Journal entries are the cornerstone for recording and reflecting the financial situation of a company. They are not just a simple entry in a ledger, but a reflection of the day-to-day operations that keep a company running. But what exactly are journal entries and how are they done properly? Find out more in the following post.
Table of Contents
1. What are accounting entries?
Accounting entries are records that reflect the economic operations carried out by a company in a given period. These entries are essential to be able to prepare the financial statements, which are the reflection of the economic and financial situation of the organisation. Each accounting entry is recorded in the journal and subsequently transferred to the general ledger.
An accounting entry consists of:
- Date: indicates the day on which the transaction took place.
- Account Receivable and Account Payable: In accounting, for every action that modifies the company’s assets, there is a value owed and a value credited. This is known as the double entry principle.
- Description or Concept: A brief description of the transaction performed, providing context as to why the entry was made.
- Amount: The figures corresponding to the transaction are entered in the debit and credit columns, as appropriate.
1.1 Principle of double entry
One of the fundamental bases of accounting is the double entry principle. This means that every transaction will affect at least two accounts. If one account increases, another must decrease by an equivalent amount, thus ensuring that the accounting equation (Assets = Liabilities Equity) is always balanced.
For example, if a company buys a machine for 1,000 euros and pays cash, the accounting entry will reflect an increase in the fixed asset account (the machine) and a decrease in the cash account.
2. Defining characteristics of an accounting entry
An accounting entry is an entry made in the accounting records to reflect an economic transaction that affects the assets of an entity. The following are the defining characteristics of an accounting entry:
- Double Entry: One of the fundamental principles of accounting is the double entry system. This means that each accounting entry must have at least two entries: a debit and a credit. These entries reflect the principle that each change in assets should be offset by a corresponding change in liabilities or equity (and vice versa).
- Balancing: The total of the amounts recorded on the debit side must equal the total of the amounts recorded on the credit side. In other words, an accounting entry must always balance.
- Date: Each accounting entry must bear the date on which it is made or on which the economic operation being recorded takes place.
- Description or Concept: It is important that each accounting entry is accompanied by a brief description or concept that explains the nature of the transaction being recorded.
- Affected Accounts: In the accounting entry, the accounts being debited and credited should be specified. These accounts must be part of the entity’s chart of accounts.
- Monetary Values: Each entry in the journal entry should carry a figure in monetary terms indicating the value of the transaction.
- Ordering: Journal entries should be recorded in an orderly manner, usually chronologically, according to the date on which the transactions occur.
- Continuity: Once an accounting entry has been recorded in the books, it should not be deleted or removed. If an error is detected, a rectifying entry should be made, but the original entry remains as evidence of the transaction recorded.
- Documentary reference: It is recommended, but not always obligatory, that each accounting entry has a reference to the source document that justifies the operation (invoice, receipt, contract, etc.). This reference facilitates the tracing and verification of transactions.
- Clarity and Legibility: Accounting entries must be clear and legible, avoiding ambiguities and allowing any person with accounting knowledge to understand the nature and purpose of the record.
3. How to make accounting entries?
Making accounting entries is a fundamental process in accounting that requires accuracy and understanding of the financial transactions and events affecting an entity. The following are the general steps in making accounting entries:
- Identify the Transaction: Before recording any journal entry, it is essential to understand the nature of the transaction. This may be a purchase, a sale, a loan, a payment, etc. It is useful to review the associated documentation, such as invoices, receipts, contracts, etc.
- Determine the Affected Accounts: Once you understand the transaction, you must identify the accounts that are affected. For example, if the company makes a purchase of goods on credit, the affected accounts could be “Purchases” and “Suppliers”.
- Apply the Double Entry System: Under this system, each transaction will affect at least two accounts. One account will be debited (debit) and one account will be credited (credit). It is crucial to correctly determine which account to debit and which to credit.
- Establish the Transaction Amount: Determine the exact value of the transaction to be recorded in the affected accounts.
- Make the Journal Entry: In the journal, write the date of the transaction. Then, list the accounts to be debited and credited, along with the corresponding amounts. It is also advisable to include a brief description or concept explaining the nature of the transaction.
- Check the Balance of the Entry: Make sure that the totals debited and credited are equal. If they are not, there is an error that must be corrected before proceeding.
- Documentary Reference: Note the reference of the source document justifying the entry (invoice number, contract, etc.) for future checks or audits.
- Record in subsidiary ledgers (if necessary): Depending on the accounting structure of the company, it may be necessary to make detailed records in subsidiary ledgers, such as the sales ledger, purchases, cash, banks, among others.
- Transfer to the General Ledger: Periodically, journal entries are transferred or “posted” to the general ledger, where they are organised by account and balances are updated.
- Review and Verification: It is good practice to regularly review and verify journal entries to detect and correct errors.
- Make Adjustments and Rectifications: If at any time errors are detected or adjustments are required (e.g. at the end of the accounting period), it is necessary to make adjusting or rectifying entries.
When making accounting entries, it is crucial to have a sound knowledge of accounting principles and to be familiar with the entity’s chart of accounts. It is always advisable to have persons with an accounting background perform or supervise these entries to ensure the accuracy and reliability of the entity’s accounting.
4. Importance of accounting entries
The importance of journal entries lies in their role as the backbone of a company’s accounting. These records are crucial to maintaining the completeness and accuracy of financial information. The following are some of the aspects that highlight their relevance:
- Reflection of Financial Reality: Accounting entries allow companies to record and monitor all their economic transactions. This means that, by reviewing these records, a clear and up-to-date picture of the company’s financial situation can be obtained.
- Basis of Financial Statements: Financial statements, such as the Balance Sheet, Income Statement and Cash Flow Statement, are prepared from the information contained in the journal entries. These reports are essential for management, investment and financing decisions.
- Legal and Tax Compliance: In many countries, companies are required by law to maintain accurate and up-to-date accounting records. These records are essential for determining tax obligations, such as income tax, VAT, among others. Proper accounting helps to avoid penalties and legal problems.
- Double Entry Principle: Accounting entries follow the double entry principle, ensuring that the accounting equation always balances. This ensures that each transaction is properly reflected in the corresponding accounts, maintaining the integrity of the accounting system.
- Traceability and Auditing: Accounting entries provide a detailed historical record of all economic transactions of the company. This is vital when conducting internal or external audits, as it facilitates the review and verification of financial information.
- Internal Control: They help companies to detect and prevent errors, fraud or misappropriation. A well-managed accounting system acts as a control mechanism, allowing irregularities or deviations to be identified.
- Informed Decisions: In order for management to make informed strategic decisions, they need accurate and up-to-date financial information. Accounting entries provide this information, enabling financial analysis to guide decision making.
In short, journal entries are not simply records in a ledger or in software; they are the representation of a company’s financial life. Without them, it would be virtually impossible to manage, analyse or understand the financial and economichealth of any organisation.
5. What are the types of accounting entries?
Accounting entries can be classified in different ways according to their nature and function. It is crucial for anyone in charge of accounting in a company to understand these different types of journal entries and when to use them. Each journal entry has its purpose and, if used properly, will ensure that the company’s financial statements accurately reflect its economic and financial position.
The most common types of journal entries are described below:
5.1 Opening Entry
The Opening Entry is the first accounting entry made at the beginning of a new financial year. Its purpose is to reflect the financial position of the company at the beginning of that period, based on the balance sheet of the previous year.
This entry incorporates all the balances of the balance sheet accounts (assets, liabilities and equity) into the journal of the new financial year, thus ensuring continuity in the company’s accounting from one year to the next.
5.1.1 Characteristics of the Opening Entry
- Itrepresents the beginning: It marks the start of the new accounting period, establishing the basis on which all transactions in the new financial year will be recorded.
- Itincorporates previous balances: It is based on the closing balances of the previous year’s accounts, which become the opening balances of the new year.
- No impact on the result: Unlike other journal entries, the opening journal entry has no impact on the result of the year (profit or loss) because it does not involve income or expense accounts.
5.1.2 Basic structure of the Opening Entry
When making the opening entry, asset accounts are debited (debit) and liability and equity accounts are credited (credit). In general terms, the structure could look like this:
- Debit: All asset accounts are debited with the values they present in the previous year’s balance sheet.
- Credit: All liability and equity accounts are credited with the values they show in the previous year’s balance sheet.
It is essential that the opening entry is correctly prepared, as it establishes the initial basis for the new year’s accounting and ensures the consistency and continuity of the company’s financial information.
5.2 Simple journal entries
Simple journal entries are accounting records that reflect a single economic transaction and involve only two accounts: a debit account and a credit account. In other words, in a single journal entry, only one entry is made on the debit side and only one on the credit side.
This type of journal entry is based on the fundamental principle of accounting called the “double entry principle”, which states that for every movement or change in a company’s assets, liabilities or equity, there will always be at least two accounts affected to keep the accounting equation balanced.
5.2.1 Examples of Simple Journal Entries
- Purchase of office supplies in cash: Suppose a company purchases office supplies worth EUR 100 and pays in cash. The accounting entry would reflect a decrease in the cash account and an increase in the office supplies expense account.
- Debit: Office supplies expenses 100 euro.
- Credit: Cash 100 euro.
- Repayment of a bank loan: If a company pays EUR 500 to repay a bank loan, there would be a decrease in the cash account and a decrease in the loan debt.
- Debit: Bank loan EUR 500
- Credit: Cash 500 euro
- In these examples, it can be seen how each transaction affects only two accounts. It is essential for bookkeepers to understand and identify when to make a simple journal entry, as it is a basic and frequent tool in the daily accounting process.
5.3 Composite Journal Entries
Composite journal entries are accounting records that reflect a transaction or economic event involving more than two accounts. In other words, in a compound journal entry, there may be multiple debit and credit entries. Despite the greater complexity compared to simple journal entries, compound journal entries also obey the double entry principle, ensuring that the total of the debit side always equals the total of the credit side.
Compound journal entries are especially useful for recording transactions that affect several accounts simultaneously and are common in transactions such as asset purchases financed partly in cash and partly on credit, or dividend distributions where part is paid in cash and part in shares, among other examples.
5.3.1 Examples of Compound Entries
- Financed purchase of a machine: Suppose a company purchases a machine for a value of EUR 10,000, paying EUR 4,000 in cash and committing to pay the balance in one year. The accounting entry would reflect an increase in fixed assets (the machine), a decrease in cash and an increase in accounts payable.
- Debit: Machine 10,000 euros
- Credit: Cash 4,000 euros
- Credit: Accounts payable Accounts payable 6,000 euros
- Sale of products with discount and VAT: A company sells products for a value of EUR 1,200, gives a discount of EUR 200 and applies VAT at 10%. The journal entry would reflect the sales revenue, the discount granted and the output VAT.
- Debit: Customers 1,100 euros (1,000 euros net value 100 euros VAT)
- Credit: Sales 1,000 euro
- Credit: Sales Sales discounts for prompt payment 200 Euro
- Credit: Output VAT 100 euro
These examples illustrate how in a compound journal entry, a single transaction can affect several accounts at the same time. It is crucial for accountants to understand and handle these entries correctly, as they provide a more detailed and accurate representation of the economic operations of the company.
5.4 Adjusting entries
Adjusting entries are accounting entries made at the end of the accounting period with the objective of bringing the accounting accounts in line with the economic reality of the company before the financial statements are presented. These entries ensure that the accounting complies with the accrual principle, which states that income and expenses should be recognised in the period in which they are actually generated, regardless of when they are received or paid.
Adjusting entries are essential to reflect an accurate and up-to-date picture of the company’s financial position. They may arise due to a variety of situations, such as expenses or income that have been accrued but not recorded, depreciation, provisions, and so on.
5.4.1 Examples of Adjustment Entries
- Accrued expenses: Suppose the company has not recorded the December salary of its employees to be paid in January of the following year. An adjusting entry is needed to recognise this expense in December, even though the disbursement is made later.
- Debit: Wages and salaries expense (Profit and loss account)
- Credit: Wages and salaries payable (Liability account)
- Accrued Income: If a company rendered services in December, but will not issue the invoice until January, it should record an accrued income.
- Debit: Customers (Asset Account)
- Credit: Income from services (Profit and Loss Account)
- Depreciation: To recognise the loss in value of a fixed asset over time.
- Debit: Depreciation expense (Profit and loss account)
- Credit: Depreciation accrual (Asset account that decreases the value of the original asset)
- Provisions: If the company estimates that it will have a future debt, such as a product guarantee.
- Debit: Guarantee expense (Profit and loss account)
- Credit: Provision for guarantees (Liability account)
- Inventory adjustments: If a physical inventory reveals differences with respect to the accounting record.
- Debits: Loss on inventory adjustment (Profit and Loss Account) and/or Inventories (Asset Account)
- Credit: Gain on inventory adjustment (Profit and Loss Account) and/or Stocks (Asset Account)
These entries ensure that the financial statements are aligned with the economic and financial reality of the enterprise at the end of the accounting period, enabling management, investors and other stakeholders to make decisions based on accurate and relevant information.
5.5 Closing entries
Closing entries are accounting entries made at the end of the financial year for the purpose of closing temporary accounts (mainly income, expenses and other income accounts) and transferring their net balance to permanent accounts, such as equity. These entries prepare the books for the new accounting period, leaving a zero balance in the accounts that reflect the economic performance of the period.
The main purpose of closing entries is to determine and record the result for the period, whether a profit or loss, and to update the balance of the retained earnings or equity account, which forms part of equity in the balance sheet.
5.5.1 Closing entries process
- Closing income accounts: All income account balances are transferred to a temporary account called the profit and loss account.
- Debit: Income accounts
- Credit: Profit and Loss Account (or similar)
- Close expense accounts: All balances of expense accounts are transferred to the profit and loss account.
- Debit: Profit and loss account (or similar)
- Credit: Expense accounts
- Determine the result for the year: Once the income and expense accounts have been closed, the profit and loss account will show the result for the period. If there is a debit balance, it indicates a loss. If there is a credit balance, it indicates a gain.
- Transfer the result to the retained earnings or equity: Depending on the balance of the profit and loss account, a gain or loss will be recorded in the retained earnings account.
- If a gain:
- Debit: Profit and loss account
- Credit: Retained Earnings or Capital
- If a loss:
- Debit: Retained Earnings or Capital
- Credit: Profit and Loss Account
- If a gain:
- Close withdrawal or dividend accounts: If the owner or shareholders have withdrawn funds or received dividends during the year, these accounts will also be closed and their balance transferred to the capital or retained earnings account.
- Debit: Capital or retained earnings account
- Credit: Withdrawals or Dividends
After making these entries, the temporary accounts are left with a zero balance, ready for the next accounting period. Balance sheet accounts, on the other hand, retain their balances to form the basis for the opening entry of the next accounting period.
5.6 Amending entries
Rectifying entries are accounting entries made to correct errors or inaccuracies that have occurred in the accounting during the recording of previous transactions. These errors may arise for a variety of reasons, such as income or expenses recorded for an incorrect amount, duplication of records, omissions, among others.
These journal entries are essential to ensure thecompleteness and accuracy of the financial statements, as they adjust the figures and present a true and fair view of the economic and financial position of the enterprise.
5.6.1 Characteristics of Rectifying Entries
- They do not alter the original result: Unlike other journal entries, the purpose of an amending entry is not to reflect a new transaction, but to correct a previous entry. Therefore, once the adjustment has been made, the situation should reflect what it would have been if the error had not occurred in the first place.
- They must be justified: It is essential to accompany these journal entries with a detailed explanation or justification of the error and the correction made in order to maintain transparency and traceability in the accounting.
5.6.2 Examples of Rectifying Entries
- Error in the amount: Suppose a company recorded the purchase of material for EUR 500 when in fact the correct amount was EUR 550. The amending entry should record the difference of EUR 50.
- Debit: Material expenses 50 euro
- Credit: Suppliers or Banks 50 euro
- Duplication of entries: If a company recorded a sales revenue of EUR 1,000 twice, the amending entry should reverse one of these entries.
- Debit: Sales 1,000 euro
- Credits: Customers 1,000 euro
- Omission of an entry: If the company forgot to record a monthly rent of 300 euro, the correcting entry would be:
- Debit: Rent expense 300 euro
- Credit: Suppliers or Banks 300 euro
It is crucial that accountants promptly detect and correct any errors through correcting entries, as financial statements based on incorrect information can lead to erroneous decisions by management, investors and other stakeholders. In addition, accurate accounting is a legal and ethical requirement for any business.
5.7 Adjustment entries
- Regularisation of Income and Expenses: The balances of income and expense accounts are transferred to a suspense account, generally referred to as the “Profit and Loss Account”. The objective is to determine the profit or loss for the period.
- Debit: Income accounts
- Credit: Profit and Loss Account (to bring the income to zero)
- Debit: Profit and Loss Account Profit and Loss Account
- Credits: Expense Accounts (to bring expenses to zero)
- Regularisation of Purchases and Sales: If accounting is carried out considering taxes such as VAT, it may be necessary to make regularising entries to separate the net of the purchase or sale from the corresponding tax.
- Provisions and Adjustments: Adjustments are made to take into account items such as depreciation, provisions for bad debts, inventory adjustments, among others.
Once the regularisation entries have been made and the result for the year (profit or loss) has been determined, the closing entries are made and the final financial statements are prepared.
It is essential to carry out these entries correctly so that the financial statements show a true and fair view of the economic and financial situation of the company. In addition, regularisation is an essential step to comply with accounting and tax regulations in many countries.
5.8 Off-balance sheet items
Extraordinary entries are accounting records that relate to unusual or infrequent transactions in the normal activity of the company and which, due to their nature, cannot be classified as ordinary transactions. These transactions are exceptional in nature and do not occur regularly in the company’s business cycle.
Extraordinary entries generally relate to events or transactions that are unusual and unexpected. For example, the sale of a division of the enterprise, a claim that results in significant damage to the enterprise’s property, or the receipt of an indemnity.
5.8.1 Examples of Extraordinary Entries
- Casualty gains or losses: If a company suffers damage to its assets as a result of a natural disaster, and receives an insurance claim, the recording of this transaction would be an extraordinary entry.
- Debits: Banks (for the amount of the indemnity)
- Credit: Extraordinary Income (for the indemnity received)
- Sale of a non-current asset: If a company sells a piece of land that was not intended for sale in its ordinary business.
- Debits: Banks (for the amount received)
- Credits: Land (for the book value of the land)
- Debits or credits: Extraordinary Gains or Losses (for the difference between the book value and the sales price)
- Restructuring costs: If the company incurs costs associated with the restructuring of its operations.
- Debit: Extraordinary Expenses (in the amount of the cost)
- Credit: Suppliers or Banks (for payment or commitment to pay)
- Severance payments: If the company has to pay exceptional indemnities, e.g. to an executive upon termination of his contract.
- It must: Extraordinary Expenses (for the amount of the severance payment)
- Credits: Suppliers or Banks
These entries allow the separation of ordinary and extraordinary transactions, which facilitates the analysis of the company’s core business . In financial statements, extraordinary items are often presented separately so that users can clearly distinguish results arising from ordinary activity from those arising from unusual events or transactions.
Journal entries are an essential tool in accounting, as they provide a systematic and detailed record of all financial transactions and operations occurring within an enterprise. These records, based on the double-entry system, ensure that the economic activities of the entity are properly represented, accurately reflecting the financial and equity reality of the business. It is crucial that the professionals in charge of keeping these records have a thorough understanding of accounting principles and standards to ensure accuracy and transparency in the presentation of information.
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