Journal entries are where your business’ financial health begins. Think of them as constituting your business's activity log. If you're unsure how to track your financial transactions or how to begin to take control of your finances in general, it is a good idea to begin by tracking your business’ activities. This log holds all the key information that will ultimately form your financial statements. 

Regardless of whether you are a solopreneur or a small business owner, this guide will explain the significance of journal entries in accounting and outline the essential steps involved in creating them accurately. We'll also touch upon common challenges businesses face and how a systematic approach to journal entries can alleviate these challenges.

What exactly are journal entries?

A journal entry is, at a fundamental level, a record of a financial transaction in chronological order. It's the initial step in the accounting process, acting as a detailed log of every financial event that impacts your business—your financial “log,” as it were. Within double-entry accounting, each journal entry requires at least two accounts to be affected: one debit and one credit, with the total debit amount always equaling the total credit amount. This ensures that the fundamental accounting equation (Assets = Liabilities + Owner's Equity) is balanced out, making sure your financial records are accurate.

Components of a journal entry

Each journal entry comprises several key components that together provide a complete and understandable record of a transaction.

Debits and Credits

Debits and credits are the “yin and yang”—the two sides—of every journal entry. They will show you how different types of accounts are increased or decreased. As a rule of thumb:

• Debits increase asset and expense accounts, while they decrease liability, owner's equity, and revenue accounts.
• Credits increase liability, owner's equity, and revenue accounts, while they decrease asset and expense accounts. 

For every transaction, the total value of the debits must always equal the total value of the credits. This fundamental rule ensures the accounting equation remains balanced. From our experience, we’ve seen businesses find it helpful to think of debits as what the business receives and credits as what the business gives up in a transaction (this also serves as a good memorization tool).

Date and description (for context)

To be helpful, a journal entry should have the date on which the transaction occurred. This ensures a chronological record of all financial activities, which makes them easier to track and to look back when needed. You should always add a brief—but helpful—description of the transaction. This further helps you identify what that transaction was about.

For example, instead of simply writing "Supplies," you can be proactive and save your future self potential trouble by writing "Purchase of office supplies from Staples, invoice #12345." This can help you save a lot of time in a future audit if you find any discrepancies.

Account titles

In each journal entry, you should specify which accounts from your chart of accounts are affected by the transaction. These account titles identify the specific assets, liabilities, owner's equity, revenues, or expenses involved.

Say your business received cash for a service it has provided; in this case, the accounts affected might be "Cash" (an asset) and "Service Revenue" (a revenue account). When you categorize and group your data in this manner, you are able to analyze your data more meaningfully, making better-informed business decisions.

Reference numbers (when applicable)

You can go above and beyond—or, if your business commonly has a large number of transactions, be diligent—by attributing an “ID” or reference number to each entry. For that, you can use invoice numbers, cheque numbers, or any other unique identifier related to the transaction.

Reference numbers provide an audit trail, making it easier to trace a journal entry back to its original source document. This is particularly helpful when reviewing transactions, investigating discrepancies, or during an audit. For example, linking a sales journal entry to the corresponding sales invoice allows for quick verification of the transaction details.

Types of journal entries

Although all journal entries follow the same blueprint and have similar sections, different types are used for different purposes in accounting. Needless to say, it is important to select the appropriate type for each entry to maintain accuracy. Here are some common types:

General journal entries

General journal entries are used for the vast majority of day-to-day business transactions that don't fit neatly into specialized journals.

General entries are used for day-to-day business transactions. If you can’t fit a transaction too neatly into one of the specialized journals below, this is the one to use. Here are some examples of general journal entries:

• Sales of goods or services.
• Purchases of inventory or supplies.
• Cash receipts and payments.
• Expenses like rent, utilities, and salaries.  

For most small businesses, the general journal is the primary place where financial transactions are initially recorded using the double entry accounting method.

Adjusting entries

Adjusting entries are crucial for ensuring that your financial statements accurately reflect your business's financial position at the end of an accounting period (e.g., month, quarter, or year). These entries typically involve non-cash transactions and are necessary to comply with the accrual basis of accounting. Common types of adjusting entries include: 

• Accrued Revenues: Recognizing revenue that has been earned but for which cash has not yet been received. For example, if you completed a service for a client in the current period but haven't invoiced them yet, an adjusting entry would record this revenue.
• Accrued Expenses: Recognizing expenses that have been incurred but for which cash has not yet been paid. An example would be salaries earned by employees at the end of the period that will be paid in the next period.  
• Depreciation: Allocating the cost of a long-term asset (like equipment) over its useful life.  
• Unearned Revenues: Adjusting for cash received in advance for services or goods that have not yet been provided.  
• Prepaid Expenses: Adjusting for expenses paid in advance that have now been used up. For instance, if you paid for an annual insurance policy upfront, an adjusting entry would recognize the portion of the insurance that has expired during the period.

Closing entries

Closing entries are made at the end of an accounting period to reset the balances of temporary accounts (revenue, expense, and dividend accounts) to zero. This process transfers the net income or loss for the period to a permanent owner's equity account (like retained earnings).

Closing entries are a key step in the accounting cycle, ensuring that each new accounting period starts with a clean slate for temporary accounts. If you would like to know more, we also have an article specifically on opening and closing entries.

Reversing entries

These are optional entries made at the start of an accounting period used to reverse certain adjusting entries made in the previous period. Their purpose is to simplify the recording of routine transactions in the new period and are most commonly used for accrued revenues and expenses.

Say, if you accrued salary expense at the end of the previous period, a reversing entry at the beginning of the new period would debit the accrued salaries payable and credit salary expense. This allows you to record the subsequent cash payment of salaries in the usual way, without needing to remember the prior accrual.

Compound entries

Finally, a compound journal entry is used when a single transaction affects three or more accounts. Instead of creating multiple separate journal entries, a compound entry combines all the related debits and credits into one entry.

For example, if your business receives a lump sum payment from a customer that includes both sales revenue and sales tax, a compound entry would debit the cash account for the total amount and credit both the sales revenue account and the sales tax payable account. Using compound entries can help allows you to reduce the number of total entries, speeding up the workstream.

How to create a journal entry?

Creating accurate journal entries requires a systematic approach. Here are the essential steps that SMB owners should follow:

You should aim at following a clear and systematic system for creating journal entries. We believe following these steps is a good way to get there:

Analyze the business transaction

The initial step—and likely the most important—involves understanding the transaction. What happened? Which accounts are affected? Will those accounts increase or decrease?

Determine which accounts to debit and credit

Now that you understand the transaction, you need to determine which specific accounts from your chart of accounts will be debited and which will be credited. Remember the fundamental rule of double-entry accounting: for every transaction, the total debits must equal the total credits. Consider the example of receiving cash for services:

• Cash is an asset that increases, so it will be debited.  
• Service Revenue is a revenue account that increases, so it will be credited.  

Ensuring this balance is maintained is critical for the accuracy of your financial records. Understanding the nuances of debits and credits can be a hurdle, but it's a foundational concept that can help your business in the future.

Enter the transaction in the journal

You've analyzed the transaction and determined the accounts to debit and credit. Now, the next step is to record the journal entry in your general journal. This involves entering the following information:

• Date: The date the transaction occurred.
• Account Titles: The names of the accounts being debited and credited. It's standard practice to list the debit account(s) first, followed by the credit account(s), often indented slightly.  
• Debit Amount(s): The monetary value of the debit(s), entered in the debit column.  
• Credit Amount(s): The monetary value of the credit(s), entered in the credit column.  

Description: A brief but clear explanation of the transaction.

Journal Entry Example

Below are two examples of journal entries- one to the general journal, and another to the sales journal.

What is the Purpose of a Journal Entry?

We make journal entries in accounting to record, calculate, and analyze the company’s overall financial position. The financial information recorded in daily journal entries is gathered and summarized in the business’ financial statements at the end of each accounting period. These statements include a balance sheet, income statement, and cash flow statement.

Where to record journal entries?

The methods businesses use to record journal entries have evolved significantly over time. Here's a look at some common approaches, along with their pros and cons:

Manual Spreadsheets

Many small businesses initially start recording journal entries using spreadsheets like Microsoft Excel or Google Sheets.

• Pros: Spreadsheets are generally inexpensive and familiar to most users. They offer a basic way to organize financial data.  
• Cons: Manual data entry in spreadsheets is time-consuming and increases the risk of errors. Spreadsheets lack built-in accounting controls and audit trails, making it difficult to ensure accuracy and track changes. As businesses grow, managing a large volume of transactions in a spreadsheet can become cumbersome and inefficient.  

Manual Ledgers

Traditionally, businesses used physical ledgers to record journal entries. While less common today, some businesses still use this method.

• Pros: Provides a tangible record of financial transactions.  
• Cons: Extremely time-consuming, prone to errors, and lacks the efficiency and analytical capabilities of digital solutions. It's also difficult to scale as the business grows.  

Digital Solutions

Modern digital accounting software like QuickBooks offers a comprehensive solution for recording and managing journal entries.  

• Automation: Automates many aspects of the journal entry process, reducing manual data entry and the risk of errors. For example, when you create an invoice or record a payment, the software automatically creates the corresponding journal entries in the background.  
• Accuracy: Built-in controls and checks help ensure the accuracy of journal entries. The double-entry system is automatically enforced.
• Efficiency: Saves significant time and effort compared to manual methods, allowing business owners to focus on other aspects of their operations.  
• Real-Time Visibility: Provides up-to-date financial information, enabling better and faster decision-making.  
• Audit Trails: Automatically tracks all changes made to journal entries, providing a clear audit trail for compliance and review.
• Integration: Integrates with other business functions like invoicing, payroll, and bank reconciliation, streamlining overall financial management. For example, you can easily connect your bank account to QuickBooks for seamless transactions. 
• Scalability: Easily scales with your business as transaction volumes increase.

As your business expands, the limitations of manual methods become increasingly apparent. The time saved, accuracy improved, and insights gained from using digital accounting software like QuickBooks can be invaluable in managing your financial health and driving growth. By automating the journal entry process, you can minimize errors, gain a real-time view of your finances, and free up valuable time to focus on strategic initiatives.

Empowering your business with digital solutions

Accurate and timely journal entries are the bedrock of sound financial management for any business, but especially for small and growing ones. While the principles of double-entry accounting and the process of creating journal entries might seem daunting at first, understanding their importance and following a systematic approach is crucial for gaining valuable insights into your business's financial performance.

Embrace the power of digital financial solutions such as QuickBooks to streamline your accounting processes, automate journal entries, and minimize errors. By leveraging these tools, you can save valuable time, gain a clearer understanding of your financial data, and ultimately empower your business to make more informed decisions for sustainable growth and success.

FAQ

What is the journal entry for an expense?

Suppose a company needs to pay an expense, possibly for its employees’ wages, out of their cash account. The journal entry for a wage expense should be recorded as a debit, while a credit would be adjusted to the cash account for the same amount.

What are the basic journal entries?

Basic journal entries of a business include purchasing an asset, buying and selling of inventory, and paying the expenses in cash.

Accounting software now allows for the automation of journal entries, the scanning of receipts with your phone, and uploading it to your journal books. Connect all your accounts, organize receipts, automatically sort entries, track incomes, and expenses with the QuickBooks expense tracker feature. Why not try it free today?

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