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Journal Entries...Why do we use them?


I hope this post finds everyone doing well. Today we will be going over the use (and often excessive use) of journal entries. If you have ever asked someone why they did something, the above image captures a response you have at least gotten one time...."I don't know" or "I dunno know, I have always done that." Hopefully, the following post will at lease shed some light on the appropriate use of Journal entries.

Best Uses:

I like a good journal entry just as much as the next accountant, however there is a time and a place to use them. Journal entries are best used in the two following circumstances:

1) To record a true adjustment by your accountant (in which case the journal entry should be flagged as an "adjusting journal entry"),

2) To record activity where both the debit & credit are not tied to another sub-ledger (i.e. depreciation when the software does not track your fixed assets, posting of accruals, etc..)

Outside of these two circumstances it is always best to use the functionality built into your accounting software.

A Little History:

Before computers made accounting super easy (with hint of sarcasm), accounting records were kept in books called Ledgers and General Journals. Think about Charles Dickens' novel A Christmas Carol. Keeping the ledgers updated is what Bob Cratchit is often seen doing in the movie versions of the novel.

When a transaction occurred, the activity was "Journalized" in the General Journal. From here it was "Posted" to the corresponding Ledger account where balances where tracked. This process helped catch math errors and provide the most efficient way to capture information at the time. Many accounting softwares' today journalize and post at the same time (ie.e QuickBooks, Sage, etc..). Here is where the overuse of Journal entries can cause issues.

The Problem:

1) Inaccurate Sub-Ledgers:

If a journal entry is entered using an account which has a sub-ledger making up the total account balance (think accounts payable & accounts receivable) the reports designed to provide information about the sub-ledger accounts will not agree to the total balance (unless you are very careful). If decisions are made using information contained in the sub-ledgers (which are inaccurate due to journal entries), this can lead to inaccurate decisions.

2) Control of Financial Data:

Given the flexibility a journal entry provides in correcting errors, it makes it a very useful accounting tool. However, due to this flexibility they can also be used to skew financial data and potentially cover up fraud. Journal entries should only be allowed by people that understand their intended uses as outlined in the "Best Uses" section above. And even then a company should at least have a review / approval process for creating journal entries.

3) Building Bad Habits:

The use of journal entries in "out of the box" accounting solutions such as QuickBooks and Sage are less detrimental than in a platform like Dynamics 365. This is due to how the software actually works. In the Out of Box platforms, the journalizing and posting of transactions happens at the same time and can be undone just as easily. This is one advantage (and weakness) to an out of the box platform, if you make a mistake just reverse / delete it.

However, on more advanced platforms entries are recorded (journalized) and then posted in another step by someone who has the authority to do so. Once posted, getting the entry removed is more difficult and typically requires manipulating the source data tables (not a good idea). This makes the process of making journal entries a little more painful and less enjoyable. The very nature of these more advanced programs encourage correct data entry the first time.

Therefore, start building these good habits on whatever platform you are on, it will make future growth much easier.

Conclusion:

As mentioned above, take the time to understand the full functionality of your system before using "adjustments" because they are easier. In the long run, using and understanding your system's full capabilities will maximize your return on investment and keep you from searching for "the next best thing"

Key Takeaway: Know what tools you have available and use the correct tool.

Please email accountingtips@integrated-accounting.com if you would like additional information or have any questions.

#Accoutning #Tips

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