A general ledger is an accounting record that compiles all financial transactions for a business.
It is a master document that is used to produce other accounting records, in particular, financial statements like the balance sheet, income statements, and cash flow statements.
The general ledger is comprised of transactions that are entered first into the general journal of the business, in the form of journal entries.
Entries in the general journal are raw data that includes basic information about the transactions and are arranged in a chronological format by the date of the transaction.
This information is subsequently posted to the general ledger where it is arranged in a manner that instead reflects the nature of the transaction.
The general ledger allows accountants and business managers to make informed analyses about the business, by looking at transactions that are arranged by different financial aspects of the business, such as its assets and liabilities, equity, sales, cash, and expenses.
To facilitate this analysis, the general ledger arranges transactions according to accounts.
General ledgers typically have accounts for five broad categories:
Assets
Liabilities
Equity
Expenses
Income or revenue
These categories are listed in the chart of accounts which is included in the general ledger.
Each category has its own separate accounts which record specific transactions. These are referred to as subledgers or subledger accounts. For example, assets may include a cash account, accounts receivable, inventory, investments, and fixed assets.
Examples of revenue accounts might include sales, rental income, and interest income. Transactions from these subledgers accounts are then summarized in the general ledger.
In addition to the chart of accounts, the general ledger also includes financial transactions, account balances, and accounting periods. Together they comprise the four main components of the general ledger.
The general ledger follows the double-entry system of accounting. According to this system, which has been widely used for centuries, every transaction has an equal and opposite effect in at least two different places. Every transaction will be represented by a journal entry in at least two different accounts. The two entries will always balance out.
Under the double-entry system, journal entries will always have a debit and a credit in the ledgers where they are recorded. By definition, credit means to entrust or loan—in simple terms, it refers to money coming in.
A debit is defined as what is due or owed—it refers to money going out.
According to this system, debits are recorded in the left-hand column of the ledger, and credits are recorded in the right-hand column.
For example, if a manufacturing company takes out a loan for $1,000 to purchase machinery, the transaction will be posted in the credit column as a $1,000 payable loan and in the debit column as a $1,000 asset. In another example, if a furniture store sells a $500 sofa to a customer on credit, it will post a $500 transaction in the credit column of the sales account and a $500 debit in the accounts receivable.
The double-entry system is also referred to as a T-account. The term describes the appearance of the bookkeeping entries, which resembles a large “T.” The title of the account appears above the top horizontal line of the “T” while debits and credits are listed on the left and right side of the vertical line.
The general ledger serves a number of important functions for the business. It helps accountants prepare a trial balance to make sure that all debits and credits balance out. This process helps accountants identify errors, unusual transactions, and fraud, and it provides an opportunity to make corrections.
The general ledger is especially important because it allows the business to produce financial statements, like income statements and the balance sheet, which provides detailed information for accountants, managers, and investors to make informed analyses about the business and its performance.
General ledger accounts or sub-ledgers fall into one of the five broad categories:
Examples of asset accounts are cash, accounts receivable, inventory, investments, land, and equipment.
Liability accounts include notes payable, accounts payable, accrued expenses payable, and customer deposits.
Equity accounts generally refer to investor related financial activity. Examples include common stock, retained earnings, and treasury stock.
Expense accounts include salaries expense, rent expense, and advertising expense.
Examples of income accounts are sales and service fee revenue.
From the general ledger, accountants can produce other financial statements:
Balance sheets show what a company owns and what it owes at a specific point in time. It is a snapshot of the company’s value or worth for the point in time when it is produced.
Income statements focus on how much revenue was earned by the business for a particular point in time. In simple terms, they list the gross, or total amount of, sales revenue generated by the business for the period, minus the costs associated with those earnings to determine the net earnings or bottom line.
Cash flow statements focus on the exchange of money between the business, its customers, and its vendors. It does not look at assets and liabilities or profit and loss. It only examines the ability of the business to generate cash. Cash flow statements will list all manner of financial activities that impact cash, such as accounts receivable, accounts payable, inventory, unearned revenue, and net income.
A statement of shareholders’ equity is a financial statement that shows changes in the interests of the company’s shareholders over time. It highlights changes in value to stockholders' or shareholders' equity, or ownership interest, in a company. The statement of shareholders’ equity is designed to highlight business activities that contribute to an increase or decrease in value of shareholders' equity.
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