By far one of the most important skills to master is the ability to write journal entries. Businesses’ financial statements would be inaccurate and a complete mess if proper journal entries were not made.
Understanding Journal Entries in Small Business Accounting
To understand journal entries, consider Isaac Newton’s third law of motion, which states that every action has an equal and opposite reaction. As a result, whenever a transaction occurs within a company, at least two accounts must be affected in opposing ways.
For example, if a company purchases a car, the value of the car is added to the company’s assets. However, there must be a separate account that changes (i.e., the equal and opposite reaction). The other account that has been impacted is the company’s cash, which has decreased because the cash was used to purchase the car.
Finally, just as the forces on the first object must be equal to those on the second, the debits and credits of each journal entry must be equal.
How to Use Journal Entries
A journal is the official book of the company in which all transactions are recorded in chronological order. Although many businesses now use accounting software to book journal entries, journals were once the primary method of doing so.
The debits and credits in each journal entry must be equal to ensure that the accounting equation (Assets = Liabilities + Shareholders’ Equity) remains balanced. When writing journal entries, we must always keep four things in mind:
- Which accounts will be impacted by the transaction?
- Determine whether each account’s balance has been increased or decreased.
- Calculate the amount of change for each account.
- Make certain that the accounting equation remains balanced.
Practice is the best way to master journal entries. Here are a variety of examples of common journal entries. The first example is a step-by-step walkthrough of the procedure.
Journal Entry Examples
Example 1 – Journal Entry for Borrowing Money ABC Company obtained a $300,000 bank loan. Cash (asset) and bank loan payable (liability) are the accounts that are affected Cash is increasing because the company is receiving cash from the bank, and bank loan payable is increasing because the company’s liability to repay the bank at a later date is increasing.
The sum at issue is $300,000 A = L + SE, where A is increased by 300,000 and L is also increased by 300,000 to maintain the accounting equation. As a result, the journal entry would be as follows:
|Bank Loan Payable||300,000|
Example 2 – Journal Entry for Purchasing Equipment Equipment (asset) was purchased for $250,000 in cash (asset). The journal entry would be as follows:
Example 3 – Journal Entry for Purchasing Inventory Assuming that you purchased inventory worth $100,000 and you paid cash on $20,000 and $80,000 on credit The journal entry would be as follows:
Example 4 –Land acquisition journal entry The land cost $50,000, and the buildings cost $400,000. I paid $100,000 in cash and signed a note to pay the balance later. The journal entry would be as follows:
How to Keep Track of Journal Entries
Financial reporting is an important aspect of accounting. Financial reporting is the presentation of a company’s financial statements to management, investors, the government, and other users in order to assist them in making better financial decisions.
Multiple journal entries are recorded and tracked in an account called a T-account, which is a visual representation of a general ledger account, to determine the final monetary value of accounts listed on the financial statements at the company’s year-end.
Learn What is a General Ledger in Accounting To determine the final value to be reported, the appropriate debits and credits are listed in the appropriate columns of the T-Accounts.
Why Are Journal Entries Important to Me and My Business?
Although recording journal entries can be tedious and repetitive, recording accurate entries at the right time is critical for businesses to show their true financial status to not only internal users but also external users.
Companies with inaccurate entries may appear to have more or less debt or to be more or less profitable than they actually are. As a result, companies and investors may make decisions based on false or misleading information, resulting in negative consequences.
Having the ability to record and understand journal entries is essential in any accounting career, whether you work in public practice and are working on a client’s audit file, you work in your own business or you are assisting in the preparation of a company’s financial statements.
In layman’s terms, the first step toward proper financial reporting is to record accurate journal entries.
Try Tracepos free for 14 days.
No credit card is required
With Tracepos, you can overcome the challenges of running a successful business while improving your entire operations. This allows you to complete real-time, daily, weekly, quarterly, month-end, yearly, and historical reports in a matter of clicks rather than days or weeks.