Practice Constructing Journal Entries
Part 1
When preparing a journal entry, a systematic method may be used in analyzing every
transaction. A journal entry involves a three step process.
1. Identify which accounts are involved.
2. For each account, determine if it is increased or decreased.
3. For each account, determine by how much it changed.
The answer to step one tells you if the accounts involved are asset, liability, or equity accounts.
The answer to step two, when considered in light of your answer to step one, tells you if the
accounts involved are to be debited or credited.
Tradition dictates that journal entries have a specific format. The account being debited is listed
first and the account being credited is listed second. Also, the credit entry is indented. The
standard format of a journal entry is as follows.
Debit
Credit
amount
amount
Below are four transactions along with a description of the process necessary to create the
journal entry associated with each transaction.
Transaction 1. Investment of $700,000 cash into the business.
1. The two accounts involved are Cash and Paid-in Capital.
2. Cash is increased, and because Cash is an asset and assets increase with debits, Cash must
be debited. Paid-in Capital also increased (representing an increase in the owner’s equity in the
business), and because Paid-in Capital is an equity and equities increase with credits, Paid-in
Capital must be credited.
3. The amount involved is $700,000. Therefore, Cash is debited for $700,000 and Paid-in Capital
is credited for $700,000.
Cash
Paid-in Capital
700,000
700,000
Transaction 2. Borrowed $300,000 cash from the bank.
1. The two accounts involved are Cash and Bank Loan Payable.
2. Cash is increased with a debit because it is an asset account. Bank Loan Payable also
increased (because the borrowing company now owes more to the bank), and because Bank
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Loan Payable is a liability and liabilities increase with credits, Bank Loan Payable must be
credited.
3. The amount involved is $300,000. Therefore, Cash is debited for $300,000 and Bank Loan
Payable is credited for $300,000.
Cash
Bank Loan Payable
300,000
300,000
Transaction 3. Purchased land costing $50,000 and buildings costing $400,000. Paid $100,000
in cash and signed a mortgage for the remaining $350,000.
1. This transaction is a bit more complex because four accounts are involved. The accounts are
Cash, Land, Buildings, and Mortgage Payable.
2. Cash is decreased with a credit because it is an asset account. Land and Buildings are
both increased with debits because they are asset accounts. Mortgage Payable also increased
(because the company now owes more in the form of a mortgage), and because Mortgage
Payable is a liability and liabilities increase with credits, Mortgage Payable must be credited.
3. The amounts involved are: $50,000 for Land, $400,000 for Buildings, $100,000 for Cash, and
$350,000 for Mortgage Payable.
Land
Buildings
Cash
Mortgage Payable
50,000
400,000
100,000
350,000
This journal entry illustrates precisely why the debit and credit framework is a useful tool
for analyzing transactions, particularly complex ones. If one forgets to record an element of
the transaction, such as the mortgage in this example, the omission is immediately apparent
because debits don’t equal credits.
Transaction 4. Purchased equipment for $650,000 in cash.
1. The accounts involved are Cash and Equipment.
2. Cash is decreased with a credit because it is an asset account. Equipment is increased with a
debit because it is an asset account.
3. The amount involved is $650,000.
Equipment
Cash
650,000
650,000
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