Journal Entry – Definition, Types, Examples & How to Record It

Introduction

Journal entries are the foundation of the accounting system, providing a systematic way of recording and tracking every financial transaction within a business. They are important for maintaining the integrity of a company’s financial data. Therefore, it is crucial for stakeholders and business owners to understand the intricacies of journal entries and their importance in ensuring financial reporting accuracy. 

In this blog, we will understand what journal entries are, their components and types, and the key role automation and AI are transforming the journal entry process for enhanced efficiency. . 

What is a Journal Entry?

A journal entry is a record of a financial transaction in the organization’s accounting system. It serves as the first step in the accounting cycle, documenting the details of a transaction, including the date, accounts affected, and amounts. It plays a crucial role in ensuring compliance with accounting standards. 

Journal entries are important in tracking monetary movements, ensuring sound financial information reporting and analysis. They are regarded as the foundation of the accounting system, offering a structured method for recording transactions across asset and liability accounts. Understanding the purpose and significance of journal entries is essential for anyone managing an organization’s financial data

What is the Purpose of a Journal Entry?

The purpose of a journal entry is to accurately record all the details regarding a transaction. Chronologically documented journal entries serve as the base for creating the general ledger, which in turn supports the preparation of financial statements that accurately report a company’s financial position. 

Journal entries make it easy to track transactions and reconcile financial information before it is used for further accounting purposes. Maintaining an accurate record of financial transactions through journal entries also helps businesses always be audit-ready and compliant with regulations and accounting standards. 

Debits and Credits in Journal Entry

Understanding how to account for debits and credits in journal entries is essential for maintaining accurate financial records. Debits and credits are fundamental principles in accounting. 

As a thumb rule, debits increase asset and expenditure accounts, while credits increase liability, equity, and income accounts. Ensuring debit equals credit is the core principle of accounting. By following these journal entry tips, you can enhance the accuracy and reliability of your financial records. 

• Understand the basics: Debits increase asset and expense accounts, while credits increase liability, equity, and revenue accounts.

• Double-check balances: Always ensure that the total debits equal the total credits in every journal entry.

• Use mnemonics: Remember the acronym DEAD CLIC (Debits increase Expenses, Assets, and Dividends; Credits increase Liabilities, Income, and Capital) to help remember the accounting principles.

• Review transactions: Regularly review journal entries to ensure that they are appropriately and accurately recorded, especially before the financial closing period.

• Be consistent: The use of a consistent format and approach in each entry minimizes any misunderstandings and mistakes.

What is Included in a Journal Entry?

A well-crafted journal entry is generally composed of five key elements, and each of them plays a critical role in maintaining the integrity and accuracy of the financial records. These elements ensure that transactions are well documented, easily understood, and verifiable. These are:

• Date: This is the transaction date and indicates when the transaction occurred.

• Accounts Affected: The accounts involved in the transaction, which normally include at least one debit and one credit account.

• Amounts: This denotes the transaction value. Adhering to the double-entry accounting principle, this amount is debited from one account and credited to the other account. 

• Description: A short description of the transaction, with additional information for reference.

• Reference Number: A unique transaction identifier for tracking and audit purposes.

What are the Different Types of Journal Entries

There are six major types of journal entries, each meant for a specific category of financial transaction. Each serves a different purpose in accounting, ranging from basic transactions to complex adjustments and period-end processes. 

• Opening journal entry: Opening journal entries are made when a new accounting year starts to establish the opening balance for relevant accounts. The balance is the amount that is carried forward for relevant accounts from the previous accounting period. For example, if the cash account has a remaining balance of $5000 after paying off all the liabilities, the amount will become the opening balance for the next accounting period.

• Compound journal entry: A compound journal entry comprises more than one debit and/or credit account. It is used for complex transactions that require multiple accounts. For instance, payroll journal entries can be a lot depending on the size of the company, but they can be compounded into a single journal entry. 

• Transfer journal entry: Transfer journal entries are used to transfer or allocate income or expense from one account to another in the same organization. For example, a transfer journal entry would be recorded if an MNC transfers money to its subsidiary.

• Adjusting journal entries: Adjusting journal entries are made at the end of an accounting period, post-trial balance to update account balances before any financial statements are prepared. They record unrecognized transactions and rectify initial recording errors. There are several types of adjusting entries, including accrued expense, accrued revenue, deferred revenue,and  deferred expense. An adjusting entry for accrued revenue will be recorded when a company provides goods or services to a client but receives the payment a month after providing the said services.

• Closing journal entry: A closing journal entry is made at the end of an accounting period to transfer balances in temporary accounts (such as revenues and expenses) to permanent accounts (such as retained earnings).

• Reversing journal entry: Reversing journal entries is optional and is posted at the beginning of an accounting period to reverse some adjusting entries posted in the prior period for easier documentation of transactions. For example, an accrued revenue entry can be reversed so that it can be recorded in the same time period when the revenue is received. 

How to Record a Journal Entry (Step by Step)

Recording a journal entry correctly ensures that all financial transactions are accurately reflected in the company’s books. Follow these steps to create a journal entry:

Step 1: Identify the Transaction

Determine the financial transaction that needs to be recorded, such as a sale, purchase, expense, or payment.

Step 2: Determine the Accounts Affected

Identify which accounts will be impacted by the transaction. Each transaction must affect at least two accounts, one debit and one credit.

Step 3: Decide Debit and Credit Amounts

Assign the correct monetary amounts to the debit and credit accounts. The total debits must always equal total credits to maintain the accounting equation.

Step 4: Record the Entry in the Journal

Use the standard journal entry format:

• Date of the transaction
• Accounts affected (debit listed first, credit indented)
• Debit and credit amounts
• A brief narration explaining the purpose of the transaction

Step 5: Post the Entry to the Ledger

Once recorded in the journal, post the amounts to the corresponding ledger accounts to update balances.

Step 6: Review and Verify

Double-check the entry for accuracy. Ensure that debits equal credits, accounts are correct, and the narration clearly explains the transaction.

Example of a Journal Entry

To illustrate how to create a journal entry, let’s consider a simple example:

Transaction: A company purchases office supplies for $500 on credit.

In this example, the office supplies account is debited to reflect the increase in supplies, while the accounts payable account is credited to record the liability incurred.

Common Mistakes To Avoid When Recording Journal Entries

The process of recording journal entries has been simplified to a large extent with the introduction of AI-based accounting software. Businesses can easily employ the use of such technologies and avoid any major mishaps while recording journal entries. However, even while leveraging technology, businesses need to be aware of some common mistakes that they should avoid while recording journal entries:

• Unmatched debit and credit accounts: The double-entry bookkeeping method requires you to match the balances on the debit and credit sides. In case the balances on both sides are not matching, some detail about one or multiple transactions hasn’t been recorded correctly. 

• Not recording entries in a chronological order: Since journal entries are the first step towards maintaining an accurate record of financial transactions, it’s important that they are recorded in a chronological order. This makes it easier to reconcile accounts and create an audit trail for audit and compliance purposes. 

• Not attaching supporting documents: Failure to attach proper documentation with journal entries can cause problems later in the accounting cycle. For instance, a lack of documentation could make the auditing process time-consuming and difficult at the end of the financial year. To counter such errors, it requires organizations to proactively take measures to ensure a high degree of visibility into the close process. Solutions such as HighRadius Close Checklist provide a close progress dashboard with a clear view of all changes made to a task to maintain the integrity of the close process. They in turn provide an efficient audit trail of supporting documents, comments, and web links for audits, ensuring 100% close checklist completion. 

• Inconsistent descriptions: Transaction descriptions make it easier for accounting professionals to understand the nature of different transactions. Therefore, vague and inconsistent descriptions might mislead and create confusion. 

• Omitting transactions: A major blunder that could lead to inaccurate financial statements is the omission of transactions. It’s important for businesses to ensure the documentation of each and every financial transaction to maintain financial integrity. 

Best Practices For Recording Journal Entries 

In order to ensure that journal entries are being recorded correctly, organizations should follow the following best practices: 

• Use advanced accounting software: Accounting software can help businesses avoid a lot of mistakes when it comes to journal entries. Using advanced automation and software helps organizations speed up processes, reduce errors, and shorten closing times, compared to relying on manual operations.. However, organizations need to look beyond merely adopting accounting software and ensure effective implementation to reap its benefits. Many organizations struggle with integrating diverse financial systems, leading to inefficient data consolidation essential for timely reporting. The challenge is exacerbated when merging legacy systems with modern platforms, often resulting in manual interventions that delay the closing process.

  Companies may need to re-evaluate their integration of new tools with existing systems, ensuring that their workflows and staff training are aligned to fully capitalize on technological benefits. However, solutions such as HighRadius Financial Close Management enable organizations to achieve this by seamlessly integrating with all major ERPs. This adaptability ensures the effortless extraction of GL accounts for payment reconciliation with bank data, facilitating a timely close. Moreover, the system sends journal entries back to the ERP in the supported format.

• Perform regular reconciliations: It’s important for organizations to perform regular account reconciliations for their journal entries to ensure the accuracy of financial information, compliance with accounting standards, and completeness of financial statements. Solutions such as HighRadius Account Reconciliation Software provide an out-of-the-box formula set that can configure matching rules and match line-level transactions from multiple data sources and create templates to automate various transaction processing required for month-end close. It provides businesses the ability to prepare and post journal entries, which will be automatically posted into the ERP, automating 70% of their account reconciliation process. 

• Ensure timeliness: Journal entries need to be recorded as soon as a business transaction occurs to avoid omitting any entries or accidentally recording the wrong information regarding a transaction. 

• Use different types of journal entries correctly: Since there are various types of journal entries, organizations should ensure that they are recording transactions according to the right type of journal entry. 

How To Track Journal Entries?

Tracking journal entries the right way can make a huge difference when it comes to financial accuracy, completeness, and transparency. Businesses ideally need to figure out the best way to track their journal entries depending on their needs. 

For example, a small business owner could use a simple accounting system or an accountant to track their business transactions. However, large enterprises will need advanced accounting software and a dedicated finance and accounting team to ensure financial transactions are being recorded correctly. 

Until a few years back, spreadsheets were a common way to keep track of journal entries. If we go further down the time, physical journals and ledgers were used for effective bookkeeping. Although these methods could still be employed today, their propensity for errors impacts financial information integrity. Hence, the easiest and most effective way to keep track of journal entries is by using modern accounting software such as HighRadius Financial Close Software, which offers features such as Close Progress Dashboards, enabling organizations to track close processes with a customizable dashboard to track the metrics important to your organization and achieve 40% close productivity improvement. 

How Can HighRadius Help with Journal Entry Automation?

The HighRadius Record to Report solution improves accounting by introducing automation to the forefront, dramatically increasing efficiency and accuracy. HighRadius’ no-code platform with an Excel-like interface, LiveCube, automates data extraction with customizable templates and is capable of handling millions of records. It enables enterprises to achieve a 50% reduction in manual operations by automating processes such as data retrieval from multiple sources and grouping certain transactions to simplify journal entry posting. 

LiveCube further allows users to do a one time set up automation for journal entry postings. HighRadius’ Journal Entry Management facilitates auto posting of entries of different formats to any ERP system or any other system of records, all the while ensuring compliance with industry standards. Journal Entries can also be customized based on individual system records. Integrating this with LiveCube can enable manual preparation of Journal Entries using templates where all company data is auto-populated.

Journal Entry Management impacts the financial close process, allowing firms to achieve 30% reduction in days to close. This function provides automated posting alternatives, which considerably speeds up the total closing process while maintaining accuracy. Close checklists and audit trail features provide a clear view of tasks that need to be completed and all the changes made to a task to maintain integrity of the close process, ensuring audit and compliance readiness. The Maker Checker Workflow adds to the efficiency of the financial close process by segregation responsibilities and enabling the monitoring of priority tasks. 

HighRadius offers innovative solutions that can significantly streamline the process of creating and managing journal entries. With advanced automation, real-time data synchronization, and user-friendly interfaces, HighRadius helps businesses maintain accurate and efficient financial records. By leveraging HighRadius’ technology, businesses can enhance their financial processes, ensuring accurate and timely journal entries that support overall financial health.

FAQs

10. How do you write a journal entry?

To write a journal entry, identify the transaction, determine which accounts are affected, assign debit and credit amounts, and record them in the journal with a date and narration. Finally, post the entry to the ledger to ensure the financial records remain balanced and accurate.

11. What is an adjusting journal entry?

An adjusting journal entry updates accounts at the end of an accounting period for accruals, deferrals, depreciation, or corrections. These entries ensure that revenues and expenses are recorded in the correct period, maintaining the accuracy of financial statements and compliance with accounting standards.

12. What is a compound journal entry?

A compound journal entry records a transaction involving more than two accounts in a single entry. It may include multiple debits and credits, allowing complex transactions to be recorded efficiently while keeping the books accurate and reducing the number of separate entries needed in the accounting journal.

13. When should you use a reversing journal entry?

Reversing entries are used at the start of a new accounting period to cancel certain adjusting entries from the previous period. They prevent double-counting, simplify subsequent entries, and help ensure that temporary accruals or adjustments do not distort the new period’s financial records.

14. Can journal entries be automated?

Yes, journal entries, especially recurring, adjusting, or standard transactions can be automated using accounting software or AI-powered tools. Automation reduces manual errors, saves time, maintains consistency, and ensures all financial records are accurately captured for reporting and audits.