How Do Journal Entries Work in Accounting?

Journal entries are one of the most fundamental and essential concepts in accounting. A journal entry is a record of a transaction that affects a company’s financial statements. Journal entries are used to record all types of transactions, such as sales, purchases, expenses, and revenue.

Here’s how journal entries work in accounting:

1. Identify the transaction

The first step in creating a journal entry is to identify the transaction that has occurred. This can be any type of business activity that affects the company’s financial position, such as a sale, a purchase, or a payment.

2. Determine the accounts involved

The next step is to determine which accounts will be affected by the transaction. For example, if a company sells a product, it will increase its sales revenue account and decrease its inventory account. If the company paid cash for the inventory, it would decrease its cash account and increase its inventory account.

3. Determine the account type

Each account in accounting is classified as either an asset, liability, equity, revenue, or expense account. It is important to determine the account type before creating the journal entry because the type of account affects whether the account is increased or decreased. For example, a revenue account is increased by credits, while an expense account is increased by debits.

4. Record the transaction in the journal

Once the accounts and their types have been determined, the transaction can be recorded in the journal. The journal entry will include the date of the transaction, the accounts affected, the amount of the transaction, and a brief description of the transaction.

Note: The amount recorded in the debit and credit columns of the journal entry must be equal, reflecting the accounting equation that assets = liabilities + equity.

Examples of Journal Entries

1. Sale of goods on credit: Debit: Accounts Receivable Credit: Sales Revenue

Explanation: When a company sells goods on credit, it records an increase in accounts receivable, which is an asset account, and an increase in sales revenue, which is a revenue account.

2. Purchase of inventory on credit: Debit: Inventory Credit: Accounts Payable

Date	Account Name	Debit	Credit
March 1	Inventory	5,000
	Accounts Payable		5,000

Explanation: When a company purchases inventory on credit, it records an increase in inventory, which is an asset account, and an increase in accounts payable, which is a liability account.

3. Payment of accounts payable: Debit: Accounts Payable Credit: Cash

Date	Account Name	Debit	Credit
March 1	Accounts Payable	5,000
	Cash		5,000

Explanation: When a company pays its accounts payable, it records a decrease in accounts payable, which is a liability account, and a decrease in cash, which is an asset account.

4. Depreciation of fixed assets: Debit: Depreciation Expense Credit: Accumulated Depreciation

Date	Account Name	Debit	Credit
March 1	Depreciation Expense	18,000
	Accumulated Depreciation		18,000

Explanation: When a company depreciates its fixed assets, it records an increase in depreciation expense, which is an expense account, and an increase in accumulated depreciation, which is a contra-asset account.

5. Issuance of common stock: Debit: Cash Credit: Common Stock

Date	Account Name	Debit	Credit
March 1	Cash	20,000
	Common Stock		20,000

Explanation: When a company issues common stock, it records an increase in cash, which is an asset account, and an increase in common stock, which is an equity account.

6. Payment of salaries: Debit: Salary Expense Credit: Cash

Date	Account Name	Debit	Credit
March 1	Salary Expense	4,000
	Cash		4,000

Explanation: When a company pays its employees’ salaries, it records an increase in salary expense, which is an expense account, and a decrease in cash, which is an asset account.

Note: The amount recorded in the debit and credit columns of the journal entry must be equal, reflecting the accounting equation that assets = liabilities + equity.