What is a Journal Entry in Accounting?
A journal entry is the first stage of the accounting process. Its purpose is to record a business transaction.
Every journal entry involves a debit and a credit. One account is debited, and another is credited. Some journal entries could affect more than two accounts, but the total of the debits would always match the sum of the credits.
In this post, we’ll examine the role journal entries play in the accounting system. We’ll also consider a few examples to get an idea about the information that goes into each journal entry.
Why are journal entries needed?
We mentioned that each journal entry would always have a debit as well as a credit amount. It’s essential to understand the reasoning behind this.
When an organization follows the double-entry accounting system, every transaction it enters into involves making a journal entry that involves both debits and credits. So, if a company makes a cash sale, the cash account would be debited, and the revenue account would be credited for the same amount.
Similarly, each and every transaction is recorded with a journal entry. And each journal entry has an impact on at least two accounts. This is the basis of the double-entry accounting system.
Journal entries are the foundation of the double-entry accounting system.
The following steps will illustrate the role that journal entries play in helping accountants prepare a company’s financial statements:
- Every business transaction is recorded with a journal entry. A couple of paragraphs earlier, we gave the example of a cash sale.
- Each journal entry is posted into the general ledger. This is a bookkeeping ledger into which data from the firm’s journals are posted.
- At the end of the accounting period, a trial balance is prepared by adding up the balances in the general ledger.
- The firm’s financial statements are made using the information in the trial balance.
What information goes into a journal entry?
Remember that each journal entry records a single transaction. As it is the first step in the accounting process, the entry must include all the information relevant to the transaction.
Typically, a journal entry could contain the following details:
- The date of the entry.
- A reference to the document on which it is based. This could be an invoice, a receipt, or some other document.
- The account being debited.
- The account being credited.
- The accounting period for which the journal entry pertains.
- The name of the person making the entry.
- A reference number.
- A brief description of the transaction.
As you can see, journal entries contain a wide range of information. These details can help auditors and even the company’s CPA or accountant review the books later.
General accounting journals and special accounting journals
Journal entries could be made in a general accounting journal or special accounting journals. Often, firms use both.
Let’s understand the reasons behind this.
A small company could use a general accounting journal to record all its transactions. This is a good option as the number of journal entries would be limited. However, for a bigger firm, it doesn’t make sense to cram all its journal entries into a single general accounting journal.
So, larger companies typically opt for several special accounting journals. They could create special journals for different categories of transactions. Every activity that requires multiple entries could warrant its own special accounting journal. Here are some examples of special accounting journals:
- Payroll journals: These are used to record payments to employees. They would also include entries for deductions.
- Sales journals: These are a necessity for companies with a large number of sales transactions.
- Purchase journals: Firms that make numerous purchases find these to be useful.
- Cash receipt journals: As the name implies, these are used to record cash receipts. Companies that have large volumes of cash transactions can use these journals to record their cash inflows.
- Cash payment journals: These are a good option for firms that make many cash disbursements.
You should also know that large firms could use both a general accounting journal as well as several special accounting journals. Journal entries that don’t fall under any of the special journal categories are made in the general journal.
Journal entry examples
Now, let’s look at some journal entries to get a practical understanding of how they’re made.
Example 1: A company purchases machinery for its factory and pays for it in cash. This would result in the fixed asset account increasing and the cash account decreasing.
Here’s the journal entry for the transaction:
|
Date |
|
Debit |
Credit |
|
March 20, 2021 |
Machinery account |
$1,000 |
|
|
March 20, 2021 |
Cash |
|
$1,000 |
Example 2: A company pays rent for its factory.
|
Date |
|
Debit |
Credit |
|
March 20, 2021 |
Rent |
$1,000 |
|
|
March 20, 2021 |
Cash |
|
$1,000 |
Example 3: A company buys raw material on credit.
|
Date |
|
Debit |
Credit |
|
March 20, 2021 |
Raw material |
$1,000 |
|
|
March 20, 2021 |
Supplier |
|
$1,000 |
Note: Each journal entry would also include details of the accounting period to which it pertains as well as a reference number, the document reference, and the name of the person who has made the entry.
The bottom line
Journal entries are used to record transactions in a company’s books. These entries play a crucial role in the double-entry accounting system and form the basis of a firm’s financial statements.
