Journal Entries: How to Record a Transaction

What a journal entry is

A journal entry is the first record of a business transaction. It goes into the journal, the book that lists every transaction in date order, before the amounts are copied (posted) to the individual accounts in the ledger. Each entry names:

• the date of the transaction;
• the account or accounts that are debited, with their amounts;
• the account or accounts that are credited, with their amounts;
• a short explanation, so that a reader can trace the entry back to its source document (an invoice, a receipt, a bank statement).

Every entry follows the rule of double entry: the total of the debits equals the total of the credits. An entry can have one debit and one credit (a simple entry) or several lines on one or both sides (a compound entry), but the two totals must always match. On PractiBalance you build the entry by placing account chips in the Debit and Credit columns and typing an amount next to each chip; the totals bar shows at once whether the two sides agree.

How to read a transaction

Most mistakes come from reading the transaction too quickly. Before you think about debits and credits, answer three questions in plain words.

1. What did the business receive? Cash, equipment, a service, a promise from a customer to pay later?
2. What did the business give up or take on? Cash, a promise to pay later, part of its ownership?
3. Did anything change the owners’ claim? Revenue earned and expenses incurred change equity, and so do owner investments and withdrawals.

Some words in the text point straight to an account:

Wording in the transaction	Account it usually points to
“on account”, “on credit” (selling)	Accounts Receivable
“on account”, “on credit” (buying)	Accounts Payable
“paid”, “received”, “by check”, “by bank transfer”	Cash
“signed a note”, “borrowed from the bank”	Notes Payable
“billed a customer for services performed”	Service Revenue
“received in advance”, “collected before the work is done”	Unearned Revenue

In the US convention used on the English pages, Cash covers currency and money in bank checking accounts, so a bank transfer is recorded in Cash. Other conventions keep a separate Bank account (see below).

The five steps

1. Identify the accounts that the transaction changes. There are always at least two.
2. Classify each account: asset, liability, equity, revenue or expense.
3. Decide the direction: does each account increase or decrease?
4. Apply the debit and credit rules: assets and expenses increase with a debit; liabilities, equity and revenue increase with a credit. The debit and credit rules guide explains why.
5. Enter the amounts and check the totals: debits must equal credits. If they do not, an amount or a side is wrong.

Worked examples

1. The owner starts the business

Kim invests $20,000 of her own money in a new consulting business. The business receives cash (an asset increases) and the owner’s claim grows (equity increases).

Account	Debit	Credit
Cash	20,000
Kim, Capital		20,000

If the business is a corporation, the credit goes to Common Stock instead of the owner’s capital account.

2. A compound entry: equipment bought partly on credit

The business buys equipment for $5,000, pays $2,000 in cash and owes the rest to the supplier. One asset increases, another decreases, and a liability increases.

Account	Debit	Credit
Equipment	5,000
Cash		2,000
Accounts Payable		3,000

The debits ($5,000) equal the credits ($2,000 + $3,000).

3. Services performed on account

The business performs consulting work and bills the client $1,500, payable in 30 days. Revenue is earned when the work is done, not when the cash arrives, so the entry is recorded now.

Account	Debit	Credit
Accounts Receivable	1,500
Service Revenue		1,500

When the client later pays, Cash is debited and Accounts Receivable credited; revenue is not recorded a second time.

4. Paying an expense

The business pays the month’s office rent of $800. The cost of using the office this month is an expense; cash decreases.

Account	Debit	Credit
Rent Expense	800
Cash		800

Common mistakes

• Recording cash received in advance as revenue. Money received before the work is done is a liability (Unearned Revenue) until it is earned.
• Treating owner withdrawals or dividends as expenses. They reduce equity directly and never appear on the income statement.
• Debiting an expense for an item that lasts several years. Equipment is an asset; only its depreciation becomes an expense, period by period.
• Recording only one side. Every transaction changes at least two accounts.

When the convention changes the entry

The rules of double entry are the same everywhere, but the accounts are not. The Spanish (PGC), French (PCG) and German conventions on this site keep a separate Bank account next to Cash, add a value added tax line to most purchases and sales (see VAT entries), and record goods bought for resale in a purchases expense account under a periodic inventory system. The US convention uses a perpetual system: goods bought go to Inventory, and each sale also moves their cost to Cost of Goods Sold. Every item on PractiBalance states its assumptions above the columns, so read them before you start.

Practice

Start with business start, then try purchases and sales. Once you are comfortable, follow the amounts into the ledger with the T-accounts guide, and look up any unfamiliar term in the glossary.