In the Accounting Cycle, Step 1 is to Collect and Analyze Transactions. This is why your bookkeeper is always asking you for those statements, bills, and receipts!
Let's talk about the first step in the accounting cycle—collect and analyze transactions. Recording financial events in a transaction journal is how you keep your books organized. Once you know how to do this, you'll see the impact it has on the rest of the cycle, specifically the chart of accounts and the general ledger.
Transaction journal overview
A transaction journal, or "journal", is used to list the details of an individual event, like an expense or revenue transaction. Listing a transaction in the journal makes it easier to see than searching through the general ledger.
What types of events get recorded?
Transactions that are recorded in a transaction journal include events such as purchase expenses and customer payments. It can also include entries for depreciation of assets like business vehicles.
The following list shows examples of the different types of events that should be recorded in a transaction journal:
Sales transactions: revenue for a business from the sale of goods and services.
Cash receipts: cash, check, and credit card sales and customer payments.
Credit purchases: items bought for the business items that involve a credit to accounts payable or a credit card account.
Cash disbursements: payments made via cash and checks by the business.
Other: general journal entries for other financial activities that occur within the business like depreciation, interest income, and interest expense.
What to include?
When transactions are entered into the system, in addition to the amount of money exchanged, there are a few key other pieces of information that should be included in the journal entry.
Date
The date when the event took place, such as the date of purchase for a good or service.
Transaction type
The type of transaction that occurred. Common transaction types include check, expense, sales, bill payment, or invoice.
Name
The customer or vendor name. Some software will require that you also enter an email address or billing address as well.
Memo or Description
A brief explanation or description of the transaction including relevant details that help identify the purpose or nature of the transaction.
Account
The accounts in the chart of accounts that are impacted by this event.
NOTE: You may have read the word vendor just now and wondered exactly what that means. Let's look at the following definition for clarification. Vendor An entity that the business purchases products or services from, sometimes for resell or for business use, also known as a supplier.
Journal entries can also be things such as marking down depreciation on something like a truck.
When items are entered into the system, your bookkeeper includes the client or vendor it refers to, billing addresses and contact information, transaction dates, and amounts.
Because of your bookkeepers commitment to consistency in tracking transactions in the transaction journal, the business owner knows the business has a comprehensive overview of all inflows and outflows of business funds.
Chart of accounts overview
The chart of accounts lists all of the accounts and sub-accounts used to categorize transactions. In doing so, it organizes and categorizes a business' financial information.
You can customize the account types and also assign account numbers, which can be created by the bookkeeper, client, or accountant.
You can use the first digit of the account number to indicate the type of account. Here are some examples:
Account numbers starting with 101 or 110 represent assets.
Account numbers starting with 201 or 221 represent liabilities.
Account numbers starting with 301 represent owner's equity.
Account numbers starting with 401 represent revenue.
Account numbers starting with 620 or 630 represent expenses.
General ledger overview
The general ledger is a record of all financial transactions in a business, organized by account. Unlike the transaction journal, which lists transactions in chronological order, the general ledger groups transactions by account type and shows the balances for each account.
The general ledger is used to prepare financial statements and other financial reports.
The "split" column in a general ledger shows the other accounts impacted by the transaction.
It's all connected
The transaction journal, chart of accounts, and general ledger all impact one another.
If you have not already noticed, everything in accounting builds on itself and is interconnected. A change here, means a change there.
When we are talking about the transaction journal, general ledger, and chart of accounts, we see this concept play out every time.
Let’s look at the transaction journal for a business. Imagine today is Oct 2. You should see one entry made for today: a bulk office supplies purchase of $290.55 from a checking account, categorized as an expense. The bookkeeper would debit the expense account and credit the checking account.
Now, take a look at the general ledger. Notice that in the first section, only checking account transactions are listed here. You can see the balance increasing and decreasing for each transaction. Looking at the office supplies purchase on Oct 2, we see it was recorded as a credit, and the balance decreases, since money is flowing out of the account.
If we look at the expense account of the general ledger, there are three expense transactions recorded, each increasing the expense balance. Specifically, for the office supplies, we see it increase by $290.55. Notice that each of the expense dollars were taken from different accounts - Cash, Visa, and Checking - but they are all expenses, and therefore in the expense section of the general ledger.
At the same time, the chart of accounts balances are changing because they will continue to reflect the balances from the general ledger. After all transactions are accounted for, we see the same ending balances here that we saw in the general ledger.
Remember, every transaction results in changes in multiple places. The transaction journal, general ledger, and chart of accounts all show a business's financial information in a different way, but they all are connected and impacted by each transaction.
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