8 Journal Entries
Learning Objectives
- Construct journal entries based on given parameters
Entering Transactions in the Journal
The financial statements that are the end product of the accounting cycle are only as good as the journal entries that happen at the beginning of the cycle. In order to better understand how bookkeeping entries are constructed, here is a simplified case study of the accounting process, starting with the daily log of transactions—the journal.
On January 10, you start a gift shop called Holiday Gifts. The first thing you do file for an assumed business name with the state and then, when you get the business name, you go to a local bank and make a $10,000 transfer from your personal checking to a new business checking account. In order to keep track of your financial results, you decided to follow GAAP and best bookkeeping practices, so you buy an accounting journal and make the following entry:
| Jan | Debit | Credit | |
| 10 | Checking account | 5,000 | |
| Capital Contributions | 5,000 |
Note that you have written the debit portion of the entry first, and that you indented the account name for the credit entry, according to common practice. You decide to wait for a few more transactions before posting to the general ledger.
On the 12th, you pay insurance in the amount of $600 and you journalize the transaction as follows:
| 12 | Insurance Expense | 600 | |
| Checking Account | 600 |
On January 15 you paid $1,000 in rent for the next 5 months ($200 per month for January through May.
The journal entry to record both the rent paid in advance and the rent for the current month would be:
| 15 | Prepaid Rent (an asset) | 800 | |
| Rent Expense (for January) | 200 | ||
| Checking Account | 1,000 |
On January 16 you bought 10 picnic baskets to resell. The vendor gave you 30 days to pay in full. You paid $60 each for them and you plan to resell them for $100 each.
The journal entry to record the purchase of inventory would be:
| 16 | Merchandise Inventory | 600 | |
| Accounts Payable (a liability) | 600 |
On January 20 you hired a part-time sales person to mind the store so that you could spend time building the customer list. Your sales person is paid twice a month on the 10th and 25th and will start immediately.
No journal entry in needed for this activity since it did not rise to the level of a financial transaction.
On January 21 you borrowed $15,000 from the bank for working capital.
| 21 | Checking Account | 15,000 | |
| Note Payable | 15,000 |
On January 30 you sold 4 picnic baskets to various cash-paying customers.
| 30 | Checking Account | 400 | |
| Merchandise Sales (a revenue account) | 400 | ||
| 30 | Cost of Goods Sold (an expense) | 240 | |
| Inventory (an asset) | 240 |
Note in the last entry on the 30th we reduced the amount of inventory we are reporting as having on hand (an assets) by the amount of picnic baskets we sold, and matched that as an expense against the sales price. That specific matching concept results in an amount accountants call Gross Profit. Gross profit is the sales price of an item less its cost. In this case, the Gross Profit per item is $40, and the total Gross Profit for January was $160.
On January 30 you paid $2,750 cash for a small travel trailer that will serve as a mobile store. You expect it to last for five years and then you’ll sell it for about $750.
| 20 | Furniture and equipment (an asset) | 2,750 | |
| Checking account | 2,750 |
Posting Entries to the Accounts
Once all the transactions for the month are journalized, they are posted to the ledger pages. Each journal entry is transferred line by line to the appropriate account. For instance, the cash ledger would appear like this:
| General Ledger | ||||
| Checking Account #1101 | ||||
| Jen | Ref | Debit | Credit | Balance |
| Opening Balance | 0 | 0 | ||
| 10 | GJ1 | 5,000 | 5,000 | |
| 12 | GJ1 | 600 | 4,400 | |
| 15 | GJ1 | 1,000 | 3,400 | |
| 20 | GJ1 | 2,750 | 650 | |
| 21 | GJ1 | 15,000 | 15,650 | |
| 30 | GJ2 | 400 | 16,050 | |
Notice that in the cash account, which is an asset account, a debit (entry to the left side of an account) represents an increase, and a credit (entry to the right side of the account) represents a decrease, and the balance is the combination of the two. This is the exact opposite for accounts on the right side of the accounting equation:
Assets = Liabilities + Equity
In liability and equity accounts that represent increases in those major categories, account balances are increased by a credit and account balances are decreased by a debit. The opposite is true for accounts that decrease those major categories.
