After identifying and measuring your business transactions, you will now move to the recording process of accounting. The first phase of recording is making the journal entries (journalizing) that should be recorded in the general journal or special journals, such as sales journal, purchases journal, cash receipts journal and cash disbursements journal. A journal is a chronological listing of an entity’s transactions, including the amounts, accounts that are affected, and in which direction the accounts are affected. From the journal, the entries will be posted to the designated accounts in the general ledger. The following will guide you on how to make accounting journal entries.
What is a business transaction?
A business transaction is an economic event or condition that directly changes an entity’s financial condition or directly affects its results of operations. An accounting transaction takes place when a business exchanges a thing of value for another. Examples of business transactions are when a company obtains loan from a bank, buys goods for sale, sell these goods to customers on account, and collect the cash from its sale of goods.
What are debits and credits?
Debits and credits form the basis of the double-entry bookkeeping system (as opposed to the Single-entry bookkeeping system); for every debit transaction there must be a corresponding credit transaction and vice versa. Every debit and credit value is initially recorded as a journal-entry and from these journal-entries is then transferred to ledger-accounts and finally from these ledger-accounts financial reports can then be prepared.
Debit and credit are the most fundamental concepts in accounting, representing the two sides of each individual transaction recorded in any accounting system. A debit transaction can be used to increase a debit balance in an asset account or to reduce a credit balance in a liability account. On the other hand, a credit transaction can be used to decrease a debit balance in an asset account, or to increase a credit balance in a liability account.
When to debit and when to credit transactions?
To understand which accounts are debited or credited in order to either increase or decrease their amounts, the following five fundamental elements of any financial statement should be considered:
Assets – are the resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. This includes cash, receivables, inventories, prepayments, investments, property and equipment.
Liabilities – are the present obligations of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. This includes accounts payable, accrued expenses, income tax payable, unearned revenue and loans payable.
Equity – this is the owner/s’ interest on the assets of the enterprise after deducting all its liabilities. The structure of equity depends on the form of a business: sole proprietorship (owner’s equity), partnership (partners’ equity), stock corporation (stockholders’ equity), and nonstick – nonprofit corporation (fund balances or members’ equity).
Income – an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants. Examples of income are rental income, sales from goods, service income, commission income, et cetera.
Expenses– are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Examples of expenses are employees’ salaries, rent expense, supplies, taxes and licenses.
Assets, liabilities and equity are the 3 elements of balance sheet (or statement of financial position) that expresses the accounting equation (assets = liabilities + equity), which must always be balanced. Income and expenses are the elements that form the income statement.
The easy way to remember when to debit and when to credit an account is to remember the normal balances of the five types of accounts on the Chart of Accounts. The Chart of Accounts is list of accounting accounts, categorized according to types of accounts (assets, liability, equity, income and expenses) with their corresponding account numbers. The normal balance is what the account would have if it increases or if its increases are more than its decreases. The following are the normal balances of those account types:
Asset accounts – debit
Liability accounts – credit
Owner’s equity – credit
Revenue accounts – credit
Expense accounts – debit
Contra assets accounts, such as allowance for bad debts and accumulated depreciation have credit normal balances.
Sample business transactions and their journal entries
The following are examples of business transactions for a sole proprietorship business and their corresponding journal entries. Take note that the amount on the left side represents debit and the amount on the right side represents credit.
M. Santos, invests P250,000 to start an internet café business.
Journal entry #1:
M. Santos, capital P250,000
To record M. Santos initial capital.
Santos purchase 5 sets of computer equipment on credit amounting to P100,000.
Journal entry #2:
Computer equipment P100,000
Accounts payable P100,000
To record purchase of 5 sets of computer equipment on account worth P100,000
Santos buys computer supplies for cash worth P50,000.
Journal entry #3:
Computer supplies P50,000
To record purchase of computer supplies on cash worth P50,000
Santos pay his taxes and licenses amounting to P20,000.
Journal entry #4
Taxes and licenses P20,000
To record payment of taxes and licenses
Santos obtain a bank loan for business use and receives P100,000.
Journal entry #5
Loans payable P100,000
To record bank loan received amounted to P100,000
Customers pay cash for internet rental amounted to P5,000.
Journal entry #6
Internet service income P5,000
To record internet rental income received on cash
Customers render printing services on account amounted to P4,000.
Journal entry #7
Accounts receivable P4,000
Printing service income P4,000
To record printing services income on customers account
Santos paid in full the computer equipment he purchased on account (see transaction #2).
Journal entry #8
Accounts payable P100,000
To record full payment of computer equipment purchased on account
Santos paid his monthly rental for the internet café shop space.
Journal entry #9
Rental expense P5,000
To record monthly rental expense paid
Santos pays salaries and wages of his staff and employees, P20,000
Journal entry #10
Salaries and wages P20,000
To record salaries and wages of employees
Note: Journal entry #10 will become different when there are withholding taxes, SSS, PHIC, HDMF and other employees benefits or deductions involved.
Santos collects its accounts receivables amounted to P4,000 from customers (see transaction #7).
Journal entry #11
Accounts receivable P4,000
To record collection of accounts receivable
Supplies amounted to P3,000 were used in business operation (see transaction #3).
Journal entry #12
Computer Supplies expense P3,000
Computer supplies P3,000
To record used supplies
Santos withdraws P25,000 cash for personal use.
Journal entry #13
Santos, drawing P25,000
To record cash drawn by Santos for his personal use
Santos invested additional cash capital amounting P50,000.
Journal entry #14
Santos, Capital P50,000
To record additional cash capital invested to the business
Note: When recording journal entries on the journals (general journal and or special journals), the entries may require a more specified account. It also includes date, reference numbers and explanations. The examples shown above are only simple entries. A compound entry may be necessary when transactions are more bulky and complicated. When a company has a standard chart of accounts, the recoding of journal entries are based on the account titles, account numbers and other specific data stated in the chart of accounts.
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