Steps to Prepare a Journal Entry
Journalizing is the process of recording a business transaction in the accounting records (Journal Book). The process to prepare a journal entry or in other words make a journal entry from scratch is divided into 4 different steps.
Example and Explanation – Steps to Prepare a Journal Entry
Example – Unreal Corp. is a local business that decides to buy furniture for 5,000 in cash. Prepare a journal entry to be noted in the journal book.
- Step I – Identify the accounts involved in the transaction – there will be a minimum of two such accounts. Going back to the above example the accounts identified in this case are “Furniture A/C” & “Cash A/C”.
Simple journal entry – There will be NO more than 2 accounts involved, one for debit and the other for credit.
Compound journal entry – There will be more than 2 accounts involved all of which are required to be identified.
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- Step II – Determine the type of accounts involved – The approach to determine the type of an account may either be traditional or modern.
Traditional Classification of Accounts – Real, Personal & Nominal. In the above example “Furniture A/C is Real” & “Cash A/C is Real”.
Modern Classification of Accounts – Asset, Liability, Capital, Revenue, Expense & Drawings. In the above example “Furniture A/C is Asset” & “Cash A/C is Asset”.
Once the type of account is identified the next step is to apply the proper rule(s) of accounting.
- Step III – After identifying the accounts & correctly determining their types the next step is to apply appropriate rules of accounting to either debit or credit the respective accounts with the currency value.
Three Golden Rules of Accounting – In the aforementioned example the applied rule is for Real accounts i.e. “Debit” what comes in and “Credit” what goes out.
Modern Rules of Accounting – In the very same example the modern rule applied will be for Asset accounts i.e. “Debit” the increase in assets and “Credit” the decrease in assets.
- Step IV – Inside the journal book record the transaction along with narration or a short description which depicts purpose of the transaction.