What is a Journal Entry?

Whether you are a professional accountant, a bookkeeper, or a small business owner, you need to understand journal entries.  Journal entries are key in recording and tracking business transactions.   Everything you want to know about a business financial-wise lies in the information written in journal entries.

A journal entry is a record of a business transaction recorded in a journal.  Each entry includes a date, account name/number, amount, brief description, and a reference number.

Historically all business transactions required a manual entry into a specific journal.  Journals such as the sales, purchases and the payroll journals were typical journals used to accumulate like transactions.  Then periodically, summary totals from each journal were transferred via a journal entry to the general ledger which summarized all business transactions.

While this may seem time consuming and mundane, today accounting software automates much of this process.  All you have to do is enter a sale or a purchase and the software does the rest.  

Because of accounting software, the most common journal entries created today are accrual entries, adjusting entries or non cash depreciation and amortization type entries.  However, understanding the logic behind an accounting system helps you manage your business better.

What is a journal entry?

A journal entry is a written record of a business transaction. It is the standardized way bookkeepers and accountants keep track of assets, liabilities, revenue and expenses of a business.

Each journal entry is one part of the big accounting system. Whenever a business buys, sells, pays, or otherwise uses or receives money or other assets in some fashion, it gets recorded as a journal entry. Journal entries help a business owner keep track of the business activity.

It may sound complicated but it's rather simple! Let's say Company XYZ pays their electric bill of $90. A journal entry would then record this transaction as an $90 increase to utility expense and a $90 reduction of cash.  

Of course, this is a very simplified explanation.  Keep reading to understand what is included in a journal entry and specific examples of journal entries.

What is included in a journal entry?

Every journal entry has five things: A date, an account, an amount credited or debited, a description, and a reference number. They are all necessary for one reason or another.

• Date: Day, month, and year of the transaction. All three are required in a good journal entry and allow an accountant to properly classify transactions into time periods.
• Account: The account is typically represented by an account number and name.  An account essentially is a bucket that accumulates like data.  For instance, 1000 Cash, 4000 Sales, 6500 Utility Expense.  Each of these buckets tracks the running total balance for that particular account.
• Amount: The amount is self-explanatory and documents the dollar value of the transaction.  It may be money coming or going out.
• Description: The description is a simple one- or two-line sentence that gives a brief detail of what the transaction was all about.  An example may be “paid $2,000 for payroll”
• Reference number: The reference number is a unique, sequential number that keeps track of all journal entries.  By using a sequential number, it is easy to identify missing entries and keep them in chronological order.

Journal entry examples

The best way to understand journal entries is to see an example.  In the examples below you will notice a minimum of two lines for every journal entry.  This is a principle in accounting known as double entry.  

Double entry is the method used to keep everything in balance.  There is always a debit and a credit to every journal entry and the debits and credits must equal.

Within accounting there are 5 main categories:  assets, liabilities, owner’s equity, revenue and expenses.  Each of these categories is either increased or decreased by a credit or a debit.

Assets – debit balance

Liabilities – credit balance

Owners’ Equity – credit balance

Revenue – credit balance

Expense – debit balance

Accordingly, the opposite of the balance type noted above will decrease the category.  For example, since assets is a debit balance, a credit will decrease assets and a debit will increase assets.

EXAMPLE #1

Company XYZ pays the monthly electric bill for their home office of $90 on 12/15/20xx.

Utilities $90
Cash $90

(Utilities expense is increased with a debit of $90 and cash is decreased with a credit of $90)

EXAMPLE #2

Company XYZ pays the biweekly payroll for their office employees amounting to $5,000 on 12/15/20xx.

Payroll Expense $5,000
Cash $5,000

(Payroll Expense is increased with a debit of $5,000 and cash is decreased with a credit of $5,000)

EXAMPLE #3

Company XYZ sales $10,000 of widgets, on credit, to one of their customers on 12/15/20xx

Accounts Receivable $10,000
Sales $10,000

(Accounts receivable an asset is increased with a debit of $10,000 and sales is increased with a credit of $10,000)

EXAMPLE #4

Company XYZ records the monthly depreciation expense associated with fixed assets on 12/15/20xx

Depreciation Expense $1,000
Accumulated Depreciation $1,000

(Depreciation expense is increased with a debit of $1,000 and accumulated depreciation is increased with a credit of $1,000)

What types of journal entries are there?

There are essentially four types of journal entries: a normal journal entry, a reversing entry, an adjusting entry, and a compound entry.

• Normal journal entry:  This is the routine type of journal entry for the daily operations of a business.  Each of the journal entries above would reflect a normal entry.  Only two accounts are affected.
• Compound journal entry: Compound entries are nothing but complex normal journal entries. When you write down two or more business transactions instead of one, you're making a compound journal entry. This is often used when you need to record multiple transactions done in one day.  A compound journal entry may only comprise one transaction but it affects multiple accounts.  An example might be payroll which includes wages, payroll tax, withholding amounts, etc.  Because multiple accounts are affected it is considered a compound entry.  The debits and credits still must equal.
• Reversing journal entry: At the beginning of every accounting period, reversing entries are made to cancel entries made in previous accounting periods. This is a tedious and boring process, more often than not made via software and not manually.  An example of a reversing journal entry would be payroll.  Often a pay period may overlap the end of the month.  To properly match payroll related to the previous month a journal entry is recorded for the amount of payroll related to that month and then reversed to offset the full payroll recorded int the subsequent month.
• Adjusting journal entry: Adjusting entries are just that, entries that adjust a mistake, a beginning balance or some other circumstance.

As mentioned previously, journal entries used to be a very manual process but with the development of accounting software most accounting functions are automated and behind the scenes.  However, most businesses still require a few journal entries a month to produce accurate financial information.

Understanding and recording journal entries produces accurate financial information that business owners, investors and managers can then trust.  The foundation of financial information is the journal entry regardless if it is manually or automatically generated.