Accounting is crucial for the business to analyze and comprehend the financial status of the entity. Further, it is essential as it points out the business’s financial position. Business leaders analyse the accounting reports to decide whether to invest in a particular business. A business owner can examine the reports to check if they can hire new resources or if they can expand etc. Plus, it also gives an idea of whether the operating expenses are higher.
If you want an answer to all these challenges and doubts, journal entry is the solution. It comprises vital details of credit and debit transactions of the accounting. Each journal entry represents a single business transaction which is later documented in the general ledger. If all the information entered in a journal entry is accurate, then the financial reports can be considered valid. In this blog, let us learn more about journal entries in detail.
What is a Journal Entry?
A journal entry in accounting documents all the business transactions in the accounting books. The journal entries follow the double-entry bookkeeping system (includes credit and debit columns). At least two transactions are made for each journal entry in the double-entry bookkeeping system. What do journal entries contain? The date, the amount to be credited or debited, a brief description of the transaction, and the affected accounts can be found in each of journal entries. Based on the business type, information regarding a list of affected subsidiaries, tax details and other relevant information will be mentioned in the journal entry.
In each journal entry, data should be entered accurately and completely as it impacts the precision of the general ledger and financial statements. Journal entries are documented in chronological order. Debit and credit of a journal entry are associated with multiple accounts. However, the amount of both should balance.
To understand this concept better, let us look at an example, if a business purchases office supplies for Rs 4000, the journal entry is written as a debit entry would be ‘office supplies’ Rs 4000. The credit ‘cash’ is Rs 4000. The debit and the credit entry must be equal.
Relying on accounting software for journal entries will help add the correct information, resulting in fewer errors. In this software, the recurring journal entries are automated and the details are added to the provided template, which will minimise errors.
What should be included in the Journal Entry?
Journal entries are a record of all the business transactions. Adequate and relevant information must be entered for the journal entry if they have to be reflected in the actual financial statements. By having access to journal entries, we gain a detailed account of actual transactions, enabling us to identify any potential inaccuracies or discrepancies rather than relying solely on account balances. This provides a more comprehensive understanding of the inaccuracy in accounts.
The following are the components of journal entries:
- Date of transaction
- Account Name and the number of impacted accounts
- The credit and debit amount
- A reference number(unique identification number for each transaction)
- A brief description of each transaction
What are Debits and Credits?
If your business is following the double-entry bookkeeping method, the debit and credit transactions must be equal. Journal entries must align with the fundamental accounting equation which describes the balance sheet:
Assets = liability + owner’s equity
Debits are entered in the left and the credits are documented on the right. Debits are added to the expense and asset accounts. However, it is subtracted from liabilities, equity balances and revenue.
Credits are opposite of the debits. They are always entered on the right. It is subtracted from the expense and asset balance. Nevertheless, it is added to the revenue and equity balance. The combination of the accounting equation and the act of debiting or crediting accounts dictates that various account categories will typically show either a debit or credit balance.
Also Read : The Role of Journal Entries in Accounting
Why do we need Journal Entry?
The purpose of the journal entry is to accurately record all the transactions. Journal entries for accounting can be documented physically or digitally. In addition, the journal entry will detail if any transaction is impacting multiple accounts. Take, for example, an equipment purchase where shipping fees and installation charges are incurred.
Journal entry forms the basic or the fundamental of effective and accurate accounting. It is categorized into various charts of accounting. Later they are verified for accuracy and finally, it is posted to the general ledger. It is later used in the creation of financial reports to help the decision-makers make accurate decisions for the business.
Journal entries give an accurate and detailed description of every transaction, so it is used for the auditioning process. Both internal and external auditors will scrutinize entries or adjustments that lack adequate documentation, explanations, approvals, or deviate from the typical practices of the business.
How is a Journal Entry in Accounting written?
- ABC Manufacturing Co. purchases Rs 7,400,000 worth of raw materials.
- It pays Rs 740,000 in cash and uses credit for the remaining balance.
- The Raw Materials account is debited by Rs 7,400,000 to reflect the increase in inventory.
- The cash account is credited by Rs 740,000 to show the amount paid.
- Accounts Payable account is credited by Rs 6,660,000 as the company now owes this amount to the vendor in the future.
- Over time, as payments are made, the cash account will continue to be credited and Accounts Payable will be debited.
As raw materials are used to make finished products (toys in this case), the raw materials account is credited to reflect their declining value, and the finished goods account is debited to show an increase in finished inventory.
Types of Journal Entries
In total, there are six types of journal entries. All six journal entry types have their own unique functions in accounting. All types together will provide insightful, accurate and balanced financial statements.
1. Opening Journal Entry
In this type of journal entry, the ending balance is transferred from the previous accounting period to serve as the initial balance for the current accounting period. Let us consider, on the balance sheet from the previous accounting period, the ending balance of the cash account is Rs 9,00,000, after paying all the liabilities during that period. Now the remaining balance, Rs 9,00,000 is the opening balance for the current accounting period.
2. Transfer Journal Entry
This journal entry type allocates or moves an expense or income from one account to another. Let us consider an example of ABC company. From the main account, cash is transferred to the subsidiary account. Hence, in the transfer journal entries, cash is transferred from one account to another and there is no involvement of the third party.
3. Closing Journal Entry
In the closing journal entry, the balance is moved from a temporary account to a permanent account or from the current accounting period to the next one. For temporary accounts, the closing entry resets the account to zero, and any remaining balance is moved to a more permanent account. Later that temporary account is closed.
Some examples of temporary accounts include expense and loss accounts; revenue, income and gain accounts, income summary accounts, and dividend and withdrawal accounts. If we look at the accounting period aspect, the ending balance for that specific account at the end of the accounting period is the closing balance entry. The account is closed for that specific accounting period for such cases.
4. Adjusting Journal Entry
In this type of journal entry, the changes are recorded to accounts generally not accounted for in the journal. Adjusting entries are in agreement with the accrual method of accounting. These changes are recorded in the general ledger at the end of the accounting period on the basis of matching and revenue recognition principles. Accruals, deferrals and estimates are some of the examples of adjusting entries.
⇒Expense accrual: It reports the expenses in a specific accounting period before it is paid. Let us consider the example of electricity used in the plant. After the electricity board reports the monthly utility expense, the amount is paid.
⇒Revenue Accrual: It indicates that the task is done or the product is delivered or the service is provided, however, the customer isn’t invoiced yet.
⇒Expense Deferral: In this type, the payment is made first before the expense is actually incurred. We can take the example of insurance companies where the premium is made for the first six months.
⇒Deferred Value: Here, the payment is accepted by the company in advance and the products or services will be delivered in the future.
5. Compound Journal Entry
This journal entry type records more than one account to be debited or more than one account to be credited. The general rule of journal entry says that the debits and credits have to be equal. However, an exception is given, the debit and credit need not be equal. For instance, assume that for one debit – two credits can be there and for one credit – two debits can be entered. Two or more debits or credits can be entered in this type of journal entry.
An example of compound entries is the payroll process. It involves multiple journal entries, to enter in simple terms, and it can be briefed into a summary.
6. Reversing Entries
This journal entry type is created at the beginning of the new accounting period. The main purpose of the reversing entries is to reverse or undo an adjusting entry made in the previous accounting period. The advantage of this type is that it helps avoid accounting errors happening due to double counting expenses or income. Plus, it can increase efficiency in generating actual invoices in the new accounting period.
Bookkeeping is made simple with the help of reversing entries. Consider this example, if an accrued expense was recorded in the previous accounting period, it can be reversed. This ensures that the expense is recognized in the period when it was actually paid, eliminating the concern of double reporting.
Also Read : Understand Accounts payable Journal Entry in detail
How to prepare Journal Entries for your Business?
The main purpose of creating a journal entry is to make sure that the transactions are documented precisely. Start recording entries by analysing where to add and what transaction to add in the right place.
Relying on accounting software will reduce the hassle and it will help reduce errors. It will help maintain the data flow and will assist in adding relevant information to the accounts. This information will again flow into other relevant accounts which will reduce a lot of work.
If the journal entry process is done manually, then the transactions have to be recorded correctly as it will impact multiple accounts which will affect the company’s books.
• Find out the accounts impacting the transactions
Begin the journal entry process by identifying the accounts wherever the transactions have been affected. So, if you are not familiar with the accounting terms and principles, this step will be confusing. In this step, you are just finding the affected accounts such as the accounts gaining something and the accounts losing due to the transactions.
→Classify transactions first
Categorize the transaction based on the following list:
- Expenses
- Bank Deposits
- Quarterly taxes
Sorting the transactions on these three basis will help in entering the correct information in the journal entry.
→Observe the cash
After sorting the transaction, analyse how these transactions affect values based on debits and credits. Think about how the money came and where it went. Plus, analyse what it has added to the business and what it took away.
→Decide the accounting type
Sometimes, transactions will be hard to sort on the basis of debits and credits. Other times it will be very easy to map out the transactions.
Knowledge regarding basic accounting types is essential – Every journal entry is categorised under fundamental account types: Assets, Liabilities, Expenses, Revenue, and Equity. Recognizing these types facilitates comprehension of their nature, their interplay with other accounts, and the impact of various transactions on them.
Apply standard accounting rules to add debit and credit correctly – Accounting rules standardized the journal entry and financial statements. Clear-cut knowledge about it is essential.
→Prepare your Journal Entry
- Every transaction date should be correctly entered in the right accounting period.
- The accounting name and the unique general ledger code should be mentioned as it is used to report transactions.
- Correctly document the debit and credit transactions. If you are using accounting software, then there will be fewer errors when adding debit and credit transactions. If it is added manually, then it is safer to double-check.
Conclusion
Journal entries are crucial for the accounting of the business. All the transactions are entered in chronological order in the journal entry. You can use an accounting software or ERP system to aptly record all the transactions which will help in preventing errors.
