What is the purpose of a general ledger?
Before the advent of accounting software, accountants literally ‘kept the books’ by making double entries in big ledgers. According to accounting terminology, the purpose of a general ledger is to keep all financial transactions – including both debit and credit entries which shows revenue, expenses, assets, liabilities, and owner’s equity – under one roof.
The general ledger is then validated by a trial balance. The general ledger is also used to generate the business’ financial statements including the balance sheet and the Profit and Loss statement.
The double-entry bookkeeping method
This is an accounting practice where an entry on the debit side must be accompanied by a corresponding entry on the credit side. A debit entry is one that increases assets for the business, for example, payment of accounts’ due by customers. A credit entry increases the business’ liability and also increases the owner’s equity account, for example, an injection of working capital.
The general ledger accounts are backed up by ledgers. Journal entries must be made in their relevant journals before being transferred to the general ledger. The different journals to include are;
• Cash receipts journal – This shows all cash inflows
• Cash payment/disbursement journal – Shows any cash flowing out
• Sales journal – Shows all sales made on credit
• Purchase journal- Shows all credit purchases made by a business
• Purchase return journal
• Sales return journal
• General journal
Basic accounting equation
The foundation of double-entry accounting is found in an equation that goes;
• Assets = Owner’s Equity + Liabilities.
This equation should balance at any time. If it does not then the books are said as not to be in balance and the accountant must offer an explanation.
• If you pay an expense of $200, for example, you enter debit entry of this amount in the expense side and credit the cash side, in both the journal and the ledger.
The income statement formula is
• Revenue – Expenses = Net Income (Profit)
This must also balance at all times. If a customer is billed $200, for example, this amount is posted as a debit in the Accounts Receivables and a credit to the revenue.
General ledger reconciliation
This term basically refers to ensuring that the general ledger is in balance. This ensures that all the entries are properly done. This is usually done by a qualified Certified Public Accountant (CPA). Balancing the books is important for the following reasons;
Shows a complete record of a business financial activity.
The general ledger shows every single transaction that the business undertakes. While capturing everything would be a bit difficult in the manual system, accounting software has enabled capturing financial information down to the cents. This creates a very good tracing platform.
It provides the foundation for checking the accuracy of all the other financial statements
The general ledger is the basis of the trial balance; Trading account, profit and loss statement.
It helps spot missing information within a short time before there is a huge financial loss
Incorrect entries will quickly show up as the ledger fails to balance. This is more so with automated accounting systems which will show these alerts as soon as a wrong entry is made. This ensures accurate information is available at all times.
It helps manage company spend and make adjustments to ensure the organization is in a better financial position
The general ledger assists in more accurate reporting on revenue and expenditure. It is possible to trace what items are taking up what share of the business money and make necessary adjustments. This ensures healthy cash flows and better financial health for a business.
Assists in tax reporting
The general ledger consolidates all income and expenses such that it is possible to do tax calculations easily. Accounting software can be set to get this input and generate tax reports automatically, which ensures better tax compliance.
It helps to check and prevent fraud
When financial transactions are easily traced, spotting fraud and unusual transactions are easier. Modern accounting systems can be set with all kinds of checks and balances to spot unusual activity. This checks fraud and financial misdemeanor, preventing massive losses before they happen.
Easy to show classified accounts
For organizations with sensitive financial transactions, the ledger can give an accurate picture of what is happening in those accounts without delving into their details.
The general ledger contains all the basic information that is needed to determine the final financial health of the business. It serves as the basis for the income statement, cash flow statement, and the balance sheet. These financial statements show profitability, liquidity and the overall financial health of a business.
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