A general ledger is a company’s financial data record-keeping system, with debit and credit account records certified by a trial balance. It keeps track of every financial transaction that occurs during the life of a running firm and stores account information required to generate the company’s financial statements. Transaction data is separated into accounts for assets, liabilities, owners’ equity, income, and expenses based on type.
- The general ledger is the foundation of a company’s double-entry accounting system.
- General ledger accounts encompass all the transaction data needed to produce the income statement, balance sheet, and other financial reports.
- General ledger is a summary of transactions made as journal entries to sub-ledger accounts.
- The trial balance is a report that lists every general ledger account and its balance, making adjustments easier to check and errors easier to locate.
How a General Ledger Works
A general ledger is the cornerstone of a system used by accountants to record and organize financial data necessary to generate financial statements for a company. Individual sub-ledger accounts are specified by the company’s chart of accounts, and transactions are posted to them.
The transactions are then closed out or summarized in the general ledger, and the accountant generates a trial balance, which serves as a report of each ledger account’s balance. The trial balance is checked for errors and adjusted by posting additional necessary entries, and then the adjusted trial balance is used to generate the financial statements.
How a General Ledger Functions With Double-Entry Accounting
Businesses that utilize the double-entry bookkeeping method, in which each financial transaction impacts at least two sub-ledger accounts, and each entry contains at least one debit and one credit transaction, use a general ledger. Double-entry transactions, sometimes known as “journal entries,” are recorded in two columns, with debit entries on the left and credit entries on the right, and the sum of all debit and credit entries must balance.
The accounting equation, which underlies double-entry accounting, is as follows:
This format is followed by the balance sheet, which displays information at the account level. In the short-term assets area, for example, the balance sheet contains many asset accounts, including cash and accounts receivable.
The accounting equation requires that transactions posted to the accounts on the left of the equal sign in the formula equal the amount of transactions posted to the account (or accounts) on the right. The balancing rule always applies, even if the equation is presented differently (for example, Assets = Liabilities + Stockholders’ Equity).
What Does a General Ledger Tell You?
The general ledger transaction records are collated and summarized at several levels to produce a trial balance, income statement, balance sheet, statement of cash flows, and a variety of other financial reports. This assists accountants, corporate management, analysts, investors, and other stakeholders in continuously assessing the company’s performance.
When a company’s expenses increase in a given period, or when it records other transactions that affect its revenues, net income, or other critical financial indicators, the financial statement data typically does not tell the whole story. To discover certain sorts of accounting errors, it is important to go back to the general ledger and dive into the detail of each recorded transaction. This can sometimes include evaluating dozens of journal entries, but it is critical to maintain consistently error-free and credible corporate financial statements.
A Balance Sheet Transaction Example
If a company receives payment from a client for a $200 invoice, for example, the company accountant increases the cash account with a $200 debit and completes the entry with a credit, or reduction, of $200 to accounts receivable. The posted debit and credit amounts are equal.
In this instance, one asset account (cash) is increased by $200, while another asset account (accounts receivable) is reduced by $200. The net result is that both the increase and the decrease only affect one side of the accounting equation. Thus, the equation remains in balance.
An Income Statement Transaction Example
The income statement is calculated using its own formula, which is as follows. When a company gets payment from a customer for the sale of a product, the cash received is recorded in net sales alongside revenues from other sales and refunds. The gross profit for that reporting period is calculated by subtracting the cost of sales from the total.
Other expenses, such as selling, general and administrative expenses, depreciation, interest, and income taxes, will also be included in the income statement. The net income for the reporting period is the difference between these inflows and outflows.
Main Function of the General Ledger
The general ledger serves a variety of roles, all of which are critical to an organization’s precise and effective financial management. Its duty extends beyond ordinary record-keeping; it is the anchor that ensures an entity’s financial stability.
Recording All Financial Transactions
Every financial transaction, whether a buy, sale, payment, or receipt, is recorded in the general ledger. It records these transactions in a timely and systematic manner, ensuring that none slip through the gaps. The general ledger supplies the raw data for subsequent accounting studies and reports by tracking every monetary move.
Serving as a Central Repository for Accounting Data
The general ledger unifies all financial data, eliminating the need to trawl through many records. It improves information access and simplifies financial auditing processes. Given its importance, the general ledger is usually structured with strong safeguards to prevent unauthorized changes, maintaining the purity and trustworthiness of financial data.
Facilitating the Creation of Financial Statements
- Income Statement: By collating revenue and expense accounts, the general ledger aids in determining an entity’s profitability over a specific period.
- Balance Sheet: The general ledger’s asset, liability, and equity account balances are synthesized to produce a snapshot of an organization’s financial position at a given point in time.
- Statement of Cash Flows: By tracking cash-related transactions, the general ledger facilitates the creation of this statement, outlining the cash inflows and outflows from operating, investing, and financing activities.
Assisting in Audit and Compliance Activities
The general ledger, with its detailed and transparent record of transactions, serves as a major reference for auditors, making the audit process more efficient and exact. The general ledger guarantees that financial data is preserved in accordance with precise standards for various companies, particularly those in regulated areas, assisting in compliance with legal and regulatory regulatory mandates.
While the general ledger is an accounting necessity, it is much more than that. It is a company’s financial compass, directing and informing a wide range of financial activities and choices. The general ledger is an indispensable instrument in the orchestration of solid financial management since it faithfully performs its various responsibilities.
Is a General Ledger Part of the Double-Entry Bookkeeping Method?
Yes, a business that uses a double-entry bookkeeping method stores financial data in the general ledger. In particular, double-entry bookkeeping occurs when each transaction has an effect on at least one debit and one credit transaction. In other words, each transaction appears in two columns, one debit and one credit, and their totals must balance. The following equation applies under this balancing rule:
- Assets – Liabilities = Stockholders’ Equity.
What Is an Example of a General Ledger Entry?
Consider the following example where a company receives a $1,000 payment from a client for its services. The accountant would then increase the asset column by $1,000 and subtract $1,000 from accounts receivable. The equation remains in balance, as the equivalent increase and decrease affect one side—the asset side—of the accounting equation.
Read more: Understanding Bank Reconciliation Statement