A general ledger serves as the primary record keeping system for a company’s financial data. It is where every monetary transaction made throughout an organization is documented.
It encompasses a wide range of account types, including assets, liabilities, owner’s equity, revenues, and expenses.
Each account in the ledger records specific details, including the date, description, and monetary amount of the transaction.
This all-encompassing record-keeping system is validated by a trial balance, ensuring that every debit and credit entry is accurately represented and both sides are equal. The general ledger forms the foundation of the double-entry accounting system, the rule that says every financial transaction impacts at least two accounts.
Steps in Creating and Operating A General Ledger
A general ledger works by systematically recording and organizing financial transactions within a company. Here’s how it typically operates:
Step 1: Chart of Accounts
First, transactions are documented in individual sub-ledger accounts as determined by the company’s chart of accounts (a list of specific categories or accounts representing different types of financial transactions). Examples include revenue, expenses, assets, liabilities, and equity.
Step 2: Recording Transactions
Whenever a financial transaction occurs, such as a sale or purchase, the details of the transaction are recorded in the appropriate account within the general ledger. This includes information like the date, description, and monetary amount of the transaction.
Step 3: Double-Entry System
The general ledger follows the principle of double-entry bookkeeping. This means that every transaction is recorded in at least two accounts, with one account debited (increased) and another account credited (decreased). This ensures that the books remain balanced.
Step 4: Posting and Balancing
As transactions are recorded, the ledger is continually updated by posting the debits and credits to the corresponding accounts. Regular account reconciliation and balancing of the ledger help ensure accuracy and maintain the fundamental accounting equation (Assets = Liabilities + Equity).
Step 5: Financial Reporting
The general ledger serves as the foundation for generating financial statements, such as the balance sheet, income statement, and cash flow statement. These reports provide a comprehensive view of a company’s financial performance, position, and cash flow.
Step 6: Analysis and Decision-Making
By examining the information in the general ledger, businesses can analyze their financial data, identify trends, and make informed decisions. It enables management to assess profitability, control expenses, monitor cash flow, and evaluate the overall financial health of the company.
General Ledger in Double Entry Accounting
A company that employs a double-entry bookkeeping method relies on the general ledger method of storing company financial data. Double-entry bookkeeping is a system where each transaction impacts at least one debit and one credit transaction. That is, each transaction appears in two columns, a debit column and a credit column, whose totals must balance. Under this balancing rule, the following equation applies:
Assets – Liabilities = Stockholders’ Equity.
Let’s take a look at a few examples to highlight the importance of the numbers balancing in each column in a General Ledger.
Example of a General Ledger Entry
Let’s say a store receives a $150 payment from a customer transaction.
- The company accountant will then increase the cash account with a $150 debit because the company received money.
- In addition, the accountant also completes the entry with a credit, or reduction, of $150 to the accounts receivable (AR).
- The posted debit and credit amounts should always be equal.
In this instance, one asset account (cash from the payment) is increased by $150, while another asset account (accounts receivable) is reduced by $150.
The result is that both the increase and the decrease only affect one side of the accounting equation, and therefore the equation remains in balance.
The same would be true in the case of money going out. Let’s say for example that the company pays rent or utilities.
If a store pays rent of $2000 dollars, the amount would be entered in the GL as “debit” and the same number entered in “credit”.
Once again the sum of the total GL debits and credits are the same because every financial transaction (whether it’s money in or out) affects both a debit account and a credit account.
In the case of the example below, the two accounts are the “Cash Account” and the “Rent Account”, the account that describes why the cash was paid.
(Notice how each one leaves one of the categories blank because each account only affects one side of the equation.)
|Apr 15, 2023||Rent||$2000|
|Apr 15, 2023||Cash||$2000|
Big companies or businesses with a lot of expenses can have hundreds of GLs. For example, a real estate company might have General Ledger accounts for Plumbing, Landscaping, Furniture, and Salaries, just to name a few of the many different types of expenses that need to be created into separate accounts.
Difference Between General Ledger and Chart of Accounts
The general ledger and the chart of accounts are both important components of the accounting system, but they serve different functions:
Chart of Accounts
The chart of accounts is a structured list of all the accounts used by a company to classify and categorize its financial transactions. It provides a systematic framework for organizing and identifying different types of accounts, such as revenue, expenses, assets, liabilities, and equity. Each account in the chart of accounts is assigned a unique number or code, making it easier to locate and track specific transactions. Essentially, the chart of accounts acts as a blueprint or roadmap for the organization of financial data.
The general ledger, on the other hand, is the actual record-keeping system that contains all the financial transactions of a company. It is a collection of all the individual accounts listed in the chart of accounts. The general ledger serves as the primary repository for recording, storing, and summarizing these transactions. It includes detailed information about each transaction, such as the date, description, and monetary amount. The general ledger provides a comprehensive view of the company’s financial activities and is used to generate financial statements and reports.
|Chart of Accounts||General Ledger|
|Structured list of accounts that categorizes and organizes financial transactions||Collection of these accounts where the actual transactions are recorded and stored|
|Sets the framework for the organization of accounts||Active recording system that tracks the specific details of each transaction|
A General Ledger is important not only for recording financial transactions but also in what companies are able to do with the information. A GL can be used to make financial statements such as income statements or balance sheets which provide an overview of financial position, profitability, and cash flow. Analyzing historical data in the general ledger helps identify trends and make informed decisions. It also ensures compliance with financial regulations and standards, aids in financial reporting, and facilitates monitoring and control of financial activities within the company.
Using Datarails to Identify Historical Trends
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