Everything you need to know about Accounting Journal Entries

Journal entries are the bread and butter of accounting for small businesses. They are the primary means by which financial transactions are recorded, providing a detailed, chronological record of all business activities. Each entry consists of a date, a description of the transaction, and the amounts debited and credited to specific accounts.

But why are journal entries so important? They serve several critical functions for small businesses:

1. Record-keeping: Journal entries provide a clear and organized record of all financial transactions, making it easier to track income, expenses, assets, and liabilities.
2. Financial analysis: By keeping accurate journal entries, small business owners can analyze their financial performance over time, identify trends, and make informed decisions about the future of their business.
3. Compliance: Properly recorded journal entries ensure that small businesses comply with tax laws and regulations, reducing the risk of audits or penalties.
4. Communication: Journal entries provide a common language for communicating financial information to stakeholders, such as investors, lenders, and employees.

In this article, we’ll delve deeper into what journal entries are, how to create them and provide examples to help you better understand their importance in managing your small business finances.

How-to Guide for Creating Journal Entries:

Creating journal entries may seem daunting at first, but with a clear understanding of the process, small business owners can accurately record their financial transactions. Follow these steps to create journal entries for your business

• Identify the Transaction:
  • Start by identifying the specific transaction that needs to be recorded. This could include sales, purchases, expenses, or any other financial activity.
• Determine the Accounts Affected:
  • Determine which accounts will be affected by the transaction. For example, a sale would affect the revenue account, while a purchase would affect an expense or asset account.
• Apply the Double-Entry System:
  • Remember that every transaction involves at least two accounts: one account will be debited, and another will be credited. The total debits must equal the total credits for each transaction.
• Select the Appropriate Accounts:
  • Choose the accounts to debit and credit based on the nature of the transaction. For example, a sale would debit the accounts receivable or cash account and credit the revenue account.
• Determine the Amounts:
  • Determine the amounts to be debited and credited for each account. The amounts should be based on the value of the transaction and the specific accounts affected.
• Record the Journal Entry:
  • Record the journal entry in the general journal, using a consistent format. Include the date of the transaction, a description of the transaction, the accounts debited and credited, and the amounts.Example:

• Post to the General Ledger:
  • After recording the journal entry, post the amounts to the general ledger, which is a record of all accounts used by the business. This step helps keep track of the balances in each account.
• Review and Adjust:
  • Periodically review your journal entries to ensure they are accurate. If necessary, make adjustments to correct any errors or discrepancies.
• Use Accounting Software:
  • Consider using accounting software to simplify the process of creating and recording journal entries. Many accounting software programs offer templates and automation features to help you manage your finances more efficiently.

By following these steps, small business owners can create accurate journal entries that provide a clear and detailed record of their financial transactions.

Journal entry examples

You’ve got a busy day today. You’re going to meet up with a client, pick up some office supplies, and stop by the bank to make a loan payment.

You get paid by a customer for an invoice

When you’re visiting with your client, they pay the $600 invoice you sent them.

The date lets you know when the entry was recorded.

The description includes relevant notes—so you know where the money is coming from or going to. In this case, it’s the invoice number.

Debit notes that $600 is being added to your cash account.

Credit notes money leaving cash. In this case, there’s no money being paid out.

At the same time you make this entry, you’d make another in the accounts receivable (aka money clients owe you) ledger account.

The money is being removed from accounts receivable—your client doesn’t owe you $600 anymore—so it’s listed as a credit (written in parentheses). Here, the credit amount and debit amount are the exact same.

You picked up some office supplies

On the way back from meeting with your client, you stopped to pick up $100 worth of office supplies.

Cash journal

When the invoice was paid, money entered the cash account, so we recorded it as a debit. But now money is leaving the account, so we credit the account for the amount leaving.

Expense journal

Just as every action has an equal and opposite reaction, every credit has an equal and opposite debit. Since we credited the cash account, we must debit the expense account.

You make a payment on your bank loan

Finally, you stop at the bank to make your loan payment. When you make a payment on a loan, a portion goes towards the balance of the loan while the rest pays the interest expense. This is called loan principal and interest.

This is an example of a compound entry. This happens when the debit or credit amount is made up of multiple lines.

Let’s look at a payment of $1,000 with $800 going towards the loan balance and $200 being interest expense.

Cash journal

For the cash side, we record the $1,000 leaving the account (a credit).

Expense journal

In the expense journal, we record a debit for the amount that went towards interest separately from the amount that reduces the balance.

Loan journal

Finally, we record a debit for the amount that went towards the principal.

Here, the debit was broken up into multiple lines: the interest amount and the principal amount.

Conclusion:

Accounting journal entries are the foundation of a small business’s financial record-keeping. They provide a detailed and chronological account of all financial transactions, ensuring accuracy and transparency in the company’s financial statements. By following the steps outlined in this guide, small business owners can effectively create and record journal entries for their business.

It’s essential for small business owners to understand the importance of accurate journal entries in maintaining financial health. Properly recorded journal entries not only help in tracking income, expenses, assets, and liabilities but also aid in financial analysis and compliance with tax laws and regulations.

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