A guide to understanding Journal Entries
Written byTim Vipond
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What are Journal Entries in Accounting?
In an accounting career, journal entries are by far one of the most important skills to master. Without proper journal entries, companies’ financial statements would be inaccurate and a complete mess.
An easy way to understand journal entries is to think of Isaac Newton’s third law of motion, which states that for every action, there is an equal and opposite reaction. So, whenever a transaction occurs within a company, there must be at least two accounts affected in opposite ways.
For example, if a company bought a car, its assets would go up by the value of the car. However, there needs to be an additional account that changes (i.e., the equal and opposite reaction). The other account affected is the company’s cash going down because they used the cash to purchase the car.
Finally, just like how the size of the forces on the first object must equal that of the second object, the debits and credits of every journal entry must be equal.
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How to Approach Journal Entries
A journal is the company’s official book in which all transactions are recorded in chronological order. Although many companies use accounting software nowadays to book journal entries, journals were the predominant method of booking entries in the past.
In every journal entry that is recorded, the debits and credits must be equal to ensure that the accounting equation (Assets = Liabilities + Shareholders’ Equity) remains in balance. When doing journal entries, we must always consider four factors:
- Which accounts are affected by the transaction
- For each account, determine if it is increased or decreased
- For each account, determine how much it is changed
- Make sure that the accounting equation stays in balance
The best way to master journal entries is through practice. Here are numerous examples that illustrate some common journal entries. The first example is a complete walkthrough of the process.
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Journal Entry Examples
Example 1 – Borrowing money journal entry
ABC Company borrowed $300,000 from the bank
- The accounts affected are cash (asset) and bank loan payable (liability)
- Cash is increasing because the company is gaining cash from the bank, and bank loan payable is increasing because the company is increasing its liability to pay back the bank at a later date.
- The amount in question is $300,000
- A = L + SE, A is increased by 300,000, and L is also increased by 300,000, keeping the accounting equation intact.
Therefore, the journal entry would look like this:
DR Cash 300,000
CR Bank Loan Payable 300,000
Example 2 – Purchasing equipment journal entry
Purchased equipment for $650,000 in cash.
DR Equipment 650,000
CR Cash 650,000
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Example 3 – Purchasing inventory journal entry
Purchased inventory costing $90,000 for $10,000 in cash and the remaining $80,000 on the account.
DR Inventory 90,000
CR Cash 10,000
CR Accounts Payable 80,000
Example 4 – Acquiring land journal entry
Purchased land costing $50,000 and buildings costing $400,000. Paid $100,000 in cash and signed a note payable for the balance.
DR Land 50,000
DR Buildings 400,000
CR Cash 100,000
CR Note payable 350,000
How to Track Journal Entries
A significant component of accounting involves financial reporting. Financial reporting is the act of presenting a company’s financial statements to management, investors, the government, and other users to help them make better financial decisions.
To determine the final monetary value of accounts listed on the financial statements on the company’s year-end, multiple journal entries are recorded and tracked in an account called a T-account, which is a visual representation of a general ledger account.
The appropriate debits and credits are listed under the appropriate columns under the T-Accounts to determine the final value to be reported. Click the link below to learn more about T-Accounts.
Why Do Journal Entries Matter to Me and My Career in Accounting?
Although recording journal entries can be very monotonous and repetitive, recording accurate entries at the right time is imperative for companies to show their correct financial status to not only people within the firm but also to external users.
With inaccurate entries, companies may be perceived to be possessing more debt or less debt or as more profitable or less profitable than they actually are. As a result, this could lead companies and investors to make decisions based on false, misleading information, leading to negative ramifications.
Having the skills to record and understand journal entries is essential in any career in accounting, whether you are involved in public practice and are working on a client’s audit file, or you are working in an industry and helping to prepare a company’s financial statements.
In simple terms, the first step to proper financial reporting heavily relies on recording accurate journal entries.
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More Resources
Thank you for reading CFI’s Journal Entries Guide. To that end, we have published many more additional resources you will find helpful:
- Closing Entry
- T-Accounts
- Accounting Careers
- The Job of a CFO
- See all accounting resources
