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A journal entry records business transactions in the company’s accounting books. Making a journal entry begins the accounting cycle. It details every financial transaction the business makes and notes each account affected by the transactions. Each entry includes all the relevant information about business activities. It functions as a foundation for all the financial reports generated. Auditors also use journal entries to analyze the impact of financial transactions on the business. 

Journal entries provide two huge benefits for businesses. They create a chronological record of all transactions and when they occur. Secondly, journal entries minimize the possibility of bookkeeping errors. In addition, entries include an explanation of each transaction, as well as providing a basis for ledger posts and creating the Trial Balance.

What is Included in a Journal Entry?

All journal entries follow a standard format. The proper format includes the date of the transaction, general ledger accounts, amounts debited and credited, transaction description, and a unique reference number. Each of these elements is used when creating a journal entry:

  • Header: this includes a title and the date of the entry
  • Reference Number: Each entry has a unique number, so it can be easily identified and retrieved.
  • First Column: Account name and number.
  • Second Column: Debit amount.
  • Third Column: Credit amount.
  • Footer: Clear description of the journal entry. 

What are the Types of Journal Entries?

There are three basic types of journal entries.

Adjusting Entry 

This type of entry brings financial statements into compliance with accounting frameworks like GAAP. An adjusting entry is made at the end of an accounting period. Typically, the adjusting entry is made to record prepaid expenses, unearned revenue, accrued expenses, and accrued income.

Adjusting entries are beneficial for accrual-based accounting. They keep the books in order and insures costs and revenue match in each period. They also provide a more accurate picture of the business’s overall financial health.

Compound Entry

A compound entry involves making more than two lines of entry in the journal. It may be used to record multiple transactions or to enter details of a complex transaction. Examples include payroll, which involves tax liabilities. This type of entry usually contains several lines.

The advantages of compound journal entries include saving time and being able to present data in a more organized manner. Compound entries provide a summary so an analysis can be made easily.

Reversing Entry

A reversing entry is created at the beginning of an accounting period and applies to the previous period. They cancel or reverse entries that are no longer necessary. One example is a payroll expenditure replacing a wage accrual.

 There are two primary benefits of making reversal entries. Firstly, a reverse entry significantly reduces the chances of making errors by double-counting some expenses and revenues. Secondly, they allow for efficient processing of invoices during an accounting period.

How to Prepare a Journal Entry

To prepare a journal entry, first read the transaction carefully so you clearly understand all it entails. Determine which accounts are to be debited and credited. Then, create the journal entry. After entering the numerical information, write a summary description for the debit and credit transactions.

What are the mistakes during preparing a journal entry?

In most cases, journal entry errors are unintentional. A small error in accounting may not have a huge effect on financial statements. But sometimes, they cause overall figures to be greatly distorted. Errors may be easily found and remedied, or they may be difficult to find. Here are some of the most common mistakes made while preparing journal entries.

  • An Error of Omission: When an accountant forgets to enter a transaction. It may be a missed invoice or a sale. An error of omission is difficult to find. If a trial balance contains an equal amount of debits and credits, a credit may have been entered without a debit transaction. They are usually discovered when a company is using petty cash to cover expenses.
  • Rounding Errors: Rounding figures create inaccurate information and lead to future errors. This type of error is often done by accountants or accounting software. For instance, entering 23.9650 rather than 23.9646 is a tiny mistake that has a snowball effect. This type of error is prevented by checking bank statements against books often.
  • Principle Errors: An error of principle occurs when a transaction uses an accounting principle incorrectly. Entering a number in the wrong account is an input error, even if the number is correct. It may be something as simple as recording personal expenses in business expenses. To find it, scan the trial balance for possible errors because your credits and debits will probably still balance.
  • An Error of Commission: This journal entry error occurs when an amount is entered in the right account, but the numerical value is incorrect. Applying a payment to the wrong invoice is an example. The owed amount is still correct in the trial balance, making the mistake difficult to find. Examining the client’s sub-ledger will reveal the mistake. 
  • An error of Reversal: An entry that is debited rather than credited, or vice versa, is an error of reversal. An example would be entering a $500 client invoice in an accounts payable rather than placing it correctly in accounts receivable. Checking the trial balance to discover the difference between debits and credits reveals the mistake.

Example of a Journal Entry

As an example, suppose a client pays a $600 invoice you sent to them. When they pay the invoice, an entry will be made. It should look like this.

Date Description Debit Credit
April 4, 2021 Invoice #987 $600 ($600)

How to Audit a Journal Entry

It is important to understand the nature of transactions posted as journal entries. Many transactions are low risk and normal for a company such as interest expense or income, depreciation, accrued expense, unearned revenue, or inventory provision. These transactions occur every month. Having a strict policy regarding posting journal entries reduces the risk of errors. Here are the steps to audit and correct a journal entry.

Step 1: Pull all the Journal Entries

Sart by pulling or extracting all the journal entries during the month or time period being assessed. Check the list to ensure it is complete.

Step 2: Ensure Completeness

After the list is compiled, auditors need to make sure it is complete and that no transactions were excluded. This can be checked simply by running number sequences. The numbers should be in order with none missing. If a number is missing, check with the accountant. Also, check the debit and credit sides to see if they are equal. If not, the list is incomplete or there has been an error.

Step 3: Separate Recurring Transactions from Non-Recurring 

Remove the recurring transactions as they are low risk. Adjustments other than recurring transactions are non-recurring and need to be checked for accuracy.

Step 4: Test for Recurring Adjustments

Group recurring adjustments together by type. Go through each group of transactions to ensure they are entered correctly and in the proper accounts.

Step 5: Test Non-Recurring Adjustments

Testing non-recurring adjustments are more subjective. They do not fit into specific groups. Find the high-risk accounts and start by checking those for accuracy. Since it is less material for transactions that are only $100 than transactions that are $100,000, you may choose to audit based on if a transaction is material or not. Once you have completed high-risk transactions, then check the remaining transactions for accuracy.

Should every accountant know how to prepare a journal entry?

A company’s journal is an official book where all transactions are recorded in the order they occur. Journals are still preferred for small businesses and may be kept in conjunction with accounting software. Accountants need to know that debits and credits need to be equal in every entry. They must ensure the accounting equation remains balanced. (Assets=liabilities + Shareholder Equity) There are four factors to consider when preparing for a journal entry:

  • Which accounts will be affected by the transaction?
  • Determine if each account increases or decreases
  • Determine how much the transaction will change each account
  • Ensure the accounting equation remains balanced

Is journal entry preparation taught in accountant education?

Yes. Mastering the skill of journal entries is essential for an accounting career. A company’s financial statements are jeopardized without proper journal entries. Inaccuracies create a financial disaster for a company. 

What are the books for Journal Entry?

There are seven different types of books used in accounting for journal entries. Books keep entries organized and help ease the process of recording transactions. The seven types of journals used in accounting include:

  1. A purchase journal
  2. A sales journal
  3. Cash receipt journals
  4. Cash payment and disbursement journals
  5. A purchase return journal
  6. Sales return journals
  7. A general journal (also called a journal proper)