What does a General Ledger do? In the simplest terms, it allows you to keep
track of every check and deposit that your company generates. It provides the
ultimate information source and is the main journal of, every financial
transaction your company makes. You _need_ one. If nothing else, you need it so
that you can keep your company's checkbooks balanced and up to date. A wonderful
side effect of performing this most basic of business functions, is the clear
picture of your company's financial operations and profitability that a
computerized G/L will provide.
A major benefit of an electronic G/L is that it can take input from other
electronic packages such as Accounts Receivable modules and Payroll modules etc.
These external systems are capable of communicating with your G/L and posting
there data directly and automatically. The old chore of manual posting your
company's data to "the books" is fast disappearing and has been all but
eliminated by the modern computer.
Overview of a General Ledger
General ledger systems vary in scope and utility, but overall there are no
differences of import between any two of them. The bells and whistles added in
recent times to the coat tails of the modern G/L usually have nothing whatever
to do with its basic function and necessity. The term ledger refers to a time
when a ledger book (one that remained in one place. [Middle Dutch: ligger
"lay"]) was the final repository of the record of accounts for a business. It
represented final entries which were copied and summed from original postings in
other journals. It showed every account dealt with by a company and the
respective outlay and income for each. Today's General Ledger is (and should
be) nothing more than that.
A G/L is comprised of 5 account types:
Within these classifications, fall your company's G/L Accounts. Each "account"
has a name, and a unique number of your choosing. There are no hard and fast
rules about naming or numbering, but in 99% of the General Ledger systems out
there, the five account types listed above carry ranges of numbers. That is,
Assets may be G/L Account#'s 1000 through 1999, Liabilities are G/L Accounts
from 2000 through 2999 and so forth. Each G/L Account you establish represents
a way your company uses money. Some accounts represent money paid out for goods
and services (Expense), some accounts represent how your company earns money
(Income), others represent the money your company has available in one form or
another (Assets), still others represent money your company owes to others
(Liabilities) and finally their are accounts which represent the value of your
company to the owner(s) (Equity). All of your G/L Accounts together are known
collectively as your Chart Of Accounts. (From here on, we will often use the
term "account" to mean an individual G/L Account, as in 5500 Advertising.)
Every account used by your company must fall into one of the 5 account type classifications listed above. There are no mysterious sub-categories, groupings
or special cases. At this most basic level, every account is either an asset,
liability, equity, income or expense account. For reporting and analysis
purposes, you may choose to organize your accounts in various ways and group
them according to special needs and criteria, but they do not ever lose their
basic account type. This is so, because it is the account type which dictates
how the account is affected by debits and credits. (Oh no!, not those, eek!,
yechh! Calm down, take it easy. Get a nice cup of coffee, light up a cigarette.
These pesky damn things will be explained thoroughly in a moment. -ed)
Some example accounts for the 5 account types might be:
Assets: Checking Account, Petty Cash, Fixed Assets,
Vehicles, Accounts Receivable.
Liabilities: Accounts Payable, Loans, Payroll Taxes Withheld
Equity: Capital Stock, Retained Earnings, YTD Profit & Loss
Income: Sales, Rental Properties, Interest Earned
Expense: Cost Of Goods Sold, Advertising, Office Supplies, Salaries
Why have,or bother to keep, a General Ledger if it just sits there "liggering"
like an old fruitcake you got 16 Christmas's ago. A G/L's purpose is to report
to you the status of your company in financial terms that you can understand.
(Whether you understand them or not, and whether you like what you see or not,
is not its concern, it just has to report the facts.
For my money, there are only SEVEN absolutely necessary reports which a G/L must
produce. They are:
Chart Of Accounts
Transaction Detail Listing
CHART OF ACCOUNTS: Simply a printout of each accounts name and G/L number.
Sometimes printed with the total money amount in each account.
BALANCE SHEET: The top three account types, Assets, Liabilities and Equity
comprise the Balance Sheet. The Balance Sheet gives a picture of the company in
all its aspects.
INCOME STATEMENT: The bottom two account types, Income and Expenses comprise the
Income Statement. The Income Statement discloses the profitability of the
TRANSACTION DETAIL LISTING: This report can be drawn for any account or group
of accounts and it shows in detail the money which went into and out of the
accounts listed. It supports the totals shown on the Balance Sheet and Income
Statement to the penny. There must be an exact accounting for how each account
arrived at its balance. The Transaction Detail Listing shows this information,
i.e., the date of the transaction, the source of the transaction etc. This
Transaction Detail Listing is the first stop on what is called an "audit trail".
TRIAL BALANCE: A report which displays whether the Chart Of Accounts is in
POSTING REPORT: This report shows the transactions which you have entered and
want applied to your Chart Of Accounts. You are given the opportunity to
preview this list before you actually "okay" the posting operation.
SUPPORTING JOURNALS: This report can present any of several supporting
journals, i.e., segregated listings of just the Cash Disbursements, Cash
Receipts, Manual Journal Postings etc. entered on the General Ledger for any
given period. For instance, the Cash Disbursement Journal shows to what G/L
accounts the check amount was distributed (what the money purchased, from what
vendor, the date of the transaction etc.), the Cash Receipts Journal shows from
which G/L accounts deposits were earned (from what customer, the date of the
transaction etc.), the Manual Journal Postings shows postings made to the
General Ledger that are not generated by the writing of a check or taking of a
deposit. There are also other supporting journals, Sales Journal, Accounts
Payable Journal, Accounts Receivable Journal, Payroll Journal and so on. (These
journals are called a variety of things in the big world of accounting, but you
should get the sense of what each one is with these fairly generic names. -ed)
Special Notes About Reports
The total of the Asset accounts on a Balance Sheet MUST be equal to the total of
the Liability Accounts plus the Equity Accounts. If this is not true, the
General Ledger is said to be, "out of balance". If you have made only
legitimate entries to the G/L, this will not ever happen. Only an improper
posting or broken program will cause an "out of balance" condition.
The net profit or loss for the period being displayed will be displayed on the
bottom of the Income Statement. (The Income Statement is sometimes even called a
"Profit & Loss Sheet".) This figure will be the result of subtracting the total
of the Expense Accounts shown from the total of the Income Accounts shown.
Obviously, if you take in more than you spend, the profit and loss figure will
be positive, and of course, if you have spent more on Expenses than you have
taken in on Income, the figure will be negative. (Incidentally, on most
financial statements, negative figures are shown as positive numbers surrounded
by parentheses. -ed)
Profit & Loss / Retained Earnings
Profit & Loss and Retained Earnings are two necessary accounts in most
accounting systems. These are both EQUITY type accounts. A standard method of
reporting a company's profitability from year to year is to keep this figure
maintained in an account called Retained Earnings. Nothing is added to or
subtracted from this account at any time during the year. At the close of the
year and just before the start of the next year's accounting, the balance in the
Profit & Loss account (which has been constantly updated with every pertinent
transaction during the year) is added into the Retained Earnings account for the
company. Obviously, if the Profit and Loss account is negative, the Retained
Earnings will be lowered, and vice versa if the company has been profitable.
Fiscal Years & Periods
A company can maintain their accounting on something other than a calendar year
basis. The accounting year is called the fiscal year and it can begin on the
first day of March or November or whatever month the company chooses. (Within
certain legal limits, that is. Some types of corporations must use a calendar
year.) Speak to your accountant regarding the reasons for having a fiscal year
other than the calendar year.
In any case the first month of your fiscal year is considered period 1, the
second month, Period 2 and so forth. (There are other weird schemes with 13
periods in the fiscal year and even stranger things. We'll leave such for
another discussion.) (Not likely. -ed)
Periods are the usual selection criteria for a financial report. You might pull
an Income Statement for the 3rd period, or a Balance Sheet for the first quarter
(3 periods). Sure, they are months, but who cares? CPA's need some excitement
There is only one key thing to remember about periods. It deals with
understanding the Balance Sheet and Income Statement Reports. If you pull an
Income Statement for period 7, you will see the balances in the Income Statement
accounts as generated by only period 7 transactions. Things that happened to
these accounts before this period or after it will not be reflected at all. The
Balance Sheet is completely different. If you pull a Balance Sheet for period 7,
you will see the balances in the Balance Sheet accounts up through and including
all the transactions in period 7. In other words "year to date" balances through
the end of the period requested. This understood, it can now be disclosed that
you may pull a "Year To Date" Income Statement. Just be aware of the difference
between that an a period statement. (The Balance Sheet only comes in the one
flavor, you can not pull anything but a "year-through-period" report (pulling
for the current period would give you "year to date").
This brings us to an interesting and important check you can perform to ensure
that your General Ledger is in balance. (Which, of course, it always should be.)
If you pull a Year To Date Income Statement and a Year To Date Balance Sheet,
the figure calculated at the bottom of the Income Statement (Net Profit/Loss)
and the balance in the Equity account, YTD Profit & Loss on the Balance Sheet
should match. If they don't, something is wrong.
Debits & Credits
General Ledger accounts are said to be either credit balance or debit balance
accounts. The Asset and Expense account types are debit balance accounts, the
Liability, Equity and Income account types are credit balance accounts. This
abstruse piece of information is ONLY important in one respect. Credits and
debits posted to these accounts subtract or add to the account differently. When
you post a money transaction to your G/L you will be taking money out of one
account and putting it into another. You will ALWAYS be working with a positive
amount to post. One side of this "posting" is called the debit and one side is
called the credit. But which is which. Here is the rule. Let me say it again.
Here is THE rule. Grasp this and you've got it all.
A debit will increment (raise) a debit balance account. (Asset or Expense)
A debit will decrement a credit balance account. (Liability, Equity, or Income)
A credit will decrement (lower) a debit balance account. (Asset or Expense)
A credit will increment a credit balance account. (Liability, Equity, or Income)
Since you can NEVER post a negative amount to a G/L Account, you must instead
use a debit or credit to indicate whether the positive amount you are working
with, should be added to or subtracted from the account balance.
Knowing rule #1 above and two other axioms of accounting, (Esaksioms?) you can
keep a General Ledger in balance, happy and healthy.
The first axiom is:
A check written out of a checking account is a credit to that account.
(which implies the opposite)
A deposit put into a checking account is a debit to that account.
The second axiom is:
Any transaction posted to a General Ledger must show debits equal to credits.
That is, if you post a $100 dollar credit you must also post $100 dollars of
debits. This is a hard and fast rule and can NEVER be broken. (period)
Here are some examples of rule #1 and the two axioms:
You deposit $100 into your checking account based on a sale of services. The
transaction would be:
Post a debit of $100 to your Checking Account (we want to raise this Asset
account) and a $100 credit to Sales (we want to raise this Income account.) As
you can see, posting a debit and credit does not always make one account balance
go up and the other account balance go down. In this case both balances went up!
You want to show $100 added to your checking account balance and you want to
indicate (to your accountant and the IRS) that it came from your Sales income.
You write a check for $75 to pay your American Express card. On the bill, you
see that $25 was for a business lunch you had last month and $50 represents the
office supplies you bought while you were in town.
Post a $75 credit to your Checking Account (we want to lower this Asset
account). Post two debits, $25 to your Travel & Entertainment account and $50 to
your Office Supplies account. For any single posting as long as TOTAL DEBITS
EQUAL TOTAL CREDITS, you can distribute them against as many accounts as
You write a check to the bank for $1500, to pay off your loan, $1250 pays down
the principal, and $250 is just interest. How do you know what is a credit and
what is a debit?
Simple, use rule #1 and the 2 axioms. The first axiom can really be your
starting point for every posting you ever make. You are writing a check so you
know it is going to be a credit. (NOTE: Try remembering that a (c)heck is a
(c)redit and a (d)eposit is a (d)ebit. This works for me. -ed)
Post a $1500 credit to your Checking Account. You need an equal number of
debits, so post a $1250 debit to your Loan Liability account and a $250 credit
to your Interest Expense account. Will all the right things happen? Yes, the
checking account goes down by $1500, the loan liability goes down by $1250 and
your interest expense goes up by $250. When your accountant looks at your books
he will see everything in order. (and probably tell you to stop wasting your
money on interest payments!)
The idea here, is to decide whether you want the accounts involved with a
posting to have their balance raised or lowered. Then do whatever is right for
a check or a deposit. If the posting doesn't involve a check or deposit, but is
just a manual entry like entering a monthly bank service charge, just compare
the transaction to a check or deposit. Is money going out of your checking
account into someone else's pocket? If so, its a check transaction and you know
what to do. Are you getting money, say interest earned from a nice bank, then
it's a like a deposit and you still know what to do. If you are making a
journal entry that does not involve a checking account, by looking at the type
of accounts involved, and the rule and axioms, you can easily determine which
amounts are credits and which are debits.
To help you remember which account types are debit balance and which are credit
balance, picture this "big backwards C" my brother drew for me a hundred years
ago when he was trying to force some accounting sense into a fringe hippie who
didn't pay enough attention. (Okay, if you like, it's a big sideways U.)
Debits ^ Credits ^
Db Bal Cr Bal
You might also remember the technical concept of debit balance accounts or
credit balance accounts as follows. The "normal" balance in either type account
is positive and is achieved by the adding its namesake to the account balance.
For instance, starting from a "0" balance in your checking account (which is an
Asset or debit balance account) you would have to add a debit to it, in order
for it to go positive. (Positive balances are the "normal" state for each of the
5 account types. They of course go negative from time to time, but think about
it. Would you want your Checking Account to show negative for longer than the
time it takes to "kite a check"? The sheriff wouldn't.) Again, to achieve a
positive (normal) balance in an Asset or Expense account you must add debits to
the account balance. The exact opposite is true of Liabilities, Equity and
Income accounts. To make them go positive you need to add credits to their
balance. (I like the rule and axioms better. -ed)
Calculating Account Balances
A long standing convention, (even noted in my American Heritage dictionary)
stipulates that when you are showing the debits and credit amounts which have
been added to a G/L Account, debits are displayed on the lefthand side and
credits are displayed on the righthand side. Hence, in a Transaction Detail
Listing (posting report) you will see each G/L Account listed with two columns
of figures, the left for debits, the right for credits. At the bottom of the
columns will be the account balance. But how is this amount obtained and on
which side should it appear? Following a modicum of logic, the account balances
are calculated this way:
Debit balance accounts ==> subtract the credits from the debits.
Liabilities, Equity, Income
Credit balance accounts ==> subtract the debits from the credits.
Any General Ledger system will do these calculations for you. You should only be
aware of how the above procedure works so that you can follow along with what
being presented to you on the reports. You don't need to remember these
calculation rules because you can always figure them out on the spot. Think
about your Checking Account (an Asset). If you only had two postings to this
account, a $100 (D)eposit and a $25 (C)heck, what would you want the account
balance to read. Obviously +$75, not -$50. Working from here and the big
backwards C in your mind, you can correctly predict which way you would do the
column math on any of the 5 account types.
When you need it, you can pull the report called a Trial Balance. This lists
the Chart Of Accounts with each balance on its proper side. (Debit balance
accounts on the left, credit balance accounts on the right) The total amount
for the left column must equal the total amount for the right column. If not
the Chart Of Accounts is again "out of balance". (Hard to believe, when you've
been so careful, huh? -ed)
You can start up a General Ledger system at any point during a company's life.
There is only one requirement, entering a Chart Of Accounts. Once this is done,
you can begin posting your transactions to these accounts. But if your company
has had a life previous to the implementation of the G/L you will have some
"beginning balances" to incorporate as a starting point. Any G/L will allow you
to do this, however, you must be sure that you enter amounts that will generate
a balanced Balance Sheet, (the top three account types). If you want to enter
the starting balances in your Income and Expenses section of the Chart Of
Accounts, you can do this to, but it isn't necessary. If you do choose to enter
Income and Expense balances, however, they must support to the penny the YTD
Profit & Loss account balance you are showing on your Balance Sheet. (Equity
account), otherwise you will never be able to pull meaningful and reconciling
reports. Ask your accountant for a balanced Chart Of Accounts to enter as your
beginning balances, he/she will give you what you need.
Closing The Year
At the beginning of every fiscal year, several things happen as you "close the
All the Income Statement accounts are brought to "0",
The YTD Profit & Loss (Equity account) is summed with the Retained Earnings
(Equity account) and the YTD Profit & Loss is is brought to "0".
All the Balance Sheet accounts are brought forward as beginning balances for the
new year and everything starts all over again.
Below are a suite of reports you might expect to see from a General Ledger that
you have just set up for a new company beginning its fiscal year in April of
1991. Six transactions (postings) are recorded.
The 6 transactions are:
1) Deposit $1,000 into your new checking account. This money came from your
hopeful stockholders to start up the operation. They receive shares of Capital
Stock for this nice gesture.
2) Write a $100 check to the printer for letterhead and envelopes.
3) Deposit $75 you received as your first income. (It was a consulting fee you
charged for telling your next door neighbor what kind of computer to buy for his
bratty 4 year old.)
4) You borrow another $500 from your Uncle Moe because you know you will need
5) You purchase $15 of raw materials on 30 day terms.
6) You ship your first widget and bill the client $27.50 on 10 day terms.
Study the reports shown to see how these postings produced the final Balance
Sheet. (NOTE: It is interesting to see that the infusion of your first $1000 as
capital did NOT affect the YTD Profit & Loss, nor did borrowing the money from
your Uncle Moe. The only transactions that affect the profitability of a company
(YTD Profit & Loss) are those which affect either an Income type account or an
Expense type account. Even paying back the loan, while it would make your Uncle
Moe happy, would not make your company more profitable. -ed)
Using the following G/L types and small Chart Of Accounts, we will make the poistings as shown, and see what the Income Statement and Balance Sheet look like when done.
General Ledger Account Type Ranges
Assets: 10000 to 19999
Liabilities: 20000 to 29999
Equity: 30000 to 39999
Income: 40000 to 49999
Expenses: 50000 to 99999
Retained Earnings G/L Account#: 39998
YTD Profit & Loss G/L Account#: 39999
G/L Acct# Name
10100 CASH IN BANK
10200 ACCOUNTS RECEIVABLE
20100 ACCOUNTS PAYABLE
20200 SHORT TERM LOANS
30000 CAPITAL STOCK
39998 RETAINED EARNINGS
39999 YTD PROFIT & LOSS
40100 WIDGET SALES
40200 CONSULTING FEES
50200 COST OF GOODS SOLD
Posting Transactions Report
Source Date G/LAcct# Account Name Debit Credit
MEdep 04/01/91 10100 CASH IN BANK 1000.00
MEdep 04/01/91 30000 CAPITAL STOCK 1000.00
MEchk 04/02/91 10100 CASH IN BANK 100.00
MEchk 04/02/91 50100 PRINTING 100.00
Medep 04/03/91 10100 CASH IN BANK 75.00
MEdep 04/03/91 40200 CONSULTING FEES 75.00
MEdep 04/03/91 10100 CASH IN BANK 500.00
MEdep 04/03/91 20200 SHORT TERM LOANS 500.00
MEjrn 04/06/91 50200 COST OF GOODS SOLD 15.00
MEjrn 04/06/91 20100 ACCOUNTS PAYABLE 15.00
MEjrn 04/10/91 40100 WIDGET SALES 27.50
MEjrn 04/10/91 10200 ACCOUNTS RECEIVABLE 27.50
Total: 1717.50 1717.50
(NOTE: The source indicates where the transaction came from. In this case these
were (M)anual (E)ntries made to the G/L, checks, deposits and journal entries.
Had these postings been made by external modules such as an Accounts Payable
package, or an Accounts Receivable package, they might be marked APchk and ARdep
The following financials are generated.
04/01/91 through 04/30/91
40100 WIDGET SALES 27.50
40200 CONSULTING FEES 75.00
Total Income 102.50
50100 PRINTING 100.00
50200 COST OF GOODS SOLD 15.00
Total Expense 115.00
Net Loss (12.50)
10100 CASH IN BANK 1,475.00
10200 ACCOUNTS RECEIVABLE 27.50
Total Assets 1,502.50
20100 ACCOUNTS PAYABLE 15.00
20200 SHORT TERM LOANS 500.00
Total Liabilities 515.00
30000 CAPITAL STOCK 1,000.00
39999 YTD PROFIT & LOSS (12.50)
Total Equity 987.50
Equity & Liabilities 1,502.50