What is a Journal Entry in Accounting?
Financial accounting is a multi-step process for companies following double-entry methods. The first and most important step begins with a journal entry: the recording of financial information related to transactions of the business or organization. This provides an audit trail to look back at and analyze, to determine the financial position of an entity.
Because business transactions happen daily, it’s imperative to keep the journal up-to-date and accurate to real-time transactions. Problems within the journal or journal entries that don’t add up spell trouble for any company. Thankfully, journal entries create a paper trail and a system of record that makes it easy to fix mistakes and prevent them from affecting the general ledger in the future.
What is a Journal?
Journal entries take place within the company’s journal, which is often confused with the company’s general ledger. The two are, in fact, different. The journal represents the very first record of financial information. It will later become part of the ledger or another accounting book. The journal is the comprehensive record of financial transactions, whereas other books represent summaries of account activity and balances.
The journal is typically a physical record: an actual book, an excel spreadsheet or a series of transactions tracked in accounting software. Accountants reconcile the journal to the general ledger periodically throughout an accounting period.
What is a Journal Entry?
Anything recorded in the company’s journal is a journal entry. Journal entries typically include sales, expenses, cash movements, inventory and debt, among other important cash flow transactions:
- Accounts payable: Cash owed by the business
- Accounts receivable: Cash owed to the business
- Equity: Retained earnings and owner investments
- Purchases: Cash payments made to suppliers
- Receipts: Cash received by the business
- Sales returns: Cash issued as refunds
- Sales: Cash recorded from sales
Entries happen in real time, at the point of origination, to ensure accuracy and transparency in financial reporting. Each entry states the data of the transaction, affected accounts and the amount of the transaction. This is important because an accountant will later reconcile these transactions to the general ledger using double-entry accounting.
An Example of a Journal Entry
Because journal entries happen in real-time, a company may see numerous entries into its journal before it’s reconciled to the general ledger. Nevertheless, each entry is an important part in maintaining accounting transparency. Often, accounting software handles journal entries automatically, so accountants don’t deal with them other than to reconcile or to manually audit them. This ensures accuracy, since journal entries are often pulled directly from sales software or selling platforms.
Reviewing journal entries is simple because the entries themselves are very simple. Generally, a traditional journal entry will contain only the essentials. For example, a company’s journal may look like this:
- March 23. $2,350 Debit. Invoice #001
- March 23. $1,500 Debit. Invoice #002
- March 24. $1,000 Credit. Invoice #900
- March 24. $1,200 Credit. Invoice #901
- March 25. $3,000 Debit. Invoice #003
In this example, the company may reconcile its journal at the end of the week or month. When it does, it’ll use double-entry accounting to post each journal entry to the proper account within the general ledger. This reconciliation ensures accuracy in cash flow and provides a standard to audit against.
What is an Adjusting Journal Entry?
While journaling helps companies stay up-to-date on financial transactions, accrual accounting can cause discrepancies—especially in companies that record hundreds or thousands of transactions each day. Unfortunately, some entries can cause turbulence when reconciled to the general ledger when a transaction starts during one period and ends in another. Accrual accounting dictates that transactions need to be recognized in the same period. To account for this, accountants will record an adjusting journal entry.
Adjusting journal entries are journal entries entered at the end of an accounting period, to account for transactions that might not settle in the current period. This allows the company to progress in double entry accounting. It also ensures all transactions remain accounted for. The adjusting journal entry simply balances the transaction so it can be appropriately reconciled. Effectively, companies adjust from a cash basis to an accrual basis, then reconcile that entry to the general ledger accordingly.
Adjusting journal entries is also corrective. For example, if there was a mistake in the previous accounting period, an adjusting journal entry can correct it in the current period, to ensure financial transparency and accuracy moving forward.
What is a Closing Entry?
A closing entry is a journal entry made at the end of an accounting period to zero-out temporary accounts and shift their balances to permanent accounts. Effectively, it zeroes accounts so the company begins the next period with no balances. Recording closing entries is a matter of debiting and crediting temporary accounts, to move journal balances over to the income summary and then, the balance sheet.
Journal Entries Tell a Story
Journal entries are the living record of a company’s financial transactions: both incoming and outgoing. They leave behind an important audit trail when it comes time to gauge the efficacy of a company’s financial accounting practices. Moreover, they help the company ensure its tracking transactions and cash flow accordingly within the general ledger. To advance your investment and financial knowledge further, sign up for the Investment U e-letter below. You’ll also find invaluable stock tips and insights on a daily basis from some of Wall Street’s top experts!
Journal entries are an integral part of everyday business operations, and the very stepping stone toward quality accounting under double entry accounting standards. Large companies likely have several journals and a multitude of daily transactions—each distilling down to the general ledger for a better snapshot of the company’s financial health. In this way, journal entries are truly the nuts and bolts of a company’s financial foundation.