Journal entries in accounting are the cornerstone of effective record-keeping. They are records of every transaction you make in your business, so you should understand their purpose to ensure accurate record-keeping.
In this guide, you'll learn the different types of journal entries, why they matter, and how to create and record them.
What is a journal entry?
A journal entry is a record of a transaction you make in your business. It also details what accounts are affected and how.
With double-entry accounting you record every transaction you make twice — once as a debit and once as a credit.
This accounting method is based on the principle that every transaction has an equal and opposite effect on your asset and liability accounts.
For example, when you pay a bill, your cash balance will change, but so will accounts payable.
Why are journal entries important?
Journal entries are important because they are the basis of your financial statements.
Accurately recording your business transactions and how they affect different accounts is vital for understanding your business's financial health.
Journal entry credits and debits
Journal entry credits and debits work together in accounting, to keep your financial transactions balanced. For every debit you record, there will be a corresponding credit.
Credit
A credit is recorded on the right-hand column of your journal entry. It represents a decrease in your asset, gain or expense account and an increase in your liability, equity, gain or revenue account.
Debit
A debit is recorded on the left-hand column of a journal entry and represents an increase in your asset, loss or expense account and a decrease in your liability, equity, loss or revenue account.
A debit (DR) is an entry made on the left side of an account. It either increases an asset or expense account or decreases equity, liability, or revenue accounts
On the other hand, a credit (CR) is an entry made on the right side of an account. It either increases equity, liability, or revenue accounts or decreases an asset or expense account (aka the opposite of a debit).
What are the different types of journal entry?
There are a few types of journal entries you should be aware of:
Opening entries
An opening entry is the first entry of a new tax period. This can be a new tax year, month or quarter. For accounting purposes, you start fresh with your financial transactions at the beginning of every period, and you need to note how much money you have. This is called your opening entry.
Closing entries
Closing entries are made at the end of accounting periods. They're used to close temporary accounts and transfer those balances to your permanent business accounts. In business accounting, temporary accounts include revenue (money coming in) and expenses (what you owe). These accounts are closed at the end of the fiscal year, so the balance is zero.
The balances are transferred to permanent accounts like retained earnings or assets and liabilities. These permanent accounts are cumulative and show what your business owns, owes and is worth overall. This reset allows you to start again with those temporary accounts for all your transactions in the next tax period.
Transfer entries
A transfer entry is made when you transfer an amount from one account to another within your business.
Adjusting entries
Adjusting entries are used when you need to change entries you've already recorded. They make sure the transactions match the correct accounting period. You might need to adjust entries if you use accrual accounting and a customer hasn't paid an invoice. This is called an accrual entry. You'd use a deferral entry when a customer has prepaid but you haven't done the work. This is also known as unearned revenue. Adjusting entries means you can record expenses and sales revenue within the same tax period, giving you a solid idea of your financial position.
Compound entries
Compound entries are combinations of more than one journal entry — with more than one credit, debit or affecting multiple accounts.
Reversing entries
Reversing entries are ways to reverse an accrual entry so that there's no double-up in numbers when the actual transaction occurs.
Let's say you've billed a customer and recorded the transaction in one tax period, but they haven't paid yet.
Reversing this entry means you won't record the same transaction twice when the customer pays you. Reversing entries are the exact opposite of the original accrual entry, usually made on the first day of the new tax period.
What to include in a journal entry
Knowing what to include in a journal entry is vital to ensuring accuracy.
Date of transaction and entry type
Include the date of the transaction and the entry type you are closing or reversing, for example.
Unique reference number for transaction
A unique reference number for each transaction makes the entry easy to identify later.
Each account impacted by transaction
Each account impacted by the transaction should be detailed in your journal entry.
For example, if you pay a bill, your cash account would be affected by money going out, and your accounts payable account would be affected by decreasing the amount you owe.
Amount credited and debited by the transaction
Note the amount credited and debited by the transaction. The credit and debit amounts should be the same.
Description of the transaction
Add a description of the transaction. This helps with auditing and catching any errors later. Your description could be an invoice number and customer name for sales or a reason for a spend, such as "toner for the office printer."
How to create and record journal entries
Knowing how to create and record journal entries is important for ensuring your financial records are accurate. It can help you:
Identify and determine what accounts will be affected by the transaction
It's important to identify and determine what accounts will be affected by the transaction. Each transaction will affect more than one account.
For example, if you pay a bill, your cash account will be affected because money will go out. Your accounts payable will also be affected because the amount of money you owe will decrease.
Identify the account to credit or debit
You need to identify the account to credit or debit in the journal entry.
When paying a bill, you'd debit accounts payable, which indicates a decrease in your liability. Your cash account, on the other hand, will be recorded as a credit.
Prepare your journal entry
Prepare your journal entry, including the date, reference number and transaction description. Many small businesses seek advice from their accountant or bookkeeper to ensure journal entries are correctly accounted for in their financial records.
Journal entry FAQs
What is a simple journal entry?
A simple journal entry is a transaction record that decreases one account and increases another by the same amount. With a simple journal entry, just two accounts are affected.
What is the difference between a journal and a ledger?
The difference between a journal and a ledger is that a journal records all business transactions. A ledger summarises and classifies those journal entries.
What is an expense as a journal entry?
An expense is a debit in a journal entry, which shows that your accounts payable account has increased.
How do you record a payment as a journal entry?
To record a payment as a journal entry, you note a debit to your accounts payable, showing your debt has decreased. The money leaving your cash account is recorded as a credit, showing the bill has been paid.
Master business accounting with journal entries
Understanding journal entries and keeping concise records is vital for ensuring your financial records are accurate in each taxable period.
Knowing your journal entries are up to date gives you a clear picture of your business's financial health. It may seem complicated, but it doesn't need to be. With MYOB small business accounting solutions, you have the heavy accounting lifting done for you — get started today.
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