While the essential concept of a ledger is simple, it can actually be hard to explain what the ledger is due to the fact that there are so many different methods of accounting. Different businesses can also use the same terms to mean different things.
This is doubly true in accounting. With this in mind, we have made the concept of the ledger as simple as possible for you. In order to truly understand the ledger, we will also need to take a look at:
- The general ledger
- The special ledger
- The journal
Table of Contents
- What is a Ledger Account?
- Differentiating Between the General Journal and the General Ledger
- Recording General Ledger vs General Journal
- Writing the General Ledger
- Breaking Down Subsidiary Ledgers, Special Ledgers, & Control Accounts
- Different Ledger Types
- Why You Need a General Ledger
- Understanding General Ledger – Major Tripping Points
- Best Software Systems to Maintain General Ledger
What is a Ledger Account?
In double-entry accounting, each transaction will be associated with a particular subsidiary ledger. All of these transactions combine to form the ‘general ledger’, an all-encompassing internal document to manage financial affairs.
The general ledger, sometimes referred to as the ‘principal books of accounts’, is used to generate a number of important financial statements, most notably the trial balance. The trial balance, in turn, is used to create the balance sheet, one of the most pivotal accounting documents.
The term ‘general’ is used to denote the all-encompassing account made up of general ledgers. The primary general ledger accounts include:
- Asset accounts (fixed assets, prepaid expenses, accounts receivable, cash)
- Liability accounts (notes payable, lines of credit, accounts payable, debt)
- Equity accounts
- Expense accounts
- Revenue accounts
There is an account (or sub-ledger account) for each asset, liability, equity, income, and expense class. In other words, the general ledger is made up of a number of sub-ledgers. Many online guides and articles use the terms ‘accounting ledger’, ‘nominal ledger, and ‘general ledger’ interchangeably, which can be confusing for those new to the field of accounting. For the purpose of this guide, we will call it the general ledger.
So, the general ledger is actually a large book of all entries for a business. It contains everything. It is made up of the sub-ledger accounts, namely assets, liabilities, equity, expenses, and revenue. These are the 5 primary sub-ledger accounts that make up the general ledger. Each class has its own ledger account. Of course, there are many categories within these sub-ledgers.
Differentiating Between the General Journal and the General Ledger
In order to gain a deeper understanding of the general ledger, we now need to look into the general journal. When a business makes a transaction, it is first recorded in a journal in raw format. For this reason, the general journal is often termed the ‘book of original entries’.
All transactions are recorded in the order in which they have been created. The typical information will include the date of transaction, serial number, transaction type, and debit/credit classification.
Next, the item is ‘posted’ in a given account to the general ledger – asset, liability, equity, expense, revenue. The general ledger is then used to generate the trial balance (a sheet that makes sure that everything truly balances), which is used to generate the income statement. The sequence of transactions in a given business would generally proceed in the following format:
Keep in mind this is a very simplified analysis and there are innumerable intermediate steps, such as balancing and closing the ledgers. And many companies will use specialized ledgers, as examined below.
Recording General Ledger vs General Journal
The general ledger is based on the double-entry accounting system. This means that if a business bought a truck for $30,000 in cash, two entries would need to be made. On one side, we would need to make a debit of ($30,000) in cash.
On the other hand, we would make a credit of $30,000 under assets. The books have to balance. Whenever you buy something, you get something in return – this is the basis of double-entry accounting.
Writing a ledger is different from writing a journal. Making journal entries is straightforward. It includes date, details, number, debit, credit. Much like the following:
|Date of transaction||Account title, details||Ledger number||Total debit amount||Total credit amount.|
Obviously, you will only be entering either a debit or a credit. Entries in the general journal are quite similar to the ledger, but with two sides. When making entries to a general ledger, the famous ‘T’ format is used:
‘Journalizing’ is known as the process by which transactions are recorded in a journal, while ‘posting’ is the term used when recording transactions in a general ledger. Another difference is that while journal entries are in sequential order of dates, in the general ledgers transactions are grouped together by account.
Writing the General Ledger
The most confusing thing about accounting is all of the terms used, which often mean the exact same thing. Yet the core concepts in the double-entry accounting system are actually quite straightforward, once you are clear on what stands for what. Writing a general ledger is a very simple process:
- Create a ledger for each account (cash, equipment, inventory, etc)
- Make columns on the far left of the page for the date, journal number, and description
- Make columns on the left side for debit, credit, and balance. Balance is the difference between the debit and credit
- Enter the information from the journals into related accounts. Place related debits and credits side by side. Calculate the balance you’ve earned or owe
- Record and make changes to the transactions as they occur. If you’ve made a journal entry, post it to the ledger immediately
- Combine the different accounts to make a full ledger. The front page includes the chart of accounts, listing each account in the ledger and its number
After this, you will want to look into creating a trial balance to ensure that everything balances.
Breaking Down Subsidiary Ledgers, Special Ledgers, & Control Accounts
As a rule of thumb, the larger the business, the more complex the method of accounting. A sole proprietorship with 4 employees and $150,000 in gross sales is a lot different from a corporation with 500+ employees and over $20 Million in sales. They will use different methods of accounting and have many special ledger accounts.
Again, the issue is compounded by the incredibly confusing terminology. For instance, in terms of control account reconciliation, the memorandum balances are often referred to as the ‘receivables ledger’ and the ‘payables ledger.’ It’s so easy to mix these up with the control accounts in the general ledger, despite there being no link whatsoever. At a high-level, subsidiary, special, and control ledgers are easy to comprehend:
- Subsidiary ledgers contain the details to support a general ledger control account. For example, the subsidiary ledger for accounts receivable contains the details for each of the company’s credit sales to customers, each customer’s remittance, the return of merchandise, discounts, etc. With these details in the subsidiary ledger, the accounts receivable account in the general ledger can report summary amounts for the accounts receivable activity. Essentially, the subsidiary ledger will allow you to see the transactions per customer.
- Special ledgers will take entries that are not reported on the general ledger but are reported on the balance sheet. They use alternative general ledger reconciliation accounts. Special ledgers are most often used for transactions related to bills of exchange, down payments, or miscellaneous transactions.
- Control accounts are very closely related to subsidiary ledgers. A control account contains only a summary amount. Examples of a control account would be the accounts receivable. If you wanted to see how much a customer spent on a particular day, you would have to visit the accounts receivable subsidiary ledger, which would have more information.
Different Ledger Types
The general ledger is the list that contains all transactions within a business, along with the journal. But there are two other kinds of journals that are kept separate from the general ledger. These are the sales ledger (‘debtors ledger’) and the purchase ledger (‘creditors ledger’).
The sales ledger is a list of sales that have been made to customers on credit – the money is not here yet. The sum total of all sales is listed here as accounts receivable, a crucial metric in accounting literature. Sometimes, this is also called trade debtors or sundry debtors (accounting is notorious for having multiple labels for the same thing). Cash sales are placed in the cash book. The purchase ledger is the same thing, just in reverse. This is all the money you owe to another business. This is referred to as accounts payable, trade creditors, or sundry creditors.
It’s worth remembering that a small minority of businesses make separate general ledger, nominal ledger, and private ledger accounts. The nominal and private ledger are most often subcategories of the general ledger. The nominal ledger contains all nominal accounts such as Salaries, Sales, Purchases, Returns Inward/Outward, Rent, Stationery, Insurance, Depreciation, etc. The private ledger contains confidential data such as bonuses, salaries, capital drawings, etc.
Why You Need a General Ledger
Simply put, you cannot run a business without a general ledger. It is the basis for the double-entry accounting system. It is your ‘master file’ that you will be referring to at all times. If you get audited, then you will have to show the auditor that everything is running smoothly and that your books balance every year with your trial balance statement. The trial balance and general ledger are internal documents used to make sure everything is running smoothly. From these documents, external financial statements (such as income statements) can be produced.
Maintaining a ledger for accounting is not something you can do without. And it is not just an irritating side job that you have to do in order to keep the auditors satisfied. The general ledger and other accounting systems will help you to understand your business and will alert you to any discrepancies. You will know intimately where your money is going and how much you can expect your business to grow in the coming year. Accounting matters to business growth, and the better you maintain your records, the better for you and everybody that you do business with.
Without a solid system of accounting revolving around a general ledger, you cannot possibly be expected to qualify for a loan and increase your credit score. Banks and financial institutions will want to see your financial statements and transaction history. Without a ledger system, no financial statements can be generated.
Understanding General Ledger – Major Tripping Points
There are many many tripping points when it comes to understanding the ledger. Most relate to the terms used. Be wary that:
- ‘Cash’ and ‘Bank’ mean the same thing – cash in the bank. Notes and coins are referred to as ‘Petty Cash’
- The ‘Nominal Ledger’ is also referred to as the ‘Main Ledger’ and the ‘General Ledger. It is not really a separate record, but some businesses will have a separate nominal ledger.
- ‘Revenue’, ‘Turnover’, and ‘Sales’ all mean the same thing.
- On the balance sheet, trade receivables are also referred to as ‘debtors’ and the ‘sales ledger control account’.
- On the balance sheet, ‘trade payables’ are called ‘creditors’ by some people and the ‘purchase ledger control account (PLCA)’ by others.
- On the balance sheet, ‘inventory’ is often referred to as ‘stock’ or ‘stores’.
Ultimately, you’ll need to get familiar with accounting on a more tangible level to see how everything fits together. The reality is that you cannot understand the ledger without also understanding the journal, subsidiary ledgers, associated terminology, and the overall double-entry system of accounting. Everything is interlinked, and accounting cannot be learned piecemeal.
Best Software Systems to Maintain General Ledger
The vast majority of people do not understand the double-entry accounting system. And with the rise of accounting software, they don’t need to. They simply need to enter a transaction in their given ledger. For instance, sales need to be correctly inputted in a system. But the person in the sales department will only need to input this once into the system. Employees in other departments will only need to input their transactions.
The software system will automatically run the checks and balances, merging all entries together and creating financial statements. At the end of each quarter, statements can be automatically generated. If there are any discrepancies, the points of error can be pinpointed to specific departments or sub-ledger accounts.
In fact, most accounting platforms now maintain a central repository where businesses can insert both ledger and journal entries at the same time. These advances in technology make it easier and less tedious to record transactions, and you don’t need to maintain each book of accounts separately. The person entering data in any module of your company’s accounting or bookkeeping software may not even be aware of these repositories. In many of these software applications, the employees only have to select a dropdown menu in order to insert a transaction in the ledger/journal.
If you are looking to streamline the general ledger and many other aspects of your accounting payroll system, then the best platforms include Intuit Quickbooks, Freshbooks, and Sage Accounting.
In the 21st century, practically every business is using an automated solution to take care of the accountancy side of things. The concept of a ledger is old (dating back to the physical ledger book), but the means to handle it have evolved.
Accounting would be a lot easier if there was only one word to describe each metric or financial statement. As it stands, you need to exert some effort to understand the area in detail. But, at its core, the concept of a ledger is quite simple.
A sub-ledger is typically an account for a customer or a vendor. You have sub-ledger accounts for each of them. The totals are added for accounts receivable and accounts payable in the general ledger, along with other transactions.
If it all balances on the trial balance sheet, then your system of accounting is working perfectly.
What Are the Main Subledger Accounts to General Ledger?
There are many kinds of sub-ledger accounts, including customer accounts, vendor accounts, bank accounts, and fixed assets. The main sub-ledger/subsidiary accounts include accounts receivable and accounts payable. The accounts receivable relates to debtors and the accounts payable relates to debtors.
What if I Don’t Want to Use General Ledger and the Double-Entry Accounting System?
You don’t really have a choice. The double-entry accounting system is what the current economic world works on. For every debit, there is a credit, and an entire system of checks and balances is in place to ensure everything is accounted for. While there are some alternatives, such as blockchain, the regulatory and political work relies on double-entry accounting for record-keeping and taxation purposes. And all accounting software is built on double-entry accounting principles.
What Is a Memorandum Account in Ledger Accounting?
Whilst maintaining control accounts most businesses will maintain what is referred to as a ‘memorandum.’ This is a separate list of individual receivable and payable amounts due from each customer and to each supplier, respectively. This simple ‘list of balances’ is used as a record so that companies know how much each customer is due to pay and how much they are due to pay each supplier. This assists with credit control and cash flow management.
What Are the Differences Between General Ledger vs. Trial Balance?
The general ledger is where all entries are displayed in a list, under the specific ledger accounts.
The trial balance is generated from the general ledger. The purpose of the trial balance is actually to see that everything balances. If there is a discrepancy in the debit or credit side, then it is time to evaluate the general ledger and the individual sub-ledger account.
What Are the Differences Between General Ledger vs. Balance Sheet?
The balance sheet is generated from the trial balance (which is generated from the general ledger). The balance sheet is sometimes referred to as the ‘Statement of Financial Position’. It demonstrates the financial position of a business at a given point in time. In contrast, the general ledger is not a financial statement open to the public. The balance sheet is. Both the trial balance and the balance sheet are far more limited in comparison to the general ledger, which is a record of all transactions.
What Are Subsidiary Books?
Subsidiary books refer to the general journal more than the general ledger. They are also called day books or special journals. Like subsidiary ledgers, subsidiary books are used to group transactions together. However, they are grouped by similarity of transaction type as opposed to the customer. Common subsidiary books include the Cashbook, Purchases book, Sales book, Purchases return or return outwards book, Sales return or return inwards book, Bills receivable book, Bills payable book and Journal proper.
What Happens if the Ledger Accounts Do Not Balance?
Well, the likelihood is that your books will not balance! It is rare for things to run so smoothly all the time, and there are so many things that can upset the system, such as a single entry from a single employee, with a misplaced comma, extra zero, or placement in the wrong column. There are other errors such as a customer paying too much, too little, the payment received in advance, etc. Good software systems can help to eliminate most of the stress associated with unbalanced accounts.