Journal entries are records of financial transactions made by a business detailing sales, expenses, and payments. They provide a clear, organized way to track a company’s money flow, ensuring accurate financial records and enabling informed decision-making.
As a small business owner, you probably wear many hats throughout the day. In Sarah’s case, for instance, she’s not just the owner of a cozy cafe in Miami; she’s also the pastry chef, cashier, and bookkeeper. Juggling these roles can make for a hectic schedule, especially when it comes to managing the café’s finances.
Don’t get us wrong. She loves what she does, especially interacting with her regular customers and experimenting with new frappuccino flavors (think Coffee Jelly Frappe and Strawberries and Cream Frappe!).
However, managing the café’s finances is not quite her cup of tea (pun intended!).
We’ll take Sarah’s practical challenges as a starting point to explore what journal entries are, why they’re crucial, and how you can make your own.
What is a journal entry?
Think of a journal entry as a detailed record of a business’s financial activities. They serve as the foundational records in bookkeeping, mentioning the essential details of financial transactions for accurate accounting.
Simply put, journal entries mark the first step in keeping track of all the money coming in and going out.
When a transaction happens, like buying supplies or getting paid by a customer, the business writes down important details: when it happened, how much money was involved, which accounts were affected (like cash or sales), and a short note about the transaction.
These details are what we call journal entries.
Did you know?
The concept of journal entries in accounting dates back to the 15th century? Back then, rather than using fancy accounting software, bookkeepers would record transactions in actual journals!
These journal entries are then organized in a big book called the General Ledger. It’s like the main hub for all the company’s financial information.
Bigger companies use a more efficient system, double-entry bookkeeping (we’ll discuss it in the upcoming sections), to ensure everything’s in order. That means every transaction gets recorded twice, once as money coming in and once as money going out (what we call debits and credits). On the contrary, smaller businesses might keep it simpler by recording transactions once.
Understanding the General Ledger
Think of the general ledger as the foundation of your financial reporting that holds everything together.
Once you record business transactions, they don’t just sit there gathering dust. Instead, they’re transferred or “posted” to your general ledger. This ledger serves as the central repository, summarizing all your journal entries in one place.
Why is it so crucial?
Well, it’s the tool you use to generate financial statements – such as your income statement, balance sheet, and your cash flow statement.
These statements provide valuable insights into your business’s financial performance. They offer a snapshot of your business’s health and tell you whether you are thriving or struggling to stay afloat.
Plus, they’re not just for show. They play a vital role in ensuring accurate tax filing, helping you navigate through tax season without any roadblocks.
Methods of journal entry: Single-entry vs. double-entry accounting
When it comes to making journal entries, there are two main methods based on the type of accounting used: single-entry and double-entry.
Double-entry accounting is like having a GPS guiding you with both your starting point and your destination. It records not only where the money is coming from but also where it’s going.
On the other hand, single-entry accounting is much simpler. It’s like jotting down your expenses and income in a checkbook. You just note down each transaction without worrying about where the money came from or where it’s going.
While single-entry accounting is simpler, double-entry is the most common method used today. That’s because it provides a more comprehensive view of a business’s financial status.
Debits and credits
The magic of balanced books happens when your debit journal entries and credit journal entries perfectly offset each other. It’s all about keeping things in harmony to maintain those balanced books.
Debits increase asset and expense accounts, reflecting money or resources coming into the business or spent on its operation. At the same time, a debit decreases liability, equity, or revenue accounts, indicating a reduction in what the business owes or earns.
On the flip side, credits are used to record transactions that either bring in revenue, increase liabilities or equity, or reduce assets or expenses.
Types of journal entries
Here, you will find the main types of journal entries commonly used in bookkeeping. To help illustrate their application, we’ll use examples from Sarah’s café. This way, you can see how different transactions are recorded and how they impact financial statements directly.
1. Standard journal entries
Being the most common type of journal entry, these entries involve routine transactions such as sales, purchases, expenses, and revenue recognition. They follow a standardized format and are regularly recorded in the accounting system.
Sarah sells coffee and pastries worth $500 in cash.
| Account | Debit | Credit |
| Cash | $500 | |
| Sales Revenue | $500 |
2. Adjusting journal entries
They are made at the end of an accounting period to ensure that the financial statements accurately reflect the company’s financial position. These entries typically involve accruals, deferrals, depreciation, and allowances for doubtful accounts.
Sarah accrues an expense for electricity that has been used but not yet billed for $150
| Account | Debit | Credit |
| Utilities Expense | $150 | |
| Accrued Liabilities | $150 |
3. Reversing journal entries
Reversing entries are made at the beginning of an accounting period to cancel out the effects of adjusting entries made in the previous period. This simplifies the accounting process and ensures that transactions are recorded in the correct period.
Reversing the previous accrual for electricity at the beginning of the new month.
| Account | Debit | Credit |
| Accrued Liabilities | $150 | |
| Utilities Expense | $150 |
4. Closing journal entries
Closing entries are made at the end of an accounting period to transfer the balances of temporary accounts (such as revenue, expenses, and dividends) to the retained earnings account. This resets the temporary accounts to zero in preparation for the next accounting period.
Closing the revenue and expenses at year-end.
| Account | Debit | Credit |
| Sales Revenue | $100,000 | |
| Income Summary | $100,000 | |
| Income Summary | $70,000 | |
| Expenses | $70,000 |
5. Reclassification journal entries
Reclassification entries involve transferring amounts from one account to another to correct errors or allocate costs properly. These entries ensure that financial information is accurately categorized and presented in the financial statements.
Sarah initially records an expense under “General Supplies” for $200, but realizes it should have been allocated to “Kitchen Supplies”.
| Account | Debit | Credit |
| Kitchen Supplies Expense | $200 | |
| General Supplies Expense | $200 |
6. Compound journal entries
These entries involve more than two accounts where multiple debits and/or credits are recorded in one single journal entry. They are used when a single business transaction impacts multiple accounts.
Sarah buys kitchen equipment for $1,000, paying $600 in cash and the remaining $400 through a note payable.
| Account | Debit | Credit |
| Kitchen Equipment | $1,000 | |
| Cash | $600 | |
| Notes Payable | $400 |
7. Opening journal entries
As the name suggests, opening entries are made at the beginning of an accounting period to set up the balances in the ledger accounts, based on the balances carried forward from the previous period.
Sarah would make an opening journal entry when starting the new fiscal year with opening balances.
| Account | Debit | Credit |
| Cash | $5,000 | |
| Inventory | $2,000 | |
| Accounts Payable | $1,000 | |
| Retained Earnings | $6,000 |
General vs. specialty journals: what you need to know
Different businesses require different types of journals to manage their bookkeeping. These typically fall into two main categories: general journal and specialty journal.
The General Journal serves as a comprehensive record, capturing transactions that do not fit neatly into specific categories. This might include entries for interest income or unusual expenses, such as repair costs for unexpected equipment failures or regulatory fines. It’s also the place for making adjusting entries to ensure account accuracy.
Specialty Journals, also known as books of first entry, are used for recording frequent, routine transactions that are typical for a business. Each journal corresponds to a particular type of transaction and is listed in the chart of accounts, which functions as a directory for your financial records.
Here are some examples of common specialty journals and the types of transactions they might record:
- Sales Journal: To record income from sales transactions.
- Sales Returns Journal: Transactions involving refunded sales.
- Accounts Receivable Journal: For tracking money owed to your business.
- Accounts Payable Journal: Managing money your business owes.
- Equity Journal: Includes transactions related to retained earnings and owner’s investments.
- Purchases Journal: Keeping track of payments made for goods or services.
- Cash Receipts Journal: Documenting money received.
These journals help organize financial records, making it easier to track a business’s income, expenses, and overall financial health.
How to record a journal entry (journal entry example)
So, what would a typical day look like for Sarah in terms of recording journal entries when multiple things are happening all at once? Let’s take a closer look at that and understand journal entries through it.
Early in the morning, a customer orders specialty coffees and pastries totaling $300. Sarah records this sale in her sales journal:
- Date: March 10, 2024
- Description: Coffee and pastry sale
- Debit: $300 (adding to cash, as the customer pays in cash)
- Credit: $300 (revenue from the sale)
A bit later, a customer returns a specialty tea worth $50, unsatisfied with the flavor. Sarah records this in her sales returns journal:
- Date: March 10, 2024
- Description: Refund issued for returned tea
- Debit: $50 (reducing revenue from the initial sale)
- Credit: $50 (deducting from cash, as the refund is given in cash)
Midday, Sarah buys $120 worth of vanilla-flavored icing from a local supplier to restock her pantry. She records this expense in her expense journal:
- Date: March 10, 2024
- Description: Purchase of vanilla-flavored icing
- Debit: $50 (increasing expenses)
- Credit: $50 (reducing cash)
Toward the end of the day, a regular customer settles their tab of $200 for the week. Sarah records this payment in her cash receipts journal:
- Date: March 10, 2024
- Description: Payment received for weekly tab
- Debit: $200 (increasing cash)
- Credit: $200 (reducing accounts receivable)
For a step-by-step guide on preparing your journal entries, make sure to read: How to prepare journal entries for your business.
The bottom line
It’s completely understandable for small business owners like Sarah to struggle with bookkeeping, as her expertise lies in roasting coffee beans and toasting sandwiches, not crunching numbers.
However, understanding how journal entries work is essential to staying informed about whether your sales, expenses, refunds, or other transactions are being documented accurately.
To save yourself the trouble and ensure accuracy in your financial records, speak to an expert at CoCountant. Proficient in the world’s best accounting software, we’ll handle your bookkeeping for an irresistibly low monthly price – so you can focus on growing your business.
FAQs
What is a general journal entry in accounting?
A general journal entry is the primary record-keeping tool in accounting. It systematically captures a wide range of financial transactions. It typically includes the date of the transaction, a brief description, the accounts affected, and the corresponding debit and credit amounts. These entries are then posted to the general ledger for further analysis and preparation of financial statements.
