Rules for Journal Entries

What are the Rules of Journal Entries?

Journal is the book of original entry, in which any business transaction is recorded for the very first time and in a chronological manner and there are rules of debit and credit which apply to such recording. Such rules vary with the nature of the accounts to be considered in the transaction.

Most popular classification is the Personal, Real & Nominal account and the rules of these are as follows:

#1 – Personal Account

A personal account is that of a person, company, an organization such as a bank, and so on.

• Debit the Receiver, Credit the giver
• Accounts that fall in this category are: Debtors, Creditors and so on

#2 – Real Account

Real Account is the account of tangible and intangible items such as inventory, cash, bank account, plant and machinery and so on

• Debit what comes in, Credit what goes out
• Accounts that fall in this category are: Cash, bank balance, stock of goods, Purchase, Sales, Plant & Machinery and so on

#3 – Nominal Account

This account is the account of profits, losses, incomes, and gains.

• Debit all losses and expenses, Credit all incomes and gains.
• Accounts that fall in this category are Profit, Interest, Dividend, Depreciation.

Example of Rules for Journal Entries

Now let’s take a few example transactions to understand these rules in the business context:

On 1^st April 2020, Ron & Daughters. started business with cash of $2000 that it received from the owner Mr. Ron

• This transaction deals with two accounts, Ron’s account, and Cash account
• Ron’s account is a personal account. Ron is the giver in this transaction, so his account should be credited. Owner’s account is called the Capital account
• Cash is a real account, and it comes in, so it should be debited.

On 2^nd April 2020, Ron Inc. bought goods with cash for $200

• This transaction deals with two accounts; Purchase account for goods purchased and Cash account
• The purchase account is a real account. Goods come in, so the account should be debited.
• Cash is a real account, and it goes out, so it should be credited.

On 3^rd April 2020, Ron Inc. Sold goods for cash for $300

• This transaction deals with two accounts; Sales account for goods sold and Cash account
• The sales account is a real account. Goods go out, so the account should be credited.
• Cash is a real account, and it comes in, so it should be debited.

On 4^rth April 2020 Ron Inc. deposited cash in its bank account $500

• This transaction deals with two accounts, Bank account, and Cash account.
• A bank account is a real account, and it comes in, so the account should be debited.
• Cash is a real account and goes out, so it should be credited.

On 31^st April 2020, Ron Inc. paid a salary to the employees $50 in cash.

• This transaction deals with two accounts, a Salary account, and Cash account.
• Salary account is nominal account, and it is an expense, so the account should be Debited.
• Cash is a real account and goes out, so it should be credited.

Rule from the Asset/Liability Classification

Let’s look at the rule from the Asset – Liability classification

• Assets are debited when they increase and credited when they decrease
• Liabilities are credited when they increase and debited when they decrease

Let’s look at all the above transactions of Ron & Daughters from this classification;

1^st April

• The firm owes Ron the money he has invested in the firm, and therefore it is a liability from the firm point of view. As liability increases, Ron’s account is credited
• Cash is an asset, and it increases, so it should be debited.

2^nd April

• Goods are assets, and they increase so the account should be debited
• Cash is an asset, and it decreases, so it should be credited.

3^rd April

• Goods are assets, and they decrease so the account should be credited
• Cash is an asset, and it increases, so it should be debited.

4^rth April

• A bank account is an asset, and it increases, so it should be debited.
• Cash is an asset, and it decreases, so it should be credited.

31^st April

• Unpaid Salary is a liability, and that decreases so the account should be Debited
• Cash is an asset, and it decreases, so it should be credited.

We need to note a few points:

• Both methods lead to the same entries
• Each entry involves at least two accounts, what is debited, is also credited. It is known as the double-entry accounting system

Now let’s record the above transactions in a Journal Proper:

Note

We need to note a few points:

• Accounts that are debited have ‘dr.’ written against them
• In some countries, the word ‘To’ is avoided in the credit part of the entry
• F. stands for Ledger Folio. It is the column in which we write the page number of the ledger where this entry is posted
• Each transaction has a narration that describes what is happening in this transaction. In some countries, the word ‘being’ is not used while it is mandatory in other countries. These are minute differences, but the over-all accounting process remains the same.
• Journal is prepared for a period, such as a month, and the totals are carried forward to the next period.
• The total of debit and credit column should always match; otherwise, there is an error in recording.
• Sometimes there is an error in recording even when the totals match, such as the omission of entry, so this is not a fool-proof check, but it is still a check.
• Profit and loss are calculated at the time of creating a ledger and the preparation of Income statement. There are journal entries too for the same; however, for the sake of simplicity, these are not mentioned here.

Conclusion

So, to sum up, there are two classification methods, based on which journal entries are recorded. Each method has its own rules, but the resulting entries remain the same. Both the methods are based on the ‘Double entry system,’ which is the backbone of accounting and implies that every transaction involves recording in at least two accounts, one is debited while the other is credited.

Journal is the first book of accounts where the transactions are recorded in the process of accounting, and it is the most critical step. Any errors here can lead to mistakes in all of the future steps.

Recommended Articles

This article has been a guide to rules for journal entries. Here we discuss the basic rules of the journal entries with the example of a transaction. Yow may learn more about accounting from the following articles –

• Journal Entry Format
• Compound Journal Entry
• Adjusting Entries in Journal
• Special Journal