What is a general ledger?
A general ledger, or simply a ‘ledger’, is a record of a business’s financial transactions. It gives an overview of all the revenue and expenses over a financial reporting period, as well as the debts a business owes and the assets it owns. In a general ledger, transactions are grouped into five main accounts: assets, liabilities, equity, revenue and expenses. The information recorded is used to produce financial reports.
Difference between a journal and a general ledger
A journal is used to record each individual transaction for an account, whereas a general ledger gives an overview of the credit and debit transactions for all of the accounts.
Back when accounting was done with a pen and paper, accountants used to record daily transactions in journals and then transfer them to the general ledger. These days, accounting software does the work for you. Software programs record daily transactions and make journal entries directly into the general ledger when you receive invoices and reconcile payments via the linked business bank account. However, it’s still useful to know how to use a journal because you will have to make journal entries manually and transfer these to your general ledgers if you don’t use accounting software.
Making a journal entry
A journal entry includes the following information about the transaction: date, description, amounts to be debited and credited, and a unique reference number. Different journals are used for different types of transaction.
There are two main types of journal: general and special. Special journals represent the most common types of transaction. A business can choose to have any number of journals, but these four cover the majority of accounting activities:
- sales journal
- purchase journal
- cash receipts journal
- cash payments journal
All other transactions are entered into a general journal. The kinds of transaction in a general journal typically include:
- accounts receivable
- accounts payable
- equipment
- accumulated depreciation
- expenses
- interest income and expenses
Journal entry example
The Speedy Cycles bike shop purchases $350 worth of bike pumps on 11 July 2022. The bookkeeper enters the transaction into a journal, increasing the balance of the equipment account and decreasing the balance of the cash account.
To create the journal entry, follow these steps:
- Draw a table with five columns and three rows and add the column headings: Date, Reference number, Account, Debit, Credit.
- On the second row, write 11/07/22 under Date, create a unique number and add it under Reference number, write Equipment under Account, $350 under Debit and leave the Credit cell blank.
- On the third row, write 11/07/22 under Date, write the same reference number as in the previous row under Reference number, leave the Debit cell blank and write $350 under Credit.
This journal entry reflects the increase in the equipment account and the corresponding decrease in the cash account (bank account). After creating the entries, you then need to ‘post’, or transfer, them to your general ledger at the end of the accounting period, for example, end of the month.
What is the purpose of a general ledger?
A general ledger is a very useful accounting tool, which businesses use for the following reasons:
- Monitor finances. General ledgers help you to keep track of your business’s transactions and cash flow.
- Prepare financial statements. General ledgers can be used to prepare important financial reports, including a trial balance (see below), balance sheet, profit and loss (P&L) statement and cash flow statement. These reports allow you to assess the financial health of your business and can assist you in making business decisions.
- Identify accounting errors and fraud. By giving you a record of all your business’s transactions and account balances, a general ledger can help you to quickly identify unusual, erroneous or fraudulent transactions.
What information is recorded in a general ledger?
As mentioned, a general ledger shows all of the transactions for a particular accounting period. These transactions are divided into five main types: assets, liabilities, equity, revenue and expenses. Let’s break down these transaction types:
- Assets. Items that your business owns or part-owns. You can have tangible assets (physical objects such as inventory, property or cars) and intangible assets (non-physical items such as trademarks and patents). A general ledger helps you keep track of the assets that you acquire and lose.
- Liabilities. These are your business’s debts. Liabilities include bank loans, mortgages and any money that you owe to other businesses, vendors, organisations, employees or other entities.
- Equity. Also called net assets, net worth and owner’s equity, this is the total value of everything that a business actually owns outright. The equation to work out your equity is total assets minus total liabilities.
- Revenue. The money coming into your business. There are two main types of revenue: operating and non-operating revenue. Operating revenue is the money you receive from your main business activities, such as sales or services. Non-operating revenue is the money you earn from activities that are outside your business’s primary operations, such as dividend income, profits from investments or money earned from renting out an office space.
- Expenses. The costs you incur to keep your business running, including fees, equipment, supplies, rent and utilities.
How to record transactions: double-entry bookkeeping
General ledgers use the double-entry bookkeeping method for recording transactions. As the name suggests, double-entry bookkeeping is an accounting method that involves making two entries for each transaction. When you enter a debit for one account, you also need to enter a credit for the corresponding account.
Debits and credits either increase or decrease the balance of an account. Whether a debit increases or decreases the balance of an account depends on the type of account. A debit increases asset and expense accounts, but decreases liability, revenue and equity accounts. And a credit increases liability, revenue and equity accounts, but decreases asset and expense accounts.
General ledger example
A general ledger report is often produced at the end of a month, summarising all of the transactions for the month. For simplicity, though, let’s look at a general ledger report for a single day.
On 12 July, Speedy Cycles purchased some bicycles (inventory items) for $2,000. The bill from the bicycle supplier is due in 30 days. They also received $600 from their debtor (customer) and paid a $200 phone bill.
To create the general ledger report, follow these steps:
- Write the title at the top: General ledger report | Speedy Cycles | 12 July 2022.
- Draw a table with 4 columns and 18 rows.
- Write the column headings: Date, Transaction, Debit, Credit.
- On the second row, write the name of the account: Accounts receivable.
- On the third row, write 12/07/22 under Date, ‘Customer 1’ under Transaction, leave the Debit cell blank and write $600 under Credit.
- On the next row, write Net movement and $600 under Credit, leaving the other cells blank.
- For clarity, leave a blank row between each account.
- On the next row, write Accounts payable.
- On the next row, write 12/07/22 under Date, ‘Bill from supplier’ under Transaction, leave the Debit cell blank and write $2,000 under Credit.
- Underneath, write 12/07/22 under Date, ‘Telephone bill payment’ under Transaction, $200 under Debit and leave the Credit cell blank.
- On the following row, write Net movement and $1,800 under Credit, leaving the other cells blank.
- Leave another row blank and then write Inventory on the next row.
- Underneath, write 12/07/22 under Date, ‘Inventory purchase’ under Transaction, $2,000 under Debit and leave the Credit cell blank.
- On the next row, write Net movement and $2,000 under Debit.
- Leave another row blank and then write Bank account on the next row.
- On the next row, write 12/07/22 under Date, ‘Payment from customer 1’ under Transaction, $600 under Credit and leave the Debit cell blank.
- On the next row, write 12/07/22 under Date, ‘Telephone bill payment’ under Transaction, leave the Debit column blank and write $200 under Credit.
- On the last row, write Net movement and $400 under Debit, leaving all other cells blank.
This example also how transactions affect different accounts. Paying the phone bill results in a decrease in our liabilities (money owed). The incoming payment from the customer increases the balance of our bank account (cash is received) but decreases the balance of our accounts receivable (the customer has settled the debt, so we are owed less money).
Trial balance
Creating a trial balance is the first step in closing the books at the end of an accounting period. A trial balance is another worksheet that shows the closing balances of all accounts in the general ledger at a particular time. The purpose of the trial balance is to identify any mistakes in your general ledger that might end up being damaging for your business. Trial balances are used to prepare balance sheets and other financial documents, and they are very useful in audits. To create a trial balance, follow these simple steps:
- List all general ledger accounts on the left side of the report. You can leave out any accounts that you haven’t used in the accounting period.
- Add two columns – one with debit balances and one with credit balances.
- Check that the debits and credits match.
If the total debits and credits don’t match, it means there’s an error in your data entry. For example, there may be a missing debit or credit entry, or a mistake may have been made when transferring the data from your general ledger.
The initial trial balance report is called an unadjusted trial balance. Then, once you’ve fixed the errors, the report is called an adjusted trial balance, which is then used to prepare other financial statements. It’s important to prepare a trial balance report at the end of each reporting period to avoid having to fix errors down the track and to give you peace of mind, knowing that your bookkeeping is accurate.
