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.
G/L
Accounts
A G/L
is comprised of 5 account types:
Asset
Liability
Equity
Income
Expense
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
Reports
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
Balance
Sheet
Income
Statement
Posting
Report
Transaction
Detail Listing
Trial
Balance
Supporting
Journals
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
company.
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
balance.
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
don't
they?
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.
POSTING
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.
RULE
#1:
A debit
will increment (raise) a debit balance account. (Asset or Expense)
A debit
will decrement a credit balance account. (Liability, Equity, or Income)
Vice
versa:
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:
Example
1:
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.
Example
2:
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
necessary.
Example
3:
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
Assets
----------+
| Liabilities
| Equity
| Income
----------+
Expenses
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:
Axiom 2
Assets,
Expenses
----------------
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)
Beginning
Balances
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
year".
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
it.
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
50100 PRINTING
50200 COST OF GOODS SOLD
Posting
Transactions Report
Through
04/30/91
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
etc.
-ed)
The
following financials are generated.
Income Statement
04/01/91 through 04/30/91
Income Amount
---------------- ----------
40100 WIDGET SALES 27.50
40200 CONSULTING FEES 75.00
----------------
Total
Income 102.50
================
Expense Amount
---------------- ----------
50100 PRINTING 100.00
50200 COST OF GOODS SOLD 15.00
----------------
Total Expense 115.00
================
----------------
Net
Loss (12.50)
================
Balance Sheet
Through
04/30/91
Assets Amount
---------------- ----------
10100 CASH IN BANK 1,475.00
10200 ACCOUNTS RECEIVABLE 27.50
----------------
Total Assets 1,502.50
================
----------------
Assets 1,502.50
================
Liabilities Amount
---------------- ----------
20100 ACCOUNTS
PAYABLE 15.00
20200 SHORT TERM LOANS 500.00
----------------
Total
Liabilities 515.00
================
Equity Amount
---------------- ----------
30000 CAPITAL STOCK 1,000.00
39999 YTD PROFIT & LOSS (12.50)
----------------
Total
Equity 987.50
================
----------------
Equity & Liabilities
1,502.50
================