Understanding Accounting Journal Entries
Ah - another Accounting Blog! I'm sure you're thinking "how thrilling!" Well, for some people this is, and for others it isn't, but either way I'm here to help you with understanding journal entries a little better with some examples that usually show up when you're taking your first accounting course.
1. Revenues (Sales) and Accounts Receivables
Let’s start with something fun, like receiving payment from our customers! When a company completes a sale and they use accrual accounting (recording transactions when they occur, versus the cash method which records transactions when cash is transferred), the sale is recorded as a credit. The debit entry (because by now you have probably ingrained in your brain that Debits = Credits), would be to either Cash or Accounts Receivables, depending on how the customer completed the sale. A lot of the time a Company will set up a credit line with their customers to be able to make sales “on credit,” and in these instances you will record the Debit to Accounts Receivables as this account is there to be able to track how much your customers actually owe you. You have completed your sale of the good or service and can record revenue, however if your customer hasn’t paid you in cash, the entry is to Accounts Receivable. The entry would look like this:
Dr. Accounts Receivable
2. Prepaid expenses
When a company wants to take advantage of discounts on upcoming expenses that are reoccurring or span over multiple months, similar to how we like to buy online subscriptions for a year instead of paying every month to save money, they will pay these in advance. A typical prepaid expense you will see in your accounting class is probably prepaid rent (because no one wants to be late on their rent payments!), however I think sometimes people get confused with what type of account a prepaid expense is. Prepaid expenses are classified as assets, because if you remember what an asset is, it is something of future economic value. In the case with prepaying rent, you record this as a Debit to Prepaid Rent to increase the asset account for the future rent benefits you receive by paying for it today. A normal entry usually looks like this:
Dr. Prepaid Rent
3. Accounts Payable
Accounts payable can be viewed as the opposite of Accounts Receivables, since Accounts Receivables are sales on credit that we will be due, Accounts Payable are purchases that a company has made on credit that will be due. Whenever a company makes a purchase of something but has not paid cash for this purchase, they will Credit Accounts Payable (it is a liability since it is owed in the future, and we always credit liabilities to increase them), and Debit whatever they are getting in return. A transaction you might see in your accounting course is that the company bought supplies on credit – remember to always think Accounts Payable when you hear “bought on credit” as this is the whole point of having the Accounts Payable account. When you buy the supplies, you Debit Supplies and Credit Accounts Payable, just like the entry below:
Cr. Accounts Payable
4. Inventory and Cost of Goods Sold
All manufacturing companies will have inventory, which is essentially the related and capitalizable costs of creating their product (Managerial Accounting / Cost Accounting courses cover how a company figures out the costs that go into these products). Since a company is planning on selling their product for future benefits (usually profits), inventory is considered an asset and will be debited to the company’s books when it is made. When a sale is completed, the company will move the inventory off of their Balance Sheet and onto the Income Statement as an expense under Cost of Goods Sold. Cost of Goods Sold are recognized when the sale is also recognized so that they are able to appropriately record the costs associated with selling that item at the time that they occur. The journal entry for the sale of a product is as follows:
Dr. Cost of Goods Sold (remember that expenses are “normal debit” entries)
Thank you for reading this blog if you got this far! If you have any questions on your accounting course or are looking for a tutor to help you breakdown the concepts, please reach out via my contact form on my website or send me an email/text.