In previous chapters, we have studied how business transactions are recorded using T-accounts. These transactions can also be recorded as journal entries.
A journal entry is simply a record of a business transaction, which typically states the date, account titles to be debited and credited along with the amounts to be debited and credited to these accounts respectively, and brief description of the business transaction. The space or register where these journal entries are recorded is called accounting journal. The accounting journal where journal entries related to all the business transactions are recorded is called general ledger. However, specific ledgers can also be used for accounts which have more frequent transactions, such as Sales ledger, Purchases ledger etc.
Let’s take a look at the following example to get a better picture of journal entries.
Mr. Arteta started a business related to IT services by incorporating a new company on 1 July 20xx with an initial capital of $15,000. During the first month of the business, following transactions took place:
- On 3 July, the Company paid $5,000 security deposit to the landlord for the office which was acquired on rent. Monthly rent of $2,500 was agreed which will be paid at the end of each month.
- On 5 July, the Company purchased some office equipment such as laptop, printers etc. by paying $4,000. Useful life of this equipment is estimated to be 3 years.
- On 15 July, the Company purchased some supplies worth $6,000 required for completing a project. Half of this amount was paid in cash whereas half was agreed to be paid after 30 days.
- On 20 July, the Company obtained an interest free loan of $15,000 from a related party to manage its working capital.
- On 27 July, the Company successfully completed its first project worth $16,000. It was agreed that 25% of the amount will be paid by the customer at the time of completion of project whereas the remainder amount will be paid after 60 days.
- On 31 July, the Company paid monthly rent of $2,500 and paid salaries to its employees amounting to $4,500.
Following are the journal entries related to above transactions:
|(Recording initial capital)|
|3 July||Security deposit||5,000|
|(Recording refundable security deposit receivable)|
|5 July||Office equipment||4,000|
|(Recording the purchase of fixed assets)|
|15 July||Material cost||6,000|
|(Recording the purchase of supplies which are used in the project)|
|(Recording the receipt of interest free loan)|
|(Recording the revenue earned from a project)|
|31 July||Office rent expense||2,500|
|(Recording monthly rent expense)|
|31 July||Staff cost||4,500|
|(Recording monthly staff cost)|
|31 July||Depreciation expense||111|
|(Recording monthly depreciation of fixed assets; $4,000/36 months)|
The accounting journal where journal entries related to all the business transactions are recorded is called general ledger. It is the base of all the financial reports as it contains summary of all the transactions of a business. From general ledger, data can be sorted out to get information about any specific account. From the general ledger, a report called trial balance is also generated which is used for preparation of financial statements.