Every transaction your business makes requires journal entries. They take transactions and translate them into the information you, your bookkeeper, or accountant use to create financial reports and file taxes.
Here’s everything you need to know about this essential building block of bookkeeping, including what they are, why they’re important, and how to make them.
What is a journal entry?
Journal entries are how you record financial transactions. To make a journal entry, you enter details of a transaction into your company’s books. In the second step of the accounting cycle, your journal entries get put into the general ledger.
Every journal entry in the general ledger will include the date of the transaction, amount, affected accounts with account number, and description. The journal entry may also include a reference number, such as a check number, along with a brief description of the transaction.
If you use accounting software or outsource your accounting, your journal entries may not be visible, but they’re being generated in the back end, ensuring your books are accurate and up to date.
What are journal entries for?
Once business transactions are entered into your accounting journals, they’re posted to your general ledger. Think of “posting” as “summarizing”—the general ledger is simply a summary of all your journal entries.
Your general ledger is the backbone of your financial reporting. It’s used to prepare financial statements like your income statement, balance sheet, and (depending on what type of accounting you use) cash flow statement.
Financial statements are the key to tracking your business performance and accurately filing your taxes. They let you see, at a glance, how your business is performing.
Suggested reading: How to Read (and Analyze) Financial Statements
How Bench can help
Going through every transaction and making journal entries is a hassle. But with Bench, all of your transaction information is imported into the platform and reviewed by an expert bookkeeper. No manually inputting journal entries, thinking twice about categorizing a transaction, or scanning for missing information—someone else will do that all for you. Learn more.
There are two methods of bookkeeping (and, therefore, two methods of making journal entries): single and double-entry.
Think of double-entry bookkeeping as a GPS showing you both the origin and the destination. It will show you where the money is coming from and where it’s going to.
Single-entry bookkeeping is much simpler. If you spend money on office supplies, note it down. If you make a sale, note it down. You don’t need to include the account that funded the purchase or where the sale was deposited.
The most common form of bookkeeping today is double-entry. We’ll be using double-entry examples to explain how journal entries work.
If you’re totally new to double-entry accounting and you don’t know the difference between debits and credits, pause here. Then check out our visual guide to debits and credits. It’ll teach you everything you need to know before continuing with this article.
Common journal examples
The precise journals you use for your bookkeeping will depend on what kind of business you run. Broadly, they’re split into two categories: The general journal and the special journals.
The general journal contains entries that don’t fit into any of your special journals—such as income or expenses from interest. It can also be the place you record adjusting entries.
The special journals, also referred to as accounts, are used to record the common, day-to-day transactions in your accounting system. All of your special journals are listed in your chart of accounts. Common examples of account names include:
Sales: income you record from sales
Accounts receivable: money you’re owed
Cash receipts: money you’ve received
Sales returns: sales you’ve refunded
Purchases: payments you’ve made
Accounts payable: money you owe
Equity: retained earnings and owners’ investment
Journal entry examples
You’ve got a busy day today. You’re going to meet up with a client, pick up some office supplies, and stop by the bank to make a loan payment.
You get paid by a customer for an invoice
When you’re visiting with your client, they pay the $600 invoice you sent them.
|Nov. 3/21||Invoice #123||$600|
Date lets you know when the entry was recorded.
Description includes relevant notes—so you know where the money is coming from or going to. In this case, it’s the invoice number.
Debit notes that $600 is being added to your cash account.
Credit notes money leaving cash. In this case, there’s no money being paid out.
At the same time you make this entry, you’d make another in the accounts receivable (aka money clients owe you) ledger account:
Accounts Receivable Journal
|Nov. 3, 2021||Invoice #123||($600)|
The money is being removed from accounts receivable—your client doesn’t owe you $600 anymore—so it’s listed as a credit (written in parentheses). Here, the credit amount and debit amount are the exact same.
You picked up some office supplies
On the way back from meeting with your client, you stopped to pick up $100 worth of office supplies.
When the invoice was paid, money entered the cash account, so we recorded it as a debit. But now money is leaving the account, so we credit the account for the amount leaving.
|Nov. 3, 2021||Office Supplies||($100)|
Just as every action has an equal and opposite reaction, every credit has an equal and opposite debit. Since we credited the cash account, we must debit the expense account.
|Nov. 3, 2021||Office Supplies||$100|
You make a payment on your bank loan
Finally, you stop at the bank to make your loan payment. When you make a payment on a loan, a portion goes towards the balance of the loan while the rest pays the interest expense. This is called loan principal and interest.
This is an example of a compound entry. This happens when the debit or credit amount is made up of multiple lines.
Let’s look at a payment of $1,000 with $800 going towards the loan balance and $200 being interest expense.
For the cash side, we record the $1,000 leaving the account (a credit).
|Nov. 3, 2021||Loan Payment||($1,000)|
In the expense journal, we record a debit for the amount that went towards interest separately from the amount that reduces the balance.
|Nov. 3, 2021||Loan payment - Interest||$200|
Finally, we record a debit for the amount that went towards the principal.
|Nov. 3, 2021||Loan payment - Principal||$800|
Here, the debit was broken up into multiple lines: the interest amount and principal amount.
Closing accounting entries
At the end of the financial year, you close your income and expense journals—also referred to as “closing the books”—by wiping them clean. That way, you can start fresh in the new year, without any income or expenses carrying over.
You can’t just erase all that money, though—it has to go somewhere. So, when it’s time to close, you create a new account called income summary and move the money there.
Here’s a simplified example of how that might look.
First, credit all the money out of your asset accounts. In this example, that consists only of cash:
Sales Revenue Journal
|Dec. 31, 2021||Year Total||$12,000|
Close Income Accounts to Income Summary
Then, credit all of your expenses out of your expense accounts. For the sake of this example, that consists only of accounts payable.
|Dec. 31, 2021||Year Total||($3,000)|
Close Expense Accounts to Income Summary
After we do that, the income summary journal looks like this:
Income Summary Journal
|Dec. 31, 2021||Income Total||$12,000|
Adjusting journal entries
If you use accrual accounting, you’ll need to make adjusting entries to your journals every month.
Adjusting entries ensure that expenses and revenue for each accounting period match up—so you get an accurate balance sheet and income statement. Check out our article on adjusting journal entries to learn how to do it yourself.
The above information is an overview of how journal entries work if you do your bookkeeping manually. But most people today use accounting software to record transactions. When you use accounting software, the above steps still apply, but the accounting software handles the details behind the scenes.