Journal entries, lite

~6 min read

Occasional

Why it matters

You do not need to be a bookkeeper for this guide, and you will never be asked to post a journal entry in an IB interview. You do need to understand one thing: every reported number is the accumulated residue of paired entries, and which side of a transaction is an asset versus an expense is a real judgment call that moves reported profit. This page gives you just enough to see inside a balance sheet and explain why certain “non-cash” items are non-cash.

Core concepts

Double entry means every transaction has exactly two sides of equal value. Either (a) value moves between two accounts on the same side of the accounting equation (cash → equipment), or (b) it increases one side and offsets on the other (equipment up, debt up). The “debit” and “credit” labels are just the two sides of that entry; the mnemonic systems are arbitrary convention.
The one structural fact worth memorizing: an entry is a debit to one account and a credit to another, and debit ≠ bad. A debit to cash means cash increased. A debit to an expense means the expense increased (which reduces profit and equity). A credit to revenue means revenue increased.
Accruals are the entries that most often surprise people. Buying $10K of equipment cash creates an expense; buying the same $10K on credit creates a liability. Buying $10K of inventory creates an asset until the inventory is sold, at which point it becomes COGS. Same cash flow, wildly different income statements.
A cash payment can be a prepaid asset or an immediate expense depending on what it buys. A one-year insurance premium paid today is a prepaid expense (an asset) amortized over twelve months, not a full-year expense hit today. This is a small example of a very large idea: capitalization vs. expensing is a timing choice with real earnings consequences, and it is the subject of most accounting-quality debates.
Book value is original cost minus accumulated adjustments. Accumulated depreciation sits on the balance sheet as a contra-asset (a negative line), so PP&E = gross PP&E − accumulated depreciation. This is why you will sometimes see a company with tiny reported PP&E despite enormous replacement cost.

Mental model

  Ask two questions about any transaction:

  1. Did CASH move?              ── no  →  at least one side is non-cash
  2. Did the benefit last >1 yr?  ── yes →  capitalize (asset, spread over time)
                                    ── no  →  expense (hits the P&L now)

  $50K delivery truck, cash        → PP&E asset, then $10K/yr depreciation   [profit smoothed]
  $50K delivery truck, financed    → PP&E asset + $50K debt liability       [same asset, more leverage]
  $50K used car for resale         → Inventory asset                        [profit awaits a buyer]
  $50K customer referral bonus     → Marketing expense, now                  [profit dented today]

Interview questions

Is depreciation an expense, an asset, or a cash outflow? Answer: It’s an expense on the income statement, and it is not a cash outflow in that period. The cash left when the asset was purchased (investing activity). Depreciation is the accounting recognition that the asset’s cost is being consumed.
Why do companies care whether a spend is capitalized or expensed? Answer: Because expensing hits the current period’s profit while capitalizing defers it. A company that wants to report higher near-term earnings has an incentive to capitalize anything it can defend (software development costs, commissions, “improvements” to equipment). The “accruals anomaly” literature and most classic accounting-fraud cases live in this gap.
A company pays $120K cash for a 24-month maintenance contract. What’s on each statement? Answer: Balance sheet: a $120K prepaid asset today. Income statement: $5K per month of expense, so $60K in the first year. Cash flow: the full $120K is an operating outflow in the period paid — this is a common interview trap, since it makes early-period CFO look worse than the income statement suggests. Nothing is capitalized as a fixed asset, and nothing hits CFI.
Explain a contra account. Why do they exist? Answer: A contra account offsets a related account from the other side so a single balance sheet line can show a net figure without hiding the gross amounts. Accumulated depreciation is a contra-asset against PP&E; Allowance for credit losses is a contra-asset against Receivables. Analysts usually want the gross number (and the change in the allowance), so never stop reading at the net.
Your friend says “the trial balance proves the numbers are right.” Why is that a dangerous belief? Answer: A balanced trial balance only proves that entries were posted consistently — arithmetic self-consistency, not economic accuracy. An entry can be balanced and completely wrong (recording a $1M sale that never happened, or misclassifying an operating expense as a capital expenditure). That’s the whole premise behind the phrase “the books balance, the company is still broke.” See Interview hotspots for how this plays out as an interview question.

Watch

ACCOUNTING BASICS: a Guide to (Almost) Everything — Accounting Stuff. The 14-minute overview that hits the equation, debits/credits, and the six account types. Good orientation even though this guide deliberately skips the drills.
A Complete Guide to Adjusting Entries — Accounting Stuff. Prepaid expenses, deferred revenue, accrued expenses, accrued revenue — the four accrual entries that explain most of the gap between the income statement and the balance sheet.
The TRIAL BALANCE Explained — Accounting Stuff. Why a balanced trial balance can still be wrong, with five specific reasons.