The success of a business is measured by the amount of profit it makes or the losses it incurs in a fiscal year. Proper and accurate accounting is the only way through which a business can estimate this success. Accounting is not just a legal requirement. It also enables business owners to manage their transactions, make better decisions for the growth of their business, and create end-of-the-year financial statements. However, 82% of businesses in the United States of America fail due to poor cash flow and accounts management. This statistic stresses the importance of diligent bookkeeping and journal entries.
Here is a crash course for you to learn the ABCs of journal entries. Read on to find out more.
When you make a transaction, it is recorded into a journal. This simple process is known as a journal entry.
For example, if you received $500 for the services you provided to your customer, then this is a successful transaction, and it must be recorded in the journal.
The entire accounting cycle is a 9-step process. The following image shows the various stages.
As you can see in the image above, journal entries make the second step in the cycle. In the first step, all the financial transactions take place. They also include the collection of all documents like bank statements, receipts, and invoices, after which they're recorded in a journal.
Keeping track of all the transactions in a fiscal year can get exceedingly difficult if they are not properly recorded and organized. A sheet journal entry helps in clearly sorting out all your transactions so that they form meaningful data. It also makes it easy to find any errors that have taken place during accounting.
Apart from this, the final financial statements, which mark the eighth step in the accounting cycle, are created using the data from the journals.
There are two ways in which bookkeeping can be done.
- Singly-entry method
- Double-entry method
The single-entry method is a simple method for beginners with no experience in bookkeeping. However, it isn’t a reliable method to follow. As a result, many people prefer to follow the double-entry method.
This method of recording transactions has been used for many decades, if not centuries. The double-entry method basically means that two accounts are affected for every transaction entered in a journal.
One account shows the debit, and the other shows the credit that takes place. This can easily be explained using the following example.
Let us consider that you are the owner of a small business that sells hardware products. When a customer purchases a particular product from you, they pay in cash or by card.
When you enter this transaction in a journal by following the double-entry method, changes are made in two columns. The account dealing with money shows a debit as it has increased, and the account that is responsible for the inventory shows a credit as it has decreased.
The entire goal of this process is to balance out the debit and the credit account by making them equal.
Apart from entering credit and debit, other basic details like the date, names of the affected accounts, and reference numbers are also added for better understanding.
Another important thing that you must understand first is the role of assets, liabilities, equity, revenue, and expenses.
- Assets are what you own or what has value, like cash, inventory, property.
- Liabilities are what you owe to others, like bank loans.
- Equity includes assets that you or stockholders completely own.
- Revenue is what you earn from sales or interest.
- Expenses include things that you normally spend on, like rent, salaries, etc.
All of the above-mentioned elements are linked to debit and credit.
Whenever a debit is made, the following happens,
- An increase in assets and expenses
- A decrease in liabilities, equity, and revenue
Credits play the opposite role.
- It decreases the assets and expense, and
- Increases the liabilities, equity, and revenue
When the credit and debit are balanced, the following accounting equation is also balanced,
Journals come in different types, each specific to a particular kind of business. However, they are generally classified into two broad categories.
- General journals
- Specific journals
The general journal is meant for small businesses or sole proprietors. Here, any transaction that is made is logged into the journal.
In the second type, the specific journal is used to record specific transactions. For example, one journal will record the sales alone, while another will focus on the purchases. This is primarily used by large companies and industries.
We understand that a lot of information has been given to you, and digesting all of it might not be easy. So what better way to explain the entire process of a journal entry exmaple than with a set of examples? The following journal examples are all general journals.
Let us take into consideration that you borrowed $100,000 from the bank on 17th April 2021
Now the accounts that change because of this move are -
- Cash, which is an asset as you gain money, and
- Money payable to the bank, which is a liability as you have to pay this money back later.
There is no equity in this problem which makes the accounting equation equal.
In a journal, the debit is always entered on the left-hand side while the credit is entered on the right.
When you make this entry into the journal, this is what it looks like -
Emma decided to invest $10,000 into her own company on 24th April 2021.
Due to this decision, two accounts were affected.
- The cash account as $10,000 was gained by the company (asset)
- The capital account, which is the owner’s equity
Once you make the entry into the journal, it would look like the following,
Let us consider one final example, which has two entries.
Michael bought $500 worth of paper supplies for his paper company on 10th May 2021, but he gets the supplies on the account and pays the amount a week later.
So when the entry is made on 10th May, two accounts are changed.
- The inventory, which is an asset to the company, and
- The account payable to the supplier, which is a liability.
After a week, on 17th May, Michael makes the payment of $500 for the supplies.
This affects two accounts again.
- The cash account, but this time as credit because the money is being spent. A
- The account payable to the supplier but this time as a debit because the liability is being removed.
When both entries are made to the journal, the debit equals the credit.
At this juncture, you have made all the entries of every transaction into your journal. Adjusting journal entries are made right at the end of the accounting period or fiscal year to ensure that all the information is up to date. This also marks step 6 in the accounting cycle.
Adjusting journal entries consist of two main types - accruals and deferrals.
This relates to revenue and expenditure that you haven’t recorded. Accrued revenue refers to the income that you earned for your service but did not receive (like a delayed payment). Accrued expense is quite the opposite. It relates to the services that you have received but have not yet paid for them (like paying monthly salaries).
Deferrals link to the money that you spend even before you benefit from the services. Examples may include one-year memberships or property insurance.
Adjusting journal entries are made right at the end to balance the journal.
This marks the last step in the accounting cycle. In this stage, you divide your business into two accounts - temporary and permanent. The permanent account consists of all the assets, liabilities, and capital. The temporary account contains the revenue and the expenses.
The aim of this is to reset your temporary account to zero as you head into a new accounting period and transfer all the balances into the permanent account.
Journal entry isn’t a cakewalk, especially for beginners. If you are a novice at this, then it may even cost you valuable time to keep your books balanced. But at the same time, it is vital for your business' steady growth.
However, there is another easier way to do this; one that allows you to spend all your time focusing on your dreams and ideas and taking your business to greater heights.
We at Fincent are here to take care of all your bookkeeping needs and help you make your business' growth hassle-free. We believe that you were born to create, not do bookkeeping. Schedule a call with us and get a free 1-month trial today!