In accounting careers, journal entries are by far one of the most important skills to master. Without proper journal entries, companies’ financial statements would be inaccurate and a complete mess.
An easy way to understand journal entries is to think of Isaac Newton’s third law of motion, which states that for every action there is an equal and opposite reaction. So, whenever a transaction occurs within a company, there must be at least 2 accounts being affected.
For example, if a company bought a car, the company’s assets would go up by the value of the car. However, there needs to be an additional account that changes (i.e., the equal and opposite reaction). The other account that is affected is the company’s cash going down because they used the cash to purchase the car.
Finally, just like how the size of the forces on the first object must equal that of the second object, so must the debits and credits of every journal entry must be equal.
How to Approach Journal Entries
A journal is the company’s official book in which all transactions are recorded in chronological order. Although many companies use accounting software nowadays to book journal entries, journals were the predominant method of booking entries in the past. In every journal entry that is recorded, the debits and credits must be equal to ensure that the accounting equation (A = L + SE) remains in balance. When doing journal entries we must always consider four factors:
- Which accounts are affected by the transaction
- For each account, determine if it is increased or decreased
- For each account, determine by how much it changed
- Make sure that the accounting equation stays in balance
Journal Entry Examples
Example 1: Borrowing money journal entry
ABC Company borrowed $300,000 from the bank
The accounts affected are cash (asset) and bank loan payable (liability)
Cash is increasing because we are gaining cash from the bank and bank loan payable is increasing because the company is increasing its liability to pay back the bank at a later date
The amount in question is $300,000
A = L + SE, A is increased by 300,000 and L is also increased by 300,000, keeping the accounting equation intact.
Therefore, the journal entry would look like:
DR Cash 300,000
CR Bank Loan Payable 300,000
Example 2: Purchasing equipment journal entry
Purchased equipment for $650,000 in cash.
DR Equipment 650,000
CR Cash 650,000
Example 3: Purchasing inventory journal entry
Purchased inventory costing $90,000 for $10,000 in cash and the remaining $80,000 on the account.
DR Inventory 90,000
CR Cash 10,000
CR Accounts Payable 80,000
Example 4: Acquiring land journal entry
Purchased land costing $50,000 and buildings costing $400,000. Paid $100,000 in cash and signed a note payable for the balance.
DR Land 50,000
DR Buildings 400,000
CR Cash 100,000
CR Note payable 350,000