- What is a Journal Entry?
- What Information Do You Need to Make a Journal Entry?
- How to Make a Journal Entry
- Manual Bookkeeping vs. Using Software
- Should You Hire a Bookkeeper Instead?
- Small Business Bookkeeping with Community Tax
- The Importance of Accounting for Your Business
- Get Started with Your Business’s Bookkeeping
What is a Journal Entry?A journal entry is how business transactions are recorded in the journal. At the end of each accounting period, journal entries are posted to the ledger. Recording journal entries is an important step in the accounting cycle.
The General Journal & General LedgerThe general journal is also known as “the book of entry”. This is where the original journal entries are made. Through a process known as “posting”, this information is moved from the journal to the designated account in the general ledger. The balances reflected in the general ledger are then used to generate the financial statements for the accounting period. Typically, small businesses only use a general journal. However, as your business grows, you may require specialized journals. For larger businesses, it is usually beneficial to have cash journals, sales journals, and purchase journals to keep track of all these transactions. The reason being that if you have a mass amount of transactions for each time of entry, you will want to have better organization. Now let’s explore the different types of journal entries you might need to make…
Types of Journal EntriesAs if it’s not confusing enough that there are different types of journals, and a journal is separate from a ledger, there are also varying types of journal entries you can make. But don’t worry, we’ll define each of them for you:
- Transaction Entries – The basic method of entry for any business activities.
- Adjusting Entries – Entries made at the end of the accounting period to adjust balances.
- Closing Entries – All temporary accounts must be shifted over to the retained earnings account so that they can be started at zero for the next accounting period. This is done with a closing entry.
- Recurring Entries – These entries are ones that occur every accounting period. Either the accounts and amounts are the same or the same accounts are affected by the same transaction, but the amounts are different. Payroll is an example of a recurring entry for which amounts will change due to hours worked.
Types of AccountsThere are five main types of accounts used in bookkeeping:
- Assets – Everything your company owns including both tangible (cars or equipment) and intangible assets (trademarks and copyrights). When you purchase new products or equipment, they should be recorded in this account. Petty cash and accounts receivable would fall into the asset category.
- Expenses – Costs incurred for business operations. Payroll, rent, and equipment would fall under the expense category.
- Revenue (Income) – Money your business earns from making sales on your goods or services. Earned interest and product sales would fall into this category.
- Liabilities – Debts or payable obligations you owe to creditors and other external sources (car loans, mortgages, and overdue bills). Accounts payable is an example of a liabilities account.
- Equity – The current worth of your business (stock, dividends, and invested cash). Owner’s equity and retained earnings are examples of an equity account.
What Information Do You Need to Make a Journal Entry?Before you can make your first journal entry, there are four questions you need to ask yourself to make sure you have all the information you need:
- Which accounts are being affected by this transaction?
- Which account increased and which account decreased?
- By how much did these accounts change?
- Are the two accounts balanced?
What’s Required for Each Journal Entry?Each journal entry needs to include:
- The date (either the exact date or the last day of the month that the transaction occurred)
- Type of transaction that occurred
- Name of the accounts being affected
- Amount of the transaction
- A description of the transaction
Rules of Making Journal EntriesThe most important rules for making journal entries are:
- Make journal entries as they occur
- All entries should be made in chronological order
- You must record a debit and a credit to the correct accounts for every transaction
- The accounts must balance for every journal entry
How Do Debits & Credits Work?One of the most important aspects of making correct journal entries is understanding how debits and credits work. Here are some critical rules to remember when recording debits and credits for each transaction:
- The debit and credit entry should always be equal to one another.
- For assets and expenses: An increase is recorded as a debit while a decrease is recorded as a credit.
- For liabilities, equities, and revenues: An increase is recorded as a credit while a decrease is recorded as a debit.
- The debit entry should be made first, followed by the credit entry.
How to Make a Journal EntrySo, you have a basic understanding of what journal entries are and how they’re used, but how do you actually make a journal entry? There are three general steps involved in making a journal entry. Let us break those down for you…
1. Identify the TransactionFirst, you must identify the transaction. But how do you know if a transaction occurred? Typically, there will be some kind of trackable notification for each business activity. For instance, if you make a sale, there will be an invoice. If you take out a loan, you will be adding the money to your account. In general, it should be fairly obvious when a transaction occurs, especially if you are handling your own small business bookkeeping.
2. Evaluate the TransactionNext, you need to determine how this transaction affected the accounting equation.
The fundamental accounting equation: assets = liabilities + owner’s equityNote:the equation can be rearranged as needed to suit the transaction. The numbers involved in the equation will depend on the existing balances in your accounts. Each transaction will either increase or decrease each side of the accounting equation. In some cases, transactions may affect all three aspects of the accounting equation. Remember, the accounting equation must always remain balanced. So, you must increase or decrease each side equally depending on which types of accounts the transaction has affected. Note: If you’re having difficulty remembering how the different types of accounts are categorized, refer back up to the “Types of Accounts” section. We know there’s a lot to keep track of us but bear with us, we’re going to make this as easy as possible for your to get the hang of! Here’s a quick example: When you pay off a loan, it will decrease the liabilities as well as assets. This is because you are using some of your assets to pay off the loan. Once the loan is paid off, it is no longer considered a liability.
3. Journalize the TransactionOnce you’ve identified and analyzed the transaction, it is time to record it with a journal entry. You will need to make an entry for both a debit and a credit. The debit entry will be made on the first line and the credit entry will be made on the next line. After you have filled out all the required information for a journal entry, you need to double-check and make sure that the debit entry is equal to the credit entry so that it is balanced. That’s all you need to do for each transaction, until the end of the accounting period. At the end of the accounting period, you will then move all the journal entries to the general ledger. Keep in mind that making journal entries is just one step of the entire eight-step accounting cycle.
Real-World Examples:Now, let’s go over a few common types of transactions and their journal entries so that you know to make them when these scenarios arise.
1. PurchaseYou purchase office supplies that’s necessary for your everyday business operations for $1,000. How is that journal entry made? You would record the purchase of the office supplies as a debit and the outgoing cash that was spent as a credit.
2. SaleA client makes a purchase of $10,000. The original cost of the goods that were sold was $5,000 (the amount you paid to purchase the inventory). Here is how you make the journal entry for this transaction. Remember, the debits for the transaction are always made first.
3. PayrollThe total payroll for all of your employees for the month is $20,000. You also must account for the $3,500 in payroll taxes you may pay.
Manual Bookkeeping vs. Using SoftwareNow that you understand how to make a manual journal entry, it’s time to decide whether you should be doing it manually. Wondering what exactly we mean by manually? Manual accounting is when you are physically writing in all the transactions on paper.
The Disadvantages of Manual BookkeepingWhile many businesses have used manual accounting in the past, there are quite a few disadvantages to using this method, including:
- It uses up your valuable time. Making manual journal entries and the other aspects of bookkeeping are time consuming because you have to track down details and double-check your work. As a small business owner, you only have so much time in a day and many of the tasks that need to get done can only be done by you. However, bookkeeping is not one of those tasks.
- High risk of errors. In bookkeeping, there are quite a few errors that can be easily made, even for the seasoned professional. One small oversight, like listing an entry in the wrong account or for the wrong amount, can have a domino effect and lead to additional time trying to find the source of the problem and re-doing calculations. Even worse, making mistakes that result in incorrect financial statements could mean that you are in violation of certain laws and may be forced to pay penalties.
- Limited security. As with most important information kept on paper, you have to worry about it getting damaged, lost, or falling into the wrong hands. If you keep everything in a single general ledger, as most small businesses do, there is the potential that you could lose all of the highly sensitive information about your business finances.
Advantages of Using Accounting SoftwareIt’s still good to know how to make a journal entry, and the logic behind how transactions are recorded, but bookkeeping software offers several advantages:
- Less work on your end. If you’re using a bookkeeping software, the journal entry process isn’t front-facing. When you’re sorting transactions into the appropriate account, the software is “making the journal entry” for you on the back-end. This is why you’re able to determine whether your books are balanced without all the steps in between. So basically, you’re just responsible for entering the transactions into the software and it does the rest of the work for you.
- Lower cost. Your time is money. If you’re just figuring out the basics of manual bookkeeping it’s likely that you’ve already invested a significant amount of time learning the process, which in turn, costs you. If your time is spent performing bookkeeping tasks, you are paying for that. Additionally, if you hire an employee to perform these responsibilities, it will likely cost you a lot more than accounting software. While you will have to learn or train an employee on the software, in the long-run, the cost will be lower.
- Peace of mind. As we mentioned earlier, paper is vulnerable, but having all your of your accounting data kept within a software is much more reliable. Typically, there is a system in place to back up the information in your account, where you would be able to recover it, should any issues arise. Additionally, accounting software is built with systems in place to prevent errors so there is improved accuracy and efficiency.
Should You Hire a Bookkeeper Instead?First off, let us explain exactly what a bookkeeper can do for your business. A bookkeeper is responsible for managing business transactions and making the corresponding records. Basically, they ensure all of your bookkeeping is in order. However, they do not generate your financial statements, analyze your costs and other financial data, or provide advisory services. That is an accountant. Hiring a bookkeeper offers many of the same advantages of using an accounting software: it frees up your time, improved accuracy, and provides peace of mind. It’s likely that they’ll even be using their own software or systems to manage your accounts. Having a bookkeeper provides the additional benefit of having a dedicated individual handling your bookkeeping. So, what’s the catch? It can be expensive to have a dedicated bookkeeper for your small business, especially if you’re just starting out. But what if we told you there was an even better option?
Small Business Bookkeeping with Community TaxHaving access to a team of accountants and bookkeepers on hand whenever you need through a user-friendly, centralized online bookkeeping interface makes managing this part of your business easier than ever. That’s where Community Tax comes in. We offer customized bookkeeping services for your small business, on your budget. From recording transactions and payroll to helping you with your small business taxes, our bookkeeping experts have you covered. Since our services are tailored to your needs, we even offer packages where we can combine bookkeeping and accounting services to meet all of your businesses’ financial needs withone, easily manageable service.
The Importance of Accounting for Your BusinessSo why exactly is it so important to understand how to make journal entries? First off, journal entries are one of the fundamental aspects of proper financial reporting. Having a basic understanding of their function and how they are done can only benefit you as a business owner, even if you don’t plan to do them yourself. Second, making journal entries allows you to keep track of the money coming and going out of your business so that you have a real-time understanding of the financial well-being of your company. Is accounting really that important to your business? Warren Buffett, now famously, described accounting as the “language of business”. In an interview with CNBC, he explained that “It’s a language all its own. Getting comfortable in a foreign language takes a little experience, a little study, early on, but it pays off big later on.” And it’s true. Understanding the accounting process, it’s significance, and your financial position is necessary as a small business owner. This empowers you to:
- Make informed financial decisions.
- Be able to discuss your company’s financial position with current or potential investors and lenders.