Key Takeaways
- The journal entry is a tool used by bookkeepers and accountants to record transactions in manual accounting systems. It consists of the transaction date, a debit entry, a credit entry, and a description of the transaction.
- A simple journal entry includes one account that is debited and one account that is credited while a compound journal entry involves a minimum of two accounts that are debited or two accounts that are credited.
- An accounting journal is where journal entries are initially entered on the accounting records. The 3 journal types are general journal, combination journal and special journal.
Overview of the Accounting Cycle
Recording business transactions in the general journal using journal entries is the second step in the accounting cycle of the business. The Accounting Cycle refers to the steps that a company takes to prepare financial statements.
Below are the steps in the accounting cycle, done in the following order:
- Gathering of business source documents
- Analyzing and journalizing business transactions
- Posting journalized transactions to the ledger
- Preparing an unadjusted trial balance
- Journalizing and posting adjusting entries
- Preparing an adjusted trial balance
- Preparing the financial statements
- Journalizing and posting closing entries
- Preparing a post-closing trial balance
- Journalizing and posting reversing entries
What is a Journal Entry?
A Journal Entry is a formal method of recording transactions using debits and credits.
A journal entry contains the following:
- Transaction date – the exact date that the transaction occurred.
- Debit entry – the accounts and amounts to be debited
- Credit entry – the accounts and amounts to be credited
- Description of the transaction – a brief explanation about the nature and purpose of the transaction
Below is an example of a journal entry template.
Understanding double-entry bookkeeping will help us learn about debits and credits and the role of journal entries in recording business transactions in the accounting books.
The Double-entry Bookkeeping is a system of recording transactions that involves recording at least two accounts that will result in a two-sided entry in the journal. This is the opposite of single-entry bookkeeping system which only involves one entry for each transaction.
For example, under a double-entry bookkeeping system, you record a sales transaction in both the cash account and the sales revenue account simultaneously. However, in a single-entry bookkeeping system, you’ll only have to record the sales transaction in the cash account, without affecting another account.
The journal entry is an essential component of the double-entry bookkeeping system. It is the tool that you’ll always be using to enter the details of the transaction as inputs in the accounting system.
To illustrate how a journal entry is used, let’s assume that your company rendered a service for $200 cash on January 5, 2023. The journal entry for this transaction should look like this:
In the above journal entry, the parts can be identified as follows:
- Transaction date – January 5, 2023
- Debit entry – Cash for $200
- Credit entry – Service Revenue for $200
- Description of the transaction – To record service revenue
Debit, which is abbreviated as Dr, refers to the left side of an account. In the example, the cash account was debited by recording the amount of the sale on the account’s left side, resulting to an increase in the balance of the account.
On the other hand, Credit, which is abbreviated as Cr, refers to the right side of an account. In the same example, the service revenue account was credited by recording the amount of the sale on the account’s right side, resulting to an increase in the balance of the account.
Remember these points about debits and credits:
- Debits and credits are two halves of each transaction. For every debit, there is a corresponding credit.
- The amounts of debits should always equal the amounts of credit. This is also in accordance with the concept of the accounting equation: Assets = Liabilities + Equity.
- When preparing a journal entry, the debit entry is always listed first before the credit entry.
Debiting or crediting an account can either increase or decrease the balance of an account. Below is a summary of the effects of debiting and crediting each financial statement element.
Using a computerized accounting system completely eliminates the need to create a journal entry such as the example above. This is already automatically done in the background by the system as you enter the details of a transaction in the fields provided by the software.
However, learning how to create and record a journal entry manually is an effective way for you to understand how the accounting process works even when using a computerized system. It can help you understand how the data you recorded are captured and then processed into a set of financial statements.
The steps to create a manual journal entry are as follows:
- Enter the transaction date.
- Input the details of the debit entry, i.e. the account name and the amount to be debited.
- Below the debit entry, input the details of the credit entry, i.e. the account name and the amount to be credited. Be sure to indent the credit entry to the right to distinguish them from the debit entry.
- Write the description of the transaction below the credit entry.
Compound Journal Entry
The above entry is an example of a Simple Journal Entry where the debit and credit entries only involve one account each. However, a journal entry with more than one account debited and/or more than one credited is called a Compound Journal Entry.
For example, let’s assume that on February 20, 2023 your company purchased inventory amounting to $1,000. You paid $200 as down payment with the balance payable on account. The journal entry for this transaction will be recorded as follows:
Notice that in this transaction, three accounts are affected, namely: inventory, cash and accounts payable. This is an example of a compound journal entry because it involves one account that is debited and two accounts that are credited.
A compound journal entry always affects more than two accounts. The number of accounts that you debited doesn’t have to be the same number of accounts that you credited. However, both the debit entries and credit entries should still have total amounts that equal each other.
General Journal
Accounting involves a great deal of recording transactions. Back in the day of manual accounting systems, the accounting department would manage countless journals and ledgers that contain all bookkeeping records.
With the advent of computerized accounting systems, the use of physical books of accounts was virtually eliminated. Electronic spreadsheets and even cloud-based databases became mainstream while physical records were already considered a thing of the past.
However, as mentioned earlier, being familiar with the manual processes of accounting is the best way to learn and appreciate it. That’s why we’re going to start with recording transactions using the accounting journal.
Journalizing or Booking is the process of recording business transactions in the journal.
An Accounting Journal is a record containing a chronological listing of business transactions. It is also called the Book of Original Entry since this is where a transaction is initially recorded before being posted to the ledger.
There are three types of accounting journal – general journal, combination journal and special journal. Each type has specific uses but all of them are considered books of original entry since they serve as initial records of transactions that enter into the accounting system.
The General Journal is the most basic journal and has also the simplest form since it only contains two columns for debits and credits. This is where you’ll be recording journal entries in a chronological order.
Below is an example of a general journal layout.
The journal contains the columns to accommodate the parts of the journal entry, i.e. transaction date, debit entry, credit entry, and transaction description. An additional column, the Post Reference, also called the Folio, indicates the ledger account where the entry will be posted.
The journal allows the recording of transactions in one place, unlike in a ledger where a single transaction will be recorded separately in different ledger accounts. This results to an easier lookup and analysis of transactions that occurred during a period.
Recording transactions can be time consuming that’s why using technologies such as accounting software and POS machines could result in easier and more streamlined data entry. It also helps reduce the possibility of errors that are usually inherent in manual accounting systems.
Combination and Special Journals
The general journal is an all-purpose journal where you can record most types of transactions. However, there are cases where you’ll find that using the general journal to record huge volumes of transactions that are similar in nature could be cumbersome and may even result in data entry errors.
Your company probably has transactions that are repetitive and occur more frequently, such as sales and purchase transactions. While you may use the general journal to record these transactions, it could be cumbersome and sometimes result in a cluttered journal and a slow recording process prone to errors.
When similar transactions occur repetitively, you may use a combination journal or even a set of special journals to record them. Using these journals can provide the following advantages:
- They help minimize bookkeeping tasks and save time because of their focus on simplifying the recording of repetitive transactions.
- The possibility of errors are minimized because the recording process of high-volume transactions are streamlined.
Combination Journal
A Combination Journal is an accounting journal that contains special columns for accounts that are frequently used by a business.
The column headings in a combination journal will depend on the needs of your business. Some examples of accounts that demand the use of separate columns are cash, receivables, payables, sales, purchases, and sales taxes since most transactions involving these accounts are recurring.
Below is an example of a combination journal layout.
Notice that the combination journal includes a miscellaneous column. This column, which is also referred to as a sundry column, is where you’ll be listing the accounts of transactions that occur less frequently.
With a combination journal, only the total amounts of each column are posted in the general ledger, thus saving a lot of time and effort. The entries in the sundry column can be posted individually to the general ledger.
If your business transactions are mostly cash-based, then all recordings can be made in the cash book rather than a combination journal. Any non-cash transactions are then recorded in the general journal.
Sometimes, maintaining a combination journal with multiple columns for different accounts may cause a lot of work especially when your company has huge volumes of similar transactions (such as sales transactions) involving the same accounts. The use of special journals is more appropriate in this situation since they are more specific in the accounts that are recorded.
Special Journal
A Special Journal is an accounting journal that contains records of high-volume business transactions that are repetitive and of the same nature.
Similar to combination journals, special journals are useful in streamlining the bookkeeping process. They are used to record recurring, high-volume transactions that are of the same nature.
When using a special journal, only the total amounts of each column in the special journal is posted in the general ledger. This is similar to the posting process of using a combination journal.
There are 4 common types of special journals:
- Sales Journal – used for recording transactions involving sales on account
- Purchases Journal – used for recording transactions involving purchases on account
- Cash Receipts Journal – used for recording transactions where cash is received such as cash sales
- Cash Disbursements Journal – used for recording transactions involving cash payments such as cash purchases
You can also use special journals for your other high-volume transactions that could not be recorded in the previously mentioned special journals. For example, you may keep a special journal for sales returns if your company encounters frequent product returns from customers. You may also use a special journal for payroll transactions.
Unlike the general journal and combination journal where only one person can handle them at a time, special journals can be worked on simultaneously by several persons, thus creating division of labor. One person can specialize on sales journals while another can be responsible for the purchases journal.
What journal should you use?
Here are some points to consider when to use each type of journal.
- Two-column general journal – use when your business has only a few transactions to be entered in the accounting books.
- Combination journal and special journals – use when your business processes huge volumes of recurring transactions on a regular basis. Special journals are more appropriate when your company has huge volumes of similar transactions that involve the same accounts.
However, even when you use a combination or a special journal, you’ll probably still need to use a general journal for transactions that seldom occur and are not recorded in the other journals. The general journal actually serves as a catchall for journal entries that don’t belong in other journals such as adjusting, closing and reversing entries.
A well-designed accounting system can contribute to the timely and efficient preparation of financial statements. Whether you use physical books of account or an accounting software, you must ensure that it suits the particular needs of your business.
When using a manual accounting system, combination and special journals are great substitutes to the general journal as a convenient way of recording large numbers of similar transactions. However, despite the conveniences offered by these journals, using a computerized accounting system greatly enhances the efficiency of your entire accounting process.
Illustrative Example
Below is an illustrative example involving several common business transactions and how to record them in the general journal.
Let’s assume that Mr. A opened a photography business that specializes in covering wedding events. Mr. A entered into several transactions during the month of March 2023, his first month of operations, as follows:
- March 1 – Mr. A paid $700 for the registration permits and licenses of his business from his personal funds.
- March 1 – invested $8,000 of personal money as initial capital for the business.
- March 2 – Mr. A transferred his personal DSLR to be used by the business. The cost of the DSLR when he purchased it two years ago was $2,000. Its fair value if it will be sold in the market today at its present condition is $1,500.
- March 2 – purchased additional DSLR and other equipment such as tripods, lenses, computers, and printers that will be used in the business. The total purchase amounted to $4,000. Mr. A paid 20% down payment with the balance payable in 10 days.
- March 3 – rented his friend’s apartment and converted it into an office. No security deposit and advance rental payments were required to be paid.
- March 5 – purchased $800 worth of furniture for his office. He also spent $300 for repainting jobs of his office.
- March 6 – hired an assistant photographer.
- March 7 – purchased office supplies amounting to $700.
- March 8 – covered a wedding event and received cash payment amounting to $2,000.
- March 9 – paid the balance for the equipment purchased on March 2.
- March 10 – purchased a vehicle amounting to $20,000, paying $2,000 down payment and obtaining a loan for the balance.
- March 11 – paid $300 for gasoline expenses.
- March 14 – received cash amounting to $2,000 from a client as payment for covering a wedding event.
- March 15 – paid $1,000 for advertising expenses.
- March 20 – received $2,000 from a client for rendering photography services.
- March 26 – covered a wedding event for $2,000. The client promised to pay on April 10, 2023.
- March 27 – paid $400 on electricity and water, and $100 for internet.
- March 28 – rendered photography services amounting to $2,000 to a client, payable on April 12, 2023
- March 29 – withdrew $750 for personal use.
- March 30 – paid $500 for the monthly amortization of his car loan. $50 of the amount went to interest payment.
- March 30 – paid $450 as rental payment for the month.
In this example, any form of payroll and sales taxes will be disregarded to simplify recording of transactions. Below are the journal entries for each transaction during March 2023 and how they are recorded in the general journal.
Notice that on March 3, there are no journal entries recorded because there was no exchange of values between Mr. A and the lessor. No security deposit and advance rental payment was made by Mr. A to the lessor.
Likewise, there is also no journal entry required to be recorded when Mr. A hired an assistant photographer on March 6 since the employee has yet to render a service for the business. No form of compensation was also paid to require recording the transaction.
The general journal above summarizes all of the transactions that occurred during March 2023 in the photography business of Mr. A. Having just a few transactions during his first month of operations, he can use the general journal to record them.
Once Mr. A’s business starts to expand to accommodate more clients and hire additional employees, he can begin to use a combination journal or even a special journal as long as it suits the needs of his business and makes the bookkeeping process more efficient and streamline.
Review Questions
- What are the parts of a journal entry?
- What is the difference between the general journal and the combination journal?
- When should you use a special journal?
- What is the difference between a simple journal entry and a compound journal entry?
- How do combination and special journals simplify the bookkeeping process?
