore both aspects – what are accounting journal entries and how do you make one? We’ll also cover best practices for recording and reconciling your day-to-day financial transactions with accuracy and ease. By the end of this article, you’ll understand what constitutes a journal entry and when these should be used during running your business!
What is a journal entry?
Journal entry facilitates the recording of business transactions within an organization’s accounting system. It records essential data for a single business transaction, including the date, amounts credited and debited, a brief description of the transaction, and affected accounts. The long-standing practices of journal entry serve as the foundation of the double-entry accounting method, which enables comprehensive tracking of a company’s resource utilization and corresponding sources. In accordance with the double-entry accounting principle, each transaction must be recorded in at least two accounts. Nonetheless, it is prudent to commence with the basics before exploring this concept further.
Types of Journal Entries
The recording of financial transactions through journal entries takes various forms, contingent upon their layout and purpose in the accounting cycle. These entries serve to either adjust or reverse previous entries or account balances or to directly input data such as depreciation or amortization that accrues over the course of the month. The following are illustrative examples of the diverse types of journal entries and their respective configurations:
Simple Journal Entry
Within the framework of double-entry bookkeeping, a simple journal entry constitutes a fundamental type of accounting entry. It entails debiting one account and crediting its corresponding account, thereby reflecting a straightforward transaction involving two accounts. The simplicity of such entries resides in their inherent limitation to affect no more than two accounts. Specifically, a simple entry solely serves to augment one account while simultaneously reducing the balance of its corresponding account.
Example
This journal entry records the payment of a utility bill. The Utilities Expense account is debited to reflect the decrease in expenses, while the Cash account is credited to reflect the decrease in assets.
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| 01/01/2023 | Utility Expense | 1,000 | |
| Cash | 1,000 |
Compound Journal Entry
Compound journal entries entail the recording of more than two accounts. The number of accounts involved in a compound journal entry may vary, with at least three accounts extending to double digits.
Example
The company has recognized a sale of $5,000, resulting in an increase in both Accounts Receivable and Sales Revenue accounts. In accordance with the matching principle, the company has recorded a decrease in Inventory and an increase in the Cost of Goods Sold of $3,000, standing for the cost of goods sold associated with the sale. This journal entry can be classified as a compound entry, as it involves multiple accounts and necessitates the recording of multiple debits and credits.
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| 01/01/2023 | Accounts Receivable | $5,000 | |
| Sales Revenue | $5,000 | ||
| Inventory | $3,000 | ||
| Cost of Goods Sold | $3,000 |
Adjusting Journal Entry
Adjusting entries serves the purpose of revising previously recorded journal entries, ensuring their alignment with the correct accounting periods. It is important to note that adjusting entries does not remove or delete transactions. Instead, they introduce new transactions that accurately reflect the business's financial situation.
Usually, adjusting entries are made at the end of the accounting period, which often coincides with the business's fiscal year. There are four primary types of adjusting entries:
1. Prepaid expenses
These are cash payments made for assets that have not yet been utilized, such as insurance payments made in advance to cover potential losses.
2. Unearned revenue:
This refers to cash received before supplying products or services, such as annual gym memberships or prepaid music subscriptions.
3. Accrued revenue:
This is income earned but not yet received, such as the interest on a loan.
4. Accrued expenses
These are expenses incurred but not yet paid, such as the monthly salaries of employees, which are paid at the end of the month.
Example
This illustrative adjusting entry encompasses three distinct components. Firstly, it acknowledges the realization of $2,000 in revenue during the current period that was previously unrecorded. Secondly, it acknowledges the exhaustion of $500 in prepaid insurance expenses over the same period and necessitates their immediate recognition as an expense. Thirdly, it recognizes $1,000 in depreciation expense associated with a long-term asset consumed during the period in question.
| Date | Account | Debit ($) | Credit ($) |
|---|---|---|---|
| 01/01/2023 | Accrued Revenue | $2,000 | |
| Revenue | $2,000 | ||
| Prepaid Insurance | $500 | ||
| Insurance Expense | $500 | ||
| Depreciation Expense | $1,000 | ||
| Accumulated | $1,000 |
Reversing Entries
Reversing entries are accounting journal entries made at the beginning of an accounting period to undo the adjusting entries recorded at the end of the earlier period. They simplify the accounting process by nullifying the earlier period's adjustments. Reversing entries are typically used for resolved or reversed accruals and deferrals from the earlier period. They reduce the risk of errors and streamline the accounting process. However, not all adjusting entries require reversing entries, and their use depends on the business's specific circumstances and accounting practices. Careful consideration and analysis are necessary before reversing entries in an accounting period.
Example
Assume that a company accrues $2,000 of salaries expense for the last week of December 2022, which will be paid in January 2023. The company records the following adjusting entry at the end of December.
| Account | Debit | Credit |
|---|---|---|
| Salaries Expense | $2,000 | |
| Salaries Payable | $2,000 |
To reverse this adjusting entry at the start of January 2023, the company records the following reversing entry:
| Account | Debit | Credit |
|---|---|---|
| Salaries Payable | $2,000 | |
| Salaries Expense | $2,000 |
This entry will reverse the December adjusting entry and ensure that the expense is recognized in the correct accounting period (January 2023), while also cutting the need for a manual adjustment to remove the accrual from the prior period.
What Is the Purpose of a Journal Entry?
A journal entry is a record of a financial transaction that includes the date, amount, and accounts that are being debited and credited. The purpose of a journal entry is to keep a chronological record of business transactions for record-keeping, financial reporting, and tax purposes. The role of journal entries is to update a company’s general ledger, which shows revenue, expenses, assets, liabilities, and equity for a company. By creating journal entries, organizations can have a detailed record of financial transactions that can be used for audits, financial reports, and decision-making. Additionally, journal entries help businesses maintain accurate financial records which aid in tracking expenses, monitoring financial performance, and identifying areas for improvement.
Steps to Prepare Journal Entries for Your Business
The infographic image steps to prepare journal entries for a business can help organizations maintain compliance with accounting standards and transparency with their key stakeholders by encouraging them to keep detailed and accurate records.
Using Accounting Software for Tracking Journal Entries
Presently, there are various accounting software solutions available in the market which facilitate entrepreneurs and accounting professionals in supporting accurate books of accounts without the need for manual data entry.
Consequently, businesses are compelled to invest a considerable amount of time and effort in manually entering their financial transactions into the accounting system.
IBN is the perfect opportunity for smart business owners to achieve success!
Our specialist team of 24+ years gives advice for software selection such as QuickBooks, NetSuite, SAGE, etc., and enables you to have continuous, 2-way sync. All your business transactions are automatically synced with your accounting software! You no longer have to waste time on manual entry or worry about inaccuracies.
Apart from this, IBN Tech has an additional offer, would you like to know more? Please contact our help desk.
Conclusion
Writing journal entries is a great way for small business owners to track and plan out their achievements and progress. There is no exact formula, but rather a tool that can be tailored to the individual’s needs and objectives. All journal entries can serve different purposes in terms of how you might use them, from measuring performance to tracking personal development. Whether it be brainstorming, reflecting, or addressing issues head-on, journaling is a helpful technique for small business owners in order to stay organized, stay motivated, and become successful.
