Think of an old fashioned journal, one where you write about what happened during your day. In your journal, you write about events in the order that they occur. The same goes for journals in accounting. An accounting journal records accounting events in chronological order, with every new event requiring a new journal entry.
Because accounting is a double-entry system, every event requires at least two accounts to be affected to keep everything in balance. Imagine for a moment a very simple math equation:
Easy enough, right? This equation is said to be balanced, meaning that the value on the left of the equation is equal to the value on the right: 10. Numbers can be added to the equation as long as we keep it balanced. For example:
In this case, we’ve added one to each side but kept the equation in balance. This extremely simplistic example illustrates a salient point for accounting: the accounting equation must stay in balance. The accounting equation is the basis of the double-entry accounting system:
This equation must always be balanced, the left side must always equal the right. Now taking our simple example from above and applying it to the accounting equation: if assets increase by 1, liabilities or shareholder’s equity must also increase by 1.
Additionally, assets could increase by 1 and decrease by 1. It will still balance:
Now that you know the underlying fundamentals, let’s turn to journal entries. To form a proper journal entry, there are several basic rules that must be followed. But first, let’s look at a simple example so we know where to begin:
In this example, a company buys equipment for $1,000 cash. The purchase of the equipment is the event that drives the entry.
The best place to start is by determining which accounts are being affected. The journal entry is formed around those account names, or titles. Look at the given example and think logically what will have changed after the transaction has completed. With the previous example in mind, after a company buys equipment they should, logically, have more equipment. Therefore we know we are going to have to change the "Equipment" account in order to reflect the new purchase. Continuing, the company paid cash for the equipment. If cash is paid, we no longer have that cash and must adjust the "Cash" account to reflect the decrease. So in the previous example, the accounts being affected are the "Equipment" account and the "Cash" account.
Once you know which accounts are being affected, the next step is to determine whether they are being debited or credited. (I'm assuming here a basic knowledge of debits and credits.) All accounts that are being debited should be aligned on the left, with no indentation. Credits are distinguished by being indented or "pushed out" to the right. All debits should be align, and all credits should align.
|→ Cash||→ 1,000|
In the example above, we have identified the "Equipment" account as the debit (assets increase with debits) and the "Cash" account as the credit (assets decrease with credits). Therefore, the "Equipment" title goes flush on the left side and the "Cash" title is indented to the right, indicative of a credit.
An extremely important thing to remember when preparing journal entries, and with accounting in general, is that the debits must always equal the credits. They must balance. Note here that the dollar value of the debits must always equal the dollar value of the credits. In our example, the debits and credits are both $1,000. Good so far.
Changing the example slightly, assume the company pays $200 down and signs a loan for the remainder ($800).
Notice now that there is only one debit (Equipment, 1000) and there are two credits (Cash, 200; Note Payable, 800). Is this a problem? Shouldn’t debits and credits be equal? Yes, they should. But what must be equal is the dollar value of the debits and credits, not the number of debits and credits. The accounting equation still balances, because the value of the debits and credits is equal.
In this modified example, the total dollar value of the debits and credits balances at $1,000 each. Regardless of the number of accounts used, the sum of the debits must equal the sum of the credits.
Now that the journal entry is complete, what is the next step? After the event has been journaled, it is posted to the appropriate account in the General Ledger. Whereas the General Journal records journal entries chronologically by event, the General Ledger records total balances by account. Posting items to the General Ledger requires no decision making, as all the decisions were made when creating the original journal entry. Taking the original example:
To post this to the General Ledger simply requires taking the account names ("Equipment" and "Cash") and entering the dollar values on the appropriate side (debit or credit). Accounts are visualized using a t-chart, as shown below.
The process of posting to the General Ledger is fairly mechanical. To post our original example from above, take the first account title ("Equipment"), the dollar value ($1,000), and wether it is a debit or credit (debit). Then fill in the sample t-chart from above with the proper information. For cash and equipment:
It may be hard to see from this simplistic example, but what the t-account gives you is a bird’s eye, snapshot view of an account. For example, at the end of the year the "Cash" account may look like the following:
Now that more events have taken place during the year, the "Cash" account starts to have more entries. On the left (debit) side are all the increases and the right (credit) side holds all the decreases. At the very bottom, the $34,200 is the ending balance of the "Cash" account, found by adding all the debits and subtracting all the credits. The t-account view makes it much easier to quickly see what happened during the year rather than looking at every event in the General Journal.
A journal entry is the recording of a financial event in the accounting journal. Events are recorded chronologically . The first step in preparing a journal entry is to determine the accounts affected. Once the accounts have been determined, the next step is to decide how much each account is being affected and whether that amount is a debit or a credit. With account names and debits/credits being decided, the journal entry begins to take shape. Debits are written first, flush to the left, followed by credits, indented to the right. It is imperative that the dollar values of the debits/credits for every journal entry be in balance. Once the journal entry is formed, it is a simple matter of posting the same amounts to the t-accounts in the General Ledger for summary viewing.