Journal Entry Types

Why This Matters

Journal entries are the foundation of the entire accounting cycle—every financial statement you'll analyze on the exam traces back to these original records. You're being tested on your ability to recognize when different entry types are required, why they exist, and how they maintain the integrity of financial reporting under accrual accounting. Understanding the purpose behind each entry type connects directly to larger concepts like the matching principle, revenue recognition, and the distinction between temporary and permanent accounts.

Don't just memorize that adjusting entries happen at period-end—know why they're necessary (accrual basis requires matching revenues and expenses to the correct period) and how they differ from closing entries (which reset temporary accounts rather than update balances). When you encounter exam questions about the accounting cycle, your ability to distinguish entry types by their function rather than just their timing will set you apart.

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Recording Day-to-Day Transactions

These entry types capture financial activity as it happens, forming the raw data that flows through the entire accounting system. The goal is complete, chronological documentation of every transaction affecting the accounting equation.

General Journal Entries

• Chronological record of all transactions—serves as the primary source document for the entire accounting system
• Required components include date, accounts debited and credited, amounts, and a brief explanation (the "narration")
• Debits must equal credits in every entry, maintaining the fundamental accounting equation: $Assets = Liabilities + Equity$

Compound Entries

• Multiple accounts affected in a single entry—more than one debit or credit (or both) recorded together
• Common scenarios include sales with tax collected, payroll with multiple withholdings, or asset purchases with trade-ins
• Streamlines complex transactions while still requiring total debits to equal total credits

Recurring Entries

• Repetitive transactions recorded at consistent intervals—monthly rent, weekly payroll, quarterly insurance
• Automation opportunity in accounting software reduces errors and ensures timely recognition
• Supports the consistency principle by treating similar transactions identically across periods

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Period-End Adjustments

Adjusting entries exist because of accrual accounting—the requirement that revenues and expenses be recognized when earned or incurred, not when cash changes hands. These entries bridge the gap between cash-basis reality and accrual-basis reporting.

Adjusting Entries

• Four main categories: accrued revenues, accrued expenses, deferred revenues (unearned), and deferred expenses (prepaid)
• Timing is critical—made at period-end before preparing financial statements to ensure proper matching
• Never involve the Cash account—if cash is changing hands, it's not an adjusting entry

Reversing Entries

• Optional entries made on the first day of the new period to reverse specific adjusting entries
• Primary purpose is simplifying subsequent cash transactions—avoids splitting entries between periods
• Best used for accruals—accrued expenses and accrued revenues where cash will be received or paid soon after period-end

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Closing the Books

Closing entries serve a specific structural purpose: separating one accounting period's performance from the next. Temporary accounts measure activity for a single period and must be reset to zero; permanent accounts carry forward indefinitely.

Closing Entries

• Temporary accounts closed: revenues, expenses, dividends (or withdrawals)—all transferred to Retained Earnings
• Four-step process: close revenues to Income Summary, close expenses to Income Summary, close Income Summary to Retained Earnings, close Dividends to Retained Earnings
• Permanent accounts remain open—assets, liabilities, and equity accounts carry their balances into the next period

Opening Entries

• Establish beginning balances when starting a new accounting system or transitioning between systems
• Record assets, liabilities, and equity at their values as of the transition date
• Critical for system migrations—moving from manual to computerized accounting or changing software platforms

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Error Correction and Maintenance

Even careful accountants make mistakes. Correcting entries maintain the integrity of financial records while creating a clear audit trail. The key principle: never erase or delete—always document corrections transparently.

Correcting Entries

• Rectify errors in previously recorded entries—wrong amounts, wrong accounts, or omitted transactions
• Documentation required—must include explanation of the original error and the correction being made
• Timing matters: errors discovered in the same period are corrected directly; errors from prior periods may require prior period adjustments affecting Retained Earnings

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Quick Reference Table

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Self-Check Questions

1. Which two entry types are specifically designed to handle the transition between accounting periods, and how do their purposes differ?

2. A company recorded three months of prepaid insurance at the start of the quarter. What type of entry is needed at month-end, and which account category (accrued or deferred) does this represent?

3. Compare and contrast adjusting entries and correcting entries: What triggers each type, and how do their effects on financial statements differ?

4. If an FRQ asks you to "prepare the entries necessary to close the books," which accounts would you expect to see debited and credited, and what is the ultimate destination of these balances?

5. Why might a company choose to use reversing entries for accrued salaries but not for depreciation adjustments? What characteristic of the underlying transaction makes reversing entries useful?