A Guide To Accounting Journal Entries

As a startup owner or C-suite executive, it's easy to overlook the nitty-gritty of your finances amid the hustle of raising investments, finalizing deals, and launching new products. But keeping accurate records of your business transactions is just as crucial as your other duties.

While journal entries happen automatically in modern accounting software, understanding what goes on behind the scenes is a must for startup owners and decision-makers. Learning how to read and make journal entries isn't just about tracking your expenses and revenues. It's about taking a proactive approach to your business finances. They help you comprehend the actual costs of running your business, understand your company's financial standing, and make informed business decisions that steer your startup toward success.

In this article, you'll discover what journal entries are, their types and significance, how to record them in your accounting books, and the common mistakes to avoid in bookkeeping.

Definition of Accounting Journal Entries

An accounting journal entry (commonly known as a bookkeeping entry) is the fundamental building block of double-entry bookkeeping, the most widely used modern accounting system. Simply put, it's a method to formally record your financial transactions. When you make a journal entry in accounting, you enter the transaction details in your company's books. Here, books refer to your virtual bookkeeping software, spreadsheet, or any other tool that you use to record your financial transactions.

Their Role in the Accounting Cycle

Journal entries are the first step of the accounting cycle. They serve several purposes, such as:

• Record keeping: Every financial transaction your business makes is recorded as a journal entry. This includes everything from purchases, invoices, salaries paid, loan payments, rent, utilities, sales, other income, etc.
• Accuracy and Transparency: Journal entries offer clear chronological proof of your company's financial activities. This transparency allows for easy monitoring of expenses, revenue, and cash flow. With accurate and timely journal entries, you have a reliable accounting system that you can share with potential investors and taxation authorities when needed.
• Financial Reporting: Financial reports like balance sheets, income statements, and profit and loss statements are created using the data in the general ledger, which is derived from journal entries. These reports provide critical insights into your business's financial performance and health, helping you make informed decisions that ensure the long-term success of your startup.

Key Components

All journal entries include the following details:

• Date: The date of the transaction. This helps maintain chronological order and track your business's cash flow. It's also helpful when calculating your taxes at the end of an accounting period.
• Accounts Affected: In double-entry bookkeeping, a journal entry always impacts two accounts, reflecting the two sides of every transaction: credit and debit. The entry includes the account name and numbers for easy reference.
• Debit and Credit: Each bookkeeping entry will either be credited or debited. A debit entry indicates an increase in the expense or asset account and a decrease in a liability account. A credit entry is the opposite. It represents a decrease in an asset account and an increase in a liability account. The total debits in an entry must always equal the total credits to maintain balance.
• Amount: The amount of money involved in the transaction.
• Description (Optional): While this isn't mandatory, it's a good accounting practice to include a brief description of the transaction. This provides additional context and clarity and is helpful for future references.

Types of Journal Entries

Journal entries can be classified into four basic types, each with a specific purpose. They are:

Standard

As the name implies, a standard entry is the most basic type of journal entry used throughout the accounting cycle. It records a single, complete financial transaction. In the double-entry bookkeeping system, you always make a standard entry in two different accounts. It debits one account and makes an equal credit to another. This ensures that total debits always equal the total credits, balancing assets and liabilities.

Let's illustrate this with a double-entry journal sample. Imagine your company purchases stationery for $300. In a standard entry, you'll make a recording in your debit account as office supplies ($300). This account increases as your company now has new supplies worth $300. The corresponding entry in your credit account is cash ($300). The credit account decreases by $300 as your company pays cash to purchase the supplies.

Adjusting

Adjusting entries are a special type of journal entry that makes adjustments or corrections to transactions that have been previously recorded. Unlike standard entries made throughout the reporting period, adjusting entries are typically made at the end of an accounting period, usually before creating financial statements. These entries provide a complete picture of a company's financial health by accounting for transactions that haven't been recorded completely. They are temporary entries that affect only the current accounting period and often involve multiple accounts. Accrued expenses, prepaid expenses, and depreciation are a few types of adjusting entries.

Recurring

As the name implies, a recurring journal entry is repeated and occurs in every accounting period. It repeats daily, weekly, monthly, quarterly, or annually. Some recurring entries involve the same amounts and accounts in every accounting period, while others involve the same accounts but have differing amounts. Salary payments, rent expenses, and insurance payments are a few examples of recurring journal entries.

Reversing

Reversing entries are made to reverse or cancel out journal entries made in a previous accounting period. They're used in conjunction with adjusting entries. Unlike standard and recurring entries, reversing entries are optional. Your financial statements will be accurate, irrespective of whether you use reversing entries. They're mainly used to simplify recordkeeping and add clarity to your financial statements.

Consider an example. Company X accrues $2,000 in vendor payments at the end of December (accounting period 1). This is reflected in an adjusting account entry debiting vendor payment and crediting accounts payable. At the beginning of January (accounting period 2), the company made a reversing account entry that credits vendor payments and debits accounts payable. This reverses the previous transaction and brings the payable account back to zero, ready to record for January.

As you can see, reversing entries help adjust your financial records instead of deleting transactions, helping maintain the integrity of your company's financial statements.

How To Make an Accounting Journal Entry

Here's a quick step-by-step guide to making an entry in a journal of accountancy:

Step 1: Identify the transaction

The first step is to identify the financial transaction that needs to be recorded in your accounting journal. Gather details such as what happened, when, and the amount involved. This could be a payment to your supplier, a sale your team closed, or salaries you paid to your employees.

Step 2: List out the affected accounts

As mentioned above, in double-entry bookkeeping, each transaction has two sides. Identify the accounts impacted by the current transaction. One account will increase (debited), and the other will decrease (credited) by the same amount. Once you've identified the accounts, you must determine which increases and which decreases.

Step 3: Record the entry

This is the final step, in which you journalize the transaction. Use the data collected in the previous steps to record the actual entry. Make sure to include the following details:

• Date of transaction
• Debit account (Dr.)
• Credit account (Cr.)
• Amount
• Description (Optional)

Here's an example to illustrate a sales entry in an accounting journal.

Scenario: A furniture maker sells office equipment worth $1,500 to Customer X on credit.  The customer promises to pay within 30 days. Here's the corresponding journal entry for this transaction:

‍

Remember, this is just a basic example of an accounting journal entry. In real life, you'll have more complex transactions that require compound entries and a deeper understanding of different account types. Using automated accounting software can help simplify the process and eliminate manual errors in accounting journal entries.

Common Mistakes and How To Avoid Them

Here are some of the errors that businesses are likely to make when they start with journal accounting:

• Data entry errors: Typos or manual mistakes in entering account numbers or amounts can disrupt the entire process, leading to huge inaccuracies. Accounting software with built-in data validation can help you avoid data entry errors by automating the entire process.
• Wrong classification: This is one of the most common errors. Recording asset accounts as expenses, or vice versa, can distort your financial statements. Make a list of all accounts and classify them as assets or expenses. Share this chart with all accounting team members so they can look it up for quick reference while recording journal entries.
• Imbalanced entries: Every journal entry in accounting has equal debits and credits. An unbalanced entry indicates an error. Accounting software usually prevents unbalanced entries from being recorded.
• Omissions: Forgetting to record a financial transaction is an omission. Standardizing the accounting process can help you capture all financial activity.

Start Your Journey Towards Accurate Accounting

Accurate accounting provides a strong foundation to build and grow your startup. It empowers you to make informed decisions, get clarity on where you're spending money, and confidently navigate the financial landscape. By understanding the basics of journal entries and bookkeeping, you'll be able to master the art of financial management for your business. Adopting an automated daily accounting and bookkeeping platform can help you avoid manual errors and build accurate financial statements that build business credibility and integrity in the long run.

‍