What is a General Ledger
A general ledger represents the formal ledger for a company's financial statements with debit and credit account records validated by a trial balance. The ledger provides a complete record of financial transactions over the life of the company. The ledger holds account information that is needed to prepare financial statements and includes accounts for assets, liabilities, owners' equity, revenues and expenses.
BREAKING DOWN General Ledger
Using a general ledger is part of a system used by accountants to create the firm’s financial statements. Transactions are posted to the general ledger accounts, and the accountant generates a trial balance, a report listing all the accounts and each account’s balance. The trial balance is adjusted by posting additional entries, and the adjusted trial balance is used to generate the financial statements.
How a Double Entry System Works
A general ledger is used by businesses that employ the double-entry bookkeeping method, which means that each financial transaction affects at least two general ledger accounts and each entry has a debit and a credit transaction. Double-entry transactions are posted in two columns, with debit postings on the left and credit entries on the right, and the total of all debit and credit entries must balance.
Factoring in the Balance Sheet
The balance sheet includes cash and accounts receivable as assets in the balance sheet accounts. The accounting equation or balance sheet formula is stated as Assets – Liabilities = Equity. The double-entry system also states that that amounts posted to the left of the equal sign in the formula must equal the total on the right.
If a client pays a $200 invoice, for example, the cash account is increased with a $200 debit and the accountant credits $200 to accounts receivable. The amount posted as debits and credits are equal. In this instance, one asset account (cash) is increased by $200, while another asset account (accounts receivable) is reduced by $200. The net result is that both the increase and the decrease only affect the left-hand side of the equation. Thus, the equation remains in balance.
Examples of Income Statement Transactions
Another important financial report is the income statement. The income statement formula can be written as Revenue – Expenses = Net Income (NI) or Net Profit. This formula must also stay in balance for the financial statements to remain in balanced and accurate. It is possible for a transaction to impact both the balance sheet and the income statement simultaneously.
For example, assume that a company bills a client for $500 and posts a $500 debit (increase) to accounts receivable and a $500 credit (increase) to revenue. Debits and credits both increase by $500, and the totals stay in balance.