General Ledger Accounting

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 BalCr 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

================