Journal Entries and Double-Entry System

Introduction

In accounting, accurate recording of transactions is essential for financial reporting and decision-
making. Journal entries and the double-entry system form the core of accounting practices. This
system ensures that every financial transaction is recorded in at least two accounts, maintaining the
accounting equation’s balance.

Chapter 1: Understanding Journal Entries

1.1 Definition of Journal Entries

Journal entries are the initial records of a transaction. Each journal entry includes details of the
transaction and ensures that financial records are accurate. Journal entries are made in a journal (or
book of original entry) before they are posted to the ledger.

Each entry has:

• Date: The date on which the transaction occurred.

• Account Titles: The names of accounts affected.

• Debit and Credit Amounts: The amount debited and credited.

• Description: A brief explanation of the transaction.

1.2 Purpose of Journal Entries

The main purposes of journal entries are:

• To ensure proper documentation of business transactions.

• To maintain accurate records for the preparation of financial statements.

• To facilitate the tracking and reporting of financial information in the general ledger.

1.3 Types of Journal Entries

1. Simple Journal Entries: Involves two accounts, one debit and one credit.

2. Compound Journal Entries: Involves more than two accounts, such as multiple debits and/or
credits.

3. Adjusting Journal Entries (AJEs): Made at the end of the accounting period to reflect changes
that are not recorded during the period.

4. Closing Journal Entries: These entries are made at the end of the fiscal year to transfer
balances from temporary accounts (like revenues and expenses) to permanent accounts (like
retained earnings).

1.4 Steps in Recording Journal Entries

2. Prepare the Entry: Record the accounts involved with their respective amounts.

3. Post to the Ledger: Transfer the journal entry to the general ledger.

4. Verify Accuracy: Ensure that debits equal credits and the accounts reflect the correct balances.

1.5 Example of a Journal Entry

Date Account Debit ($) Credit ($)

01/01/2025 Cash 1,000

Service Revenue 1,000

This example reflects a business receiving $1,000 in cash for services provided.

Chapter 2: The Double-Entry System

2.1 Overview of Double-Entry Accounting

The double-entry system is a foundational concept in accounting, stating that every financial
transaction affects at least two accounts. It ensures that the accounting equation (Assets = Liabilities +
Equity) remains balanced after every transaction.

In this system:

• Debit: Increases asset accounts or decreases liability/equity accounts.

• Credit: Increases liability/equity accounts or decreases asset accounts.

2.2 Basic Accounting Equation

The accounting equation is:

Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} + \text{Equity}Assets=Liabilities+Equity

The double-entry system ensures that every transaction adheres to this equation, maintaining the
balance between the left and right sides.

2.3 Debit and Credit Rules

• Asset Accounts: Debit increases, credit decreases.

• Liability Accounts: Credit increases, debit decreases.

• Equity Accounts: Credit increases, debit decreases.

• Revenue Accounts: Credit increases, debit decreases.

• Expense Accounts: Debit increases, credit decreases.

1. Accuracy: Ensures no transaction is omitted, as every transaction impacts both sides of the
balance sheet.

2. Fraud Prevention: Reduces the chance of financial manipulation since it’s difficult to balance
accounts without proper documentation.

3. Financial Transparency: Enhances the reliability of financial reports.

Chapter 3: How the Double-Entry System Works

3.1 Recording a Transaction

For every transaction, two entries are made:

• Debit entry: Increases assets or expenses, or decreases liabilities or equity.

• Credit entry: Increases liabilities or equity, or decreases assets or expenses.

Example:

Suppose a business purchases office supplies on credit worth $500.

Date Account Debit ($) Credit ($)

01/01/2025 Office Supplies 500

Accounts Payable 500

• Debit Office Supplies (asset account) for $500 (increase).

• Credit Accounts Payable (liability account) for $500 (increase).

3.2 Trial Balance

After journal entries are posted to the general ledger, a trial balance is prepared to ensure that debits
equal credits. If the trial balance doesn’t balance, errors in the journal entries may exist.

Chapter 4: Examples of Journal Entries

4.1 Example 1: Cash Sale

A business sells goods for $2,000 in cash.

Date Account Debit ($) Credit ($)

01/02/2025 Cash 2,000

Sales Revenue 2,000

Here, Cash (an asset) is debited (increased) and Sales Revenue (a revenue account) is credited
(increased).

4.2 Example 2: Purchase of Equipment on Credit

A business buys equipment worth $5,000 on credit.

Date Account Debit ($) Credit ($)

01/03/2025 Equipment 5,000

Accounts Payable 5,000

Here, Equipment (an asset) is debited (increased), and Accounts Payable (a liability) is credited
(increased).

4.3 Example 3: Salary Payment

A business pays salaries of $3,000 in cash.

Date Account Debit ($) Credit ($)

01/04/2025 Salary Expense 3,000

Cash 3,000

Here, Salary Expense (an expense) is debited (increased), and Cash (an asset) is credited (decreased).

Chapter 5: Adjusting Journal Entries (AJEs)

5.1 Definition and Purpose of AJEs

Adjusting Journal Entries (AJEs) are made at the end of an accounting period to record income or
expenses that have not yet been recognized. These entries ensure that the financial statements reflect
the correct amounts.

5.2 Types of Adjusting Entries

1. Accrued Revenues: Revenues earned but not yet recorded (e.g., services performed but not
billed).

2. Accrued Expenses: Expenses incurred but not yet recorded (e.g., wages owed but not paid).

3. Deferred Revenues: Cash received before services are rendered (e.g., advance payments).

4. Deferred Expenses: Payments made for services not yet rendered (e.g., prepaid insurance).
5.3 Example of an Adjusting Entry

If a company earns $500 in interest revenue that is not yet recorded:

Date Account Debit ($) Credit ($)

12/31/2025 Interest Receivable 500

Interest Revenue 500

This reflects the accrued interest revenue that has been earned but not yet recorded.

Chapter 6: Closing Entries

6.1 Purpose of Closing Entries

Closing entries are made at the end of the accounting period to transfer balances from temporary
accounts (like revenues and expenses) to permanent accounts (like retained earnings). This resets
temporary accounts to zero for the new period.

6.2 Example of Closing Entries

If the company has earned $10,000 in revenue and incurred $6,000 in expenses during the period:

Date Account Debit ($) Credit ($)

12/31/2025 Sales Revenue 10,000

Retained Earnings 10,000

12/31/2025 Retained Earnings 6,000

Expense Account 6,000

This ensures that the revenue and expense accounts are reset, and the profit (or loss) is transferred to
Retained Earnings.