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accounting journal entries
May 06

Eight Types of Accounting Journal Entries

By Charles Hall | Accounting

In this article, I provide eight different types of accounting journal entries.

Understanding journal entries is critical to understanding accounting. So, read on.

Journal entry types include the following:

  1. Recurring
  2. Nonstandard
  3. Accruals and deferrals
  4. Adjusting entries
  5. Reclassifying entries
  6. Closing entries
  7. Consolidating entries
  8. Proposed audit adjustments

These journal entry types are not mutually exclusive. For example, an accrual entry can be recurring or nonstandard.

accounting journal entries

1. Recurring Journal Entries

Recurring journal entries are those that are repetitive. Often, these entries are automated with the company’s accounting software.

For instance, if a company will pay $5,000 per month for rent for the next three years, the accountants might set up an automated entry. That way, the company doesn’t have to make this monthly entry manually. Most accounting software packages provide for automated entries. Set it up once and specify the number of periods to make the entry. Then, the software will record an entry such as the following until the rental agreement terminates.

Account

Debit

Credit

Rent

5,000

Accounts payable

5,000

To accrue the monthly rental expense due to Clockworks, Inc.

 

Another example of a recurring journal entry is depreciation. If the company purchases a corporate office for $5,000,000 and plans to depreciate it straight-line over 50 years, it can create an automated entry of $8,333 each month.

Account

Debit

Credit

Depreciation expense

8,333

Accumulated depreciation – buildings

8,333

To record the monthly building depreciation for the corporate office

So, what are nonstandard journal entries?

2. Nonstandard Journal Entries

Nonstandard journal entries are those that are not repetitive. For example, they might be one-time entries or occur twice a year. These entries are usually manually inputted into the company’s accounting software. Examples of nonstandard entries include the following:

  • Impairment charges
  • Writing off bad debts
  • Stock buy-backs
  • Legal settlements
  • Debt restructuring

Nonstandard journal entries, such as those for mergers with or acquisitions of other companies, can be complex.

Next, I explain what accruals and deferrals are.

3. Accruals and Deferrals

When a company uses the accrual basis of accounting, it accrues and defers revenues and expenses based on when it earns revenues and incurs expenses. The company’s activity—goods or services provided or purchased—drives the accounting.

For example, if you are an attorney, you can recognize revenue as you provide services on a particular day, even though you may not receive the related payment until weeks later. And if you buy office supplies on the first day of a month, you accrue (record) the expense on that day, though you make the related payment thirty-five days later. Accruals are the recognition of revenues and expenses before cash is received or paid.

In contrast, a company using the cash basis of accounting recognizes revenues and expenses as cash is received and paid: the receipt and payment of cash drive the accounting. Companies using the cash basis of accounting do not accrue or defer revenues and expenses.

Accruals

Suppose a company receives an invoice from a CPA for audit services totaling $25,000, but it plans to pay the expense at the end of the month. The company can accrue the expense upon receiving the invoice.

Account

Debit

Credit

Professional services

25,000

Accounts payable

25,000

To accrue audit expenses for the September 12, 20XX Crofts and Seals invoice #1015

Cash Payment

The company would recognize the cash payment when paid.

Account

Debit

Credit

Accounts payable

25,000

Operating checking

25,000

To record the October 2, 20XX payment of the Crofts and Seals invoice #1015

Deferrals

Deferrals postpone the recognition of revenues and expenses until a period after the one in which cash is received or paid.

Suppose a repair company receives $10,000 for services on April 2, 20XX, but performs the work on May 10, 20XX. The company can defer revenue recognition until it provides the repair work. Deferred revenue is a liability account.

Account

Debit

Credit

Cash

10,000

Deferred revenue

10,000

To defer revenue recognition for the April 2, 20XX receipt from Jerry’s, Inc., repair work is to be done in May.

 

The company recognizes the earned revenue when it provides that service on May 10, 20XX.

Account

Debit

Credit

Deferred revenue

10,000

Repair services

10,000

To recognize income earned on May 10, 20XX, repair ticket 1452

Another type of journal entry is an adjusting entry. 

4. Adjusting Entries

Adjusting entries are often made at period-end (e.g., month-end) to correct the company’s financial statements, though they can be made during the period.

For example, if company employees work one week but are not paid by month-end, an accrual can be made to recognize the salary expense incurred. So, the company makes an adjusting entry (in the form of an accrual) at the end of the month.

While adjusting entry is often used synonymously with the word accrual, they are not the same. Adjusting entry is broader than accrual and encompasses all entries made to record a company’s activities. Accruals record revenues and expenses. On the other hand, adjusting entries include non-accrual activities such as depreciation, allocations, and bad debts—and accruals of revenues and expenses.

Here are examples of adjusting entries:

  • Accrued expenses
  • Accrued revenues
  • Prepaid expenses
  • Unearned revenues
  • Depreciation
  • Amortization
  • Bad debts

Adjusting entries also encompass prior period adjustments. A prior period adjustment is an entry made to correct a prior period error.

Suppose a company uses GAAP and does not record $45,000 in payables at the end of December 31, 20X3, and records that amount as an expense in January 20X4. Now, the expense appears in the wrong year (assuming the company has a calendar year-end), resulting in an understatement of 20X3 expenses and an overstatement of 20X4 expenses. On July 2, 20X4, the company discovers the error. So, a prior period adjustment is necessary and is recorded in December 20X4.

Now, let’s look at reclassifying entries.

5. Reclassifying Entries

A reclassifying entry is one made to move amounts between different accounts.

For example, if a company has recorded an expense as Miscellaneous Expense that should be Office Expense, a reclassifying entry is made to debit Office Expense and credit Miscellaneous Expense. Doing so moves the expense from Miscellaneous Expense to Office Expense. This entry has no impact on net income. It only reclassifies the expense to the correct account.

Here is the reclassification entry:

Account

Debit

Credit

Office Expense

15,232

Miscellaneous Expense

15,232

To reclassify office expenses to the appropriate account for the Skagg’s invoice #41230

 

Classification of amounts can be critical to accurate reporting. For instance, what if a company defaults on the debt covenants of a $9 million loan? According to GAAP, the debt usually becomes short-term. Why? The loan is callable by the lender, meaning the creditor can demand immediate payment. So, a reclassifying entry is made to move the debt from long-term to short-term. This reclassification entry has no impact on equity, only on the presentation on the balance sheet.

Account

Debit

Credit

Debt – long-term

9,000,000

Debt – short-term

9,000,000

To reclassify the Herald Bank note payable to short-term after default of debt covenants

Next, we explore closing entries. 

6. Closing Entries

Closing entries are journal entries made at the end of an accounting period to transfer balances from temporary accounts (e.g., revenue accounts) to permanent accounts (e.g., equity accounts).

A temporary account is an account that is closed at the end of every accounting period, meaning its balance is $0 on the first day of the next accounting period (usually a year). Temporary accounts include all income statement accounts, such as revenues and expenses.

Permanent accounts are those that are not closed out at period end. Their balances do not reset to $0 on the last day of the period. Permanent accounts include asset, liability, and equity accounts—balance sheet accounts.

Closing Out Revenues

For example, sales revenue is $2,010,099 on December 31, 20X3 (for a calendar year entity), but $0 on January 1, 20X4. The revenue is closed to retained earnings (an equity account) at year-end. Revenue accounts start with a $0 balance at the beginning of the new accounting year. 

Account

Debit

Credit

Sales

2,010,099

Retained earnings

2,010,099

To close out the sales revenue amount at year-end

 

This entry increases retained earnings, which is a permanent account.

Closing Out Expenses

In another example, the salary expense account is $687,098 on December 31, 20X3 (for a calendar year entity), but $0 on January 1, 20X4. At year-end, the expense is closed to retained earnings (an equity account). Expense accounts start with a $0 balance at the beginning of the new accounting year.

Account

Debit

Credit

Retained earnings

687,098

Salaries

687,098

To close out the salary expense amount at year-end

 

This entry decreases retained earnings, which is a permanent account.

Closing entries are normally made automatically by a company’s accounting software.

7. Consolidating Entries

Companies make consolidating entries when two or more entities are combined. Consolidating entries eliminate intercompany transactions.  

In consolidation (or combined) financial statements, the presentation should appear as though the two entities are one. So, revenues recognized in selling from company A to company B are eliminated (when consolidating the two entities). Company B’s expense (for these transactions) is also removed from the consolidated financial statements.

Additionally, companies eliminate intercompany receivables and payables. That is, companies normally offset intercompany receivables and payables against each other.

Consolidating entries are often made in a spreadsheet (e.g., Excel) with the two entities’ account balances side by side and then additional columns to record the eliminating entries. The final columns include the adjusted balances for the financial statement balances.

Some accounting software packages make the consolidating entries for you, and no spreadsheet is necessary.

Finally, we look at proposed audit adjustments. 

8. Proposed Audit Adjustments

External auditors sometimes propose journal entries to adjust a company’s accounts. Auditors create the proposed audit adjustments to correct misstatements. These are provided to the company, and it decides whether it will record the entries; this is why they are called “proposed adjustments.” If the company does not record material proposed audit adjustments, the auditor may need to modify their audit opinion. Companies seldom desire a modified audit opinion.

Types of Journal Entries – Summary

There, you have eight types of accounting journal entries. Now, it will be easier to speak the language of accounting. 

If you’re an auditor, see my article about testing journal entries

chart of accounts
Mar 21

Understanding the Chart of Accounts: A Fundamental Guide

By Charles Hall | Accounting

What is a chart of accounts? If you are new to accounting, you may not know. But you need to understand this part of bookkeeping and accounting whether you use a manual system or an online one such as QuickBooks. A chart of accounts is helpful whether you are using FASB, GASB, or special purpose frameworks

Below, I explain what a chart of accounts is and how you will use it in bookkeeping and accounting. I also provide thirteen steps to developing a chart of accounts. 

What is a Chart of Accounts?

A chart of accounts (COA) is a structured list of an organization’s financial accounts used to categorize and record financial transactions. It serves as the backbone of an accounting system, providing a framework for organizing financial data in a logical manner. The COA is tailored to an organization’s needs and can vary widely in complexity.

The COA is usually hierarchical, with accounts organized in categories and subcategories. These categories include assets, liabilities, equity, revenue, and expenses. Each account within the COA is typically assigned a unique identifier, usually a numerical code (see examples below), to facilitate data entry and reporting.

chart of accounts

Example Chart of Accounts

Here’s an example of a chart of accounts:

Assets

– 1010: Cash

– 1010.1 Operating Checking

– 1010.2 Payroll Checking

– 1010.3 Special Projects Checking

– 1020: Accounts Receivable

– 1030: Inventory

– 1040: Fixed Assets

– 1040.1: Buildings

– 1040.2: Machinery

Liabilities

– 2010: Accounts Payable

– 2020: Loan Payable

– 2030: Accrued Expenses

Equity

– 3010: Owner’s Capital

– 3020: Retained Earnings

Revenue

– 4010: Sales Revenue

– 4020: Interest Income

Expenses

– 5010: Cost of Goods Sold

– 5020: Rent Expense

– 5030: Utilities Expense

– 5040: Salaries and Wages

Next, I’ll show you how to create account codes. 

Account Coding

The numbers used to identify an account (e.g., 1010 for Cash) vary from entity to entity. Account coding involves several elements, including the following:

  • Length of the code (the number of digits or characters in the account number)
  • Use of spaces, dots, or spaces
  • Hierarchical structure (using general categories and subcategories)
  • Numerical and alphanumeric (numbers and letters; e.g., 1010AA-15)

Here are examples of operating cash accounts for different companies:

Account number for operating cash

Entity

100.01

Joe’s Machine Shop

1000-01

Wonderful Coffee, Inc.

10-100-01

Jet Products Partnership

10-10-1000-01-A

Bose Industrial

C-10-10-1000-01

Johnson Farms, Inc.

As you can see, the account code for each operating cash account can vary significantly from entity to entity. So, why the differences?

Factors Affecting Account Coding

Several factors drive the account coding, including the following:

  • Laws or regulations (e.g., state law can dictate account coding for governments)
  • Industry guidelines
  • Business needs for certain information
  • Software requirements (some software packages require the use of specific account coding, such as the number of characters)

Additionally, some entities use prefixes to identify the type of asset, liability, equity, revenue, or expense. Here are examples:

Prefix

Type

10

Asset

20

Liability

30

Equity

40

Revenue

50

Expense

Using the prefixes, the cash and receivable accounts might appear as follows:

Account Number

Account

10-1000

Operating account

10-1005

Payroll account

10-1010

Capital construction account

10-1020

Accounts receivable

10-1025

Due from employees

chart of accounts

More complex entities may have longer account codes to accommodate the reporting needs of the entity. For example, a company might use prefix numbers for specific accounts, such as cash. Here’s an example with the first 10 representing assets and the second 10 representing cash.

Account Number

Account

10-10-1000

Operating account

10-10-1005

Payroll account

10-10-1010

Capital construction account

10-20-2000

Accounts receivable

 

So, why would you add these additional layers in the chart of account number? Additional account coding can make it easier to create financial statements. For example, in the preceding table, total cash can be determined by adding all accounts preceded with 10-10.

So, a company can use account coding to generate certain information, such as total cash.

Next, I’ll show you how the chart of accounts is a part of the financial statement building process. 

The Building Blocks of Financial Statements

Key building blocks in the creation of financial statements include:

  1. Chart of accounts
  2. Journal entries
  3. General ledger
  4. Trial balance
  5. Financial statement

First, let’s look at how the chart of accounts and journal entries work together

The relationship between journal entries and the chart of accounts is akin to the relationship between a script and its cast of characters. The COA serves as the cast—a structured list of all accounts where financial transactions can be recorded. Journal entries, on the other hand, are the script— the actual recording of financial transactions as they occur.

Each line in a journal entry uses an account from the COA. The account’s unique identifier (e.g., 1010.1) is used to specify where the debit or credit is to be recorded.

Account Description Debit  Credit
1010.1 Operating Checking 1,000
4010 Sales Revenue 1,000

 

Second, let’s see how the journal entries feed into the general ledger which feeds into the trial balance

The COA helps categorize transactions appropriately. For example, if a company makes a sale, it debits an asset account (like Accounts Receivable or Cash) and credits a revenue account (Sales Revenue), as defined in the COA. The company records each transaction (journal entry or accounting entry) in the general ledger account, and the general ledger totals create the trial balances.

For example, if there are ten checking account transactions in May, those are added or subtracted from the May 1 opening balance in the general ledger to arrive at the May 31 balance (e.g., $125,453 in the table below).

Third, here’s how the trial balance feeds into the financial statements

Now, the trial balance (the summary of all account balances) checking account balance reflects $125,453 at the end of May which is included in the financial statements

Accounting Sequence

So, let me summarize and say once more what the accounting sequence is.

  1. Accounting entries are made to the general ledger
  2. The general ledger feeds into the trial balance
  3. The trial balance feeds into the financial statement. 

Summarizing Accounts for Financial Statements

Here is an example of a company’s cash accounts being combined for presentation in the financial statements. 

Account Number

Account Name Balance
1010.1 Operating Checking  125,453
1010.2 Payroll Checking 55,871
1010.3 Special Projects Checking 144,120
Total Cash

$325,444

 

From here, we use the total cash balance in the balance sheet.

Financial Statements

Here are a few lines in the balance sheet:

ABC Company

Balance Sheet

12/31/20X4

 

Cash

$325,444

Account Receivable

     548,465

Inventory

  2,587,132

Current Assets

$3,461,041

 

In addition to assisting with financial statement creation, there are other advantages to using a chart of accounts. 

Four Advantages to a Chart of Accounts

  1. Consistency and Standardization: The COA provides a standardized framework for recording transactions. This ensures that everyone in the organization uses the same numbering system when making accounting entries, which is crucial for consistency and accuracy.
  2. Budgeting and Analysis: The COA allows for easier budgeting and financial analysis. Management can assess performance against budgets or historical data by reviewing entries in specific accounts (e.g., sales).
  3. Compliance and Regulation: A well-defined COA ensures that journal entries comply with regulatory requirements for financial reporting, especially in sectors like governments and nonprofits.
  4. Error Detection: A well-organized COA can help you quickly identify accounting entry errors. If an entry doesn’t align with the account type (e.g., crediting an asset account when it should be debited), it’s easier to spot. 

In light of the above, you may be wondering, “What steps should I follow to get this done?”

chart of accounts

Thirteen Steps to Set Up Your COA

Here are steps you can use to set up your COA:

  1. Understand the Business Structure: Before you start, understand the nature of the business or organization. Is it a manufacturing company, a service provider, a nonprofit, or a government entity? The type of organization will influence the accounts you need.
  2. Identify Reporting Needs: Determine the financial statements and reports the organization will need. For example, review sample city financial statements to see what is required if your entity is a city government. This will help you structure the COA to align with the financial statements.
  3. Determine the Basis of Accounting: Cash basis accounting, for example, differs from generally accepted accounting principles (GAAP). GAAP requires accrual accounts such as Accounts Receivable, and the cash basis of accounting does not.
  4. Consult Regulatory Guidelines: For certain types of organizations, especially governments and nonprofits, regulatory guidelines might dictate the structure of the COA.
  5. Choose a Numbering System: Decide your account numbering system. A common approach is to use a series of numbers, often in increments of 10 or 100, to allow for future additions.
  6. Create Main Categories: List the main categories of accounts, such as Assets, Liabilities, Equity, Revenue, and Expenses.
  7. Add Subcategories: Within each main category, add subcategories. For example, Assets contain Current Assets and Noncurrent Assets.
  8. Assign Account Numbers: Assign a unique number to each account based on your numbering system.
  9. Provide Descriptions: Briefly describe each account to clarify its purpose (e.g., operating cash). This is especially useful for anyone not involved in setting up the COA.
  10. Implement in Accounting Software: Most accounting software allows you to customize your COA. Input the accounts, numbers, and descriptions into the software. Before creating your COA, ensure your accounting software allows your desired numbering system. For example, the software might limit the account number to ten digits.
  11. Test and Revise: Test the COA by recording sample transactions after initial setup. Make any necessary adjustments.
  12. Train the Team: Ensure that everyone using the COA understands how to use it correctly.
  13. Review Periodically: Business needs change, and your COA should accommodate those changes. Review the COA periodically and make updates as necessary.

Additional Chart of Account Considerations

Here are some things you need to consider as you develop your chart of accounts:

  1. Balance the number of accounts with your reporting needs. Create additional accounts only when necessary. For example, create salary sub-accounts for each department (e.g., operations salaries, logistics salaries, oversight salaries, management salaries) in a large organization, but one salary account might be sufficient in a small entity.
  2. Some industries, such as healthcare, provide sample COAs. (You’ll find healthcare COA examples on the Internet. The same is true of other industries.) Moreover, some sectors have required COAs. For instance, local governments in Georgia must follow a state-mandated COA.
  3. There are competing issues in developing account codes: Desire for short account numbers versus Desire for additional information. Short account numbers take less time to enter, but they may limit the entity’s informational abilities. The result: the company may need to export account numbers and balances to Excel and manually compute the required information. Many entities lengthen their account numbers to automatically generate information without additional steps (such as exporting to Excel). The 10-10 prefix for all cash accounts (see above) is an example.
  4. As you develop the chart of accounts, share it with all stakeholders, those that this will affect (e.g., department heads in your organization). It’s best to get negative feedback as you develop the chart of accounts, not after it is live in your accounting system. 
  5. If you are creating a new account coding system, consider all the information you need (now and in the future) and design the codes accordingly. A common problem for all entities is they outgrow their account codes; when they do, the business may need to revamp the entire account coding—not a pleasant process.

Give Some Love to COA

As I close, let me encourage you to give your chart of account decisions plenty of thought. You’ll be glad you did. If you don’t give your chart of accounts the early love it deserves, you may regret it. Creating a new accounting systems six years out, for example, would be a major headache. 

I wish you well as you create your chart of accounts. 

See my related article, Eight Types of Accounting Journal Entries

Preparation Enagement
Jan 12

Bookkeeping, Preparations, Compilations, and Reviews

By Charles Hall | Preparation, Compilation & Review

Today, we’ll answer various questions regarding bookkeeping, preparations, compilations, and review engagement.

Compilation Enagement

Q: Should I issue management letters for preparation, compilation, or review engagements?

A: While not required, it is advisable to provide management letters when performing SSARS services. Why? Two reasons: (1) It’s a way to add value to the engagement, and (2) it’s a way to protect yourself from potential litigation. Clients do sometimes sue CPAs in these so-called “lower risk” engagements. If we see control weaknesses (while performing a compilation for example), we should communicate those, even though standards don’t require it. Then, if theft occurs in that area and you are later sued regarding the fraud, you have a defense. If you don’t issue a management letter, at least send an email regarding the issues noted and retain a copy.

Q: Why obtain an engagement letter for nonattest services such as bookkeeping and tax (standards don’t require it)?

A: In all engagements, we want to state exactly what we are doing. Why? So, it is obvious what the client has hired us to do–and what they have not hired us to do. If a client says, “I told you to do my monthly bookkeeping and to file my property tax returns,” but you have no recollection of being asked to perform the latter, you need an engagement letter that specifies monthly bookkeeping (and nothing else).

Q: Should I say–in a bookkeeping engagement letter–the service is not designed to prevent fraud?

A: We should obtain a signed engagement letter for bookkeeping services, even though not required by standards. And yes, by all means, include a statement that the bookkeeping service is not designed to detect or prevent fraud.

Q: If I note fraud while performing a bookkeeping, preparation, compilation, or review engagement, should I report it to the appropriate levels of management?

A: Standards require this communication for review engagements. I would do likewise for the other services.

Q: Am I required to be independent if I perform bookkeeping and preparation services?

A: No, since both are nonattest services.

Q: If I create financial statements as a byproduct of an 1120 tax return, am I subject to AR-C 70 Preparation of Financial Statements?

A: No, you are only subject to AR-C 70 if you are engaged to prepare financial statements.

Q: If I perform bookkeeping services in a cloud-based accounting package such as QuickBooks, am I subject to AR-C 70?

A: It depends. Yes, if you are engaged to prepare financial statements. No, if you were not engaged to prepare financial statements. Who “pushes the button” to print the financial statements has no bearing on the applicability of AR-C 70.

Q: Am I required to have a signed engagement letter for all preparation, compilation, and review engagements?

A: Yes.

Q: Can I act as a controller-for-hire and perform a compilation engagement?

A: Yes, but you need to state that you are not independent in the compilation report.

Q: Can I act as the controller-for-hire and perform a review engagement?

A: No. Independence is required for review engagements.

Q: If I prepare financial statements and perform a compilation, am I performing one service or are these considered two separate services?

A: They are two services. The preparation is a nonattest service, and the compilation is an attest engagement. Both can be specified in one engagement letter.

Here’s a video explaining the differences in preparation and compilation services.

YouTube player

Comparison of Preparing Financial Statements and Compilations

QuestionPreparing Financial StatementsCompilations
Can notes to the financial statements be omitted?
YesYes
Can the financial statements go to users other management?
YesYes
Considered an assurance service?
NoNo
Considered an attest service?
No Yes
Does the engagement require a report?
No - required wording stating “no assurance is provided” or a disclaimer
Yes - compilation report
If the accountant is not independent, is that fact required to be disclosed?
No Yes
Is a signed engagement letter required?
YesYes
Is the accountant required to determine if he or she is independent of the client?
NoYes
Management is responsible for financial statements?YesYes
Minimum documentation
1. Engagement letter

2. Copy of financial statements
1. Engagement letter

2. Copy of financial statements

3. Copy of report
Procedures1. Prepare the financial statements based on the information provided

2. If the accountant becomes aware that supplied information is incorrect or incomplete, request corrected or additional information
1. Read the financial statements

2. Consider whether the financial statements appear appropriate

3. If the accountant becomes aware that supplied information is incorrect or incomplete, request corrected or additional information

4. If the accountant becomes aware that revisions to the financial statements are necessary, request that corrections be made
Is the accountant required to make inquiries or perform other procedures to verify, corroborate, or review information supplied?NoNo
Subject to Peer ReviewOnly if firm is required to have a peer reviewYes
When does the standard apply?
Accountant engaged to prepare financial statements
Accountant engaged to compile financial statements

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