Journal Entries

Learn What They Reveal About the Health of Your Financial Operations

journal entries

Journal entries in accounting are somewhat analogous to the initial readings and observation that is made every time you visit your doctor. They are very revealing!

Most transactions are recorded in specialized journals: accounts receivable and payable; cash receipts and disbursements; payroll. Other events are used to smooth expenses over multiple accounting periods: insurance premiums paid in one month charged equally to all 12 months; equipment paid for in one period that will be used over many years.

Then there are items like corrections and adjustments. Something might have been recorded above into the wrong account. Or new information might require that a transaction be recorded differently. For these, accountants typically use journal entries.

Some journal entries are routine or standard and are made every month, such as recording depreciation of plant and equipment.

But the remaining journal entries, which represent exceptions or abnormalities, can be very revealing about the quality and reliability of the financial function.

A visit to your doctor usually starts with blood pressure, pulse rate, temperature and a general observation. Lots of possible problems might be revealed or would if there are exceptions or changes noted.

The same can be true from a perusal of the journal entries.

So, what do you look for? What is good and what's bad?

Here are some tips and thoughts.

  1. Neat and orderly as pretty obvious.
  2. Explanations. The entry should explain the problem clearly enough for the reader to understand the problem and the solution.
  3. Supporting documentation should be complete and attached.
  4. Corrections -- why was the error made in the first place? Not enough information? Incorrect interpretation of information? Plain sloppy work?
  5. Who is making the original errors? Do they not know their job? Careless?
  6. Is this correcting a previous correction? People might not know their job.
  7. Approach to correction...

    When I am flying, I use "dead reckoning" to cross check my position. If I compare the chart and what I see out the window, it might tell me I have drifted off course; or that I have head winds and have not moved as far as I should have. Either way, I use this information to plan a course change or adjust my arrival time -- even stopping for more fuel if necessary! But it would almost never be necessary or appropriate to go back to the departure airport in order to correct the error in my original estimate.

    Accounting is different. Here, the object is to leave a trail that can be followed by others.

    The lazy way to correct the problem is to start from what the correct answer would have been to record the transaction -- that is like remembering in navigation what the final destination is. Then you figure out where you are -- that is like using pilotage and map reading in navigation. Then you lay out a new course to get from your actual position to your final goal.

    Great in navigation. And it works in accounting in that you get to the correct goal. But the "new course" only makes sense in terms of the intermediate position.

    For accounting, the preferred methodology is to take a few minutes more to write a two-part correction. The first part simply reverses or undoes the original error. Its explanation is simple. Subsequent review of many transactions will show the offsetting error and reversal clearly, so others need not spend any time wondering what they meant.Then the second part writes the transaction correctly. Its explanation will clearly show the transaction and its intent, so it will make sense to the reviewer. Contrast this result with a correct position that was arrived at by an error then a meaningless transaction to get you from the erroneous position to the final goal.

    Watching how your staff handle errors with journal entries is very revealing of the clarity and accuracy of their thinking.

  8. Categories of accounts involved.

    Shifting dollars from one account to another changes the accuracy of the statement detail -- was it "miscellaneous" expense or "advertising" expense -- but it does not affect profit. Shifting from a balance sheet account to an expense account does affect profit -- moving from "prepaid" expense to "insurance" expense.

    Some of this is normal, but some can also hide profit and loss manipulation.

  9. Dates of original transactions -- if there are a lot of items relating to earlier periods, the statements for those earlier periods could be incomplete and/or inaccurate. Of course, the current period' financial statements will also be incorrect because they contain transactions relating to an earlier period.
  10. Entries between departments. These do not affect overall profit but could be the symptom of internal squabbling between department managers. Or profit manipulation to affect department bonuses.

Just as your doctor would not make a complete diagnosis based on only the preliminary review, so the journal entries do not often prove a final position. But they are a very powerful diagnostic tool that points to underlying problems.

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