General Ledger 101

The core of any accounting system is the General Ledger.  This  document is used to record all financial activity that takes place within a business.  A summary report of the ledger will provide an  analysis of the profitability of the company, and the status of its  worth.

Companies that do not maintain a General Ledger perform  'shoebox accounting' where they total their income and receipts at  the end of the year, and whatever is left over is their profit.  While this may work for some very small concerns, it does not lend  itself to forecasting (making assumptions about the future of the  business), or planning for profits.  In lean times, shoebox  accountants don't really know where their expenses lie, and they may  find themselves overwhelmed with debt before its too late.

The General Ledger is setup according to specific rules of  accounting, and is maintained by clearly defined processes.  These  are defined in the following paragraphs.

Double Entry Bookkeeping

In bookkeeping, each transaction must be logged into a record  keeping system.  The Double Entry Bookkeeping method actually logs  each transaction into two accounts.  When a dollar amount is recorded in one account, the same amount is also recorded in another  account.  The goal is to keep a balance of all funds.

The T Account

The T account method is used to handle the double entry system.  All  accounts have a left side, and a right side.  Visualize a very large  T on the right of a listing of accounts.   When an amount is entered  next to an account on the left side of the T, the same amount must  also be entered on the right side of the T, but next to a different  account.

Because the same amounts are being entered, the total of  the left side amounts must equal that of the right side.  If not,  the ledger is out of balance.  The General Ledger is nothing more than one gigantic T that may have  a few, or hundreds, of accounts.

Lest we confuse you from the beginning, it is not necessary to  always post the exact same amount on both sides.  It is acceptable  to post one amount to the left, and several items on the right,  which equal the total of the amount on the left.  Some people say  they wish to disperse an amount among several accounts.  Perhaps  spread is an easier word to use.

Debits and Credits

Rather than confuse people by using the words left, and right,  accountants have simplified the process by giving each side a title.  The left side of the T is always known as the Debit amount.  The  right side has been called the Credit amount.  This is consistent  and never varies.  Debits and Credits are used to record the increases and decreases to  an account.  Applying the rule of the T system, for every amount  entered on the debit side, the same amount must be entered on the  credit side.

Ledger Framework

The General Ledger is divided into five sections.  The first three  are used to make up the basic accounting equation. This is: ASSETS  = LIABILITIES + OWNERS EQUITY.  The last two make up the profit and loss analysis:  PROFIT = INCOME - EXPENSES.

These five areas are  the standard used by most accountants.

Assets

Anything that your business owns, which has monetary value, is considered an asset.  This includes all of the cash, including  receivables, inventory, supplies, property, furniture, equipment,  and investments.

Liabilities

The liabilities are all monies owed to others, including bills for  vendors, loans, taxes held in trust, unpaid employee earnings, and  other obligations.

Capital

When one deducts the total liabilities, from the assets, the result  is the owner's equity, also known as capital.  This can be divided  into multiple groups, including notes held, stock, and profit to be  retained by the owner, or divided among the principles.

Income

All money earned by the business, through sales, services, rentals,  and investments, is classified as income.  Most businesses have  income from a wide range of sources, all of which may be specified  in the general ledger.

Expense

All costs charged against the business are expenses.  The cost of  items purchased for resale, and direct labor services,  may be  classified as cost of goods sold.  All other expenses, including  taxes, rent, telephones, advertising, postal services, insurance,  etc. are operating expenses.

The Balance Side

Each classification has a balance side.  This is where the total for  the account will reside.  It is always the side used to record  increases to the account.

Assets and Expenses are balanced on the debit  side of the T.  To increase these accounts, an amount is added to their debit column.  To decrease the accounts, an amount is added to their credit column.

Liabilities, Owners Equity, and Income are balanced on the credit  side of the T.  To increase these accounts, an amount is added to  their credit column.  To decrease the accounts, an amount is added  to their debit column.

Posting To A Ledger

Whenever transactions take place, and they are placed on the ledger,  they are said to be posted.  Actually, the amount that is entered on  the debit side must equal the amount entered on the credit side.

Posting the two entries is known as double entry bookkeeping.  Posting will always be done to two separate accounts.  Otherwise,  you would add, and subtract, the same amount, at the same time, from  the same account.  Frequently, the two accounts will be in different  sections.

Balancing The Ledger

When all of the ledger debits are summed, their is a debit total.  Summing all of the ledger credits results in a credit total.

When the debit total and credit total are equal, the ledger is said to be  in balance.  The debits and credits within a section will not balance, nor will  any two 'corresponding' sections balance.  Only the ledger as a  whole will be in balance, consisting of all assets, liabilities,  equity, income, and expenses.

Profit And Loss Statement

The Profit and Loss Statement is a summary of the activity of your  business for whatever period of time is specified.  It includes  income from all sources, including services, sales, rentals,  contracts, and investments.

The expenses are divided into Cost of  Goods Sold, and Operating Expenses.  The end result is the profit,  or loss, of the business operations.  The statement presents the income, and sources, and then the  expenses. These are listed first as Cost of Goods Sold, and then  Operating Expenses.  Finally, the profit or loss should be  specified.

The Balance Sheet

The Balance Sheet is a summary of the assets, liabilities, and  equity, at any given point in time.  This document is derived from  the three sections of the general ledger, but is often printed in a  clean format, with only the titles and totals.  It is titled a  balance sheet because it shows how the accounting equation sides  balance within your business.

The Balance Sheet is used to provide a view of how much of the  business you actually own.  Because it compares assets with  liabilities, it is easy to determine the actual equity of the  owner(s), and the debt level.  This is the sheet used by accountants  to determine the health of a business, and by lenders to calculate  the amount available for loans when needed.