What is a General Ledger?
Accounting and bookkeeping are complex practices that require the ability to keep track of countless transactions. There’s always money coming in and going out of a business. To ensure it’s all accounted for properly, businesses maintain a general ledger. This document represents the records of accounting information, to organize and summarize all financial transactions. It provides all data for financial statements of the organization.
Every company that uses the double-entry accounting method has a general ledger. It’s a fundamental part of bookkeeping and a valuable tool in auditing a company’s general financial records. A well-kept general ledger provides clear and accurate data about the business’ financial status; an unbalanced one indicates a problem.
General Ledger: The Heart of Double-Entry Accounting
The general ledger is at the core of double-entry accounting. It’s a detailed representation of the debits and credits a company makes as money flows into and out of the business. Because the entire standard of double-entry accounting depends on equal debits and credits, the general ledger has two sections to represent both.
- On the left are the company’s debits, assets, expenses, losses and dividends.
- On the right are the company’s credits, liabilities, gains, income, revenues and equity.
In double-entry accounting, every transaction has a debit component and a credit component. This means it affects both sides of the general ledger. For example, if the business buys business cards from a printing company, it’s recorded as a debit to expenses and a credit to cash. This is the fundamental basis for every single transaction, and the key to keeping the general ledger balanced.
Ledger Entry Example
Company XYZ receives $2,000 as an accounts receivable payment from a customer. It would debit that $2,000 into assets and credit accounts receivable for $2,000. The amount remains the same for both transactions, which keeps the general ledger in balance.
Why is General Ledger Balance Important?
When the general ledger is out of balance, it means there’s a mistake somewhere in the accounting. If debits outweigh credits (or vice-versa), it typically means there’s a single entry somewhere, or that the amounts debited and credited changed at some point. In any case, an accountant needs to audit the ledger to find the entries that don’t match up.
If the company’s general ledger isn’t balanced, it risks producing non-GAAP financial statements and/or incurring a fee for this noncompliant reporting. An unbalanced ledger also obfuscates the company’s cash flows, making it difficult to predict, plan and project figures accordingly.
Finding and fixing ledger errors takes time and can cost even more money, depending on the discrepancy. While some transposition errors are easy to find and fix, complex ledgers with numerous transactions may require a full audit. Worse still, rebalancing the ledger can delay other recording or reporting, which only compounds a company’s headaches.
What is the General Ledger Used For?
The general ledger summarizes the many credit and debit accounts of the business. In effect, it’s a measure of shareholder equity because it accounts for both assets and liabilities. While it’s much more complex than that, this is often how many investors quickly assess the health of a company:
Stockholders’ Equity = Assets – Liabilities
For large companies, the general ledger is actually a representation of many sub-ledgers, which show detailed cash inflows and outflows. If there are ever questions about a company’s financial transactions that stem from the income statement or balance sheet, it’s easy to dig deeper in the general ledger.
Take a business like the Walt Disney Company (NYSE: DIS), which has many different business segments: theme parks, television and movies, merchandise, consumer goods and many, many others. Each business line is big enough to have its own robust range of transactions—yet, they all fall under the same company umbrella. Companies like this keep many ledgers that are then summarized in the general ledger, to paint a comprehensive picture of the business.
Understanding Summary and Trial Balances
When the time comes for periodic financial reporting—such as quarterly reports—a business needs to summarize its general ledger. To do this, it summarizes each account on the ledger into a trial balance. Those trial balances then serve as the basis for financial statement preparation, including for income statements and balance sheets. This allows the business to produce clear and accurate reports at any time during the accounting period. It’s also an opportunity for the business to ensure its general ledger is still in balance throughout the year.
The Financial Bedrock of Every Company
Of the many financial documents a company relies on, none is more important than the general ledger. Not only is it a representation of every transaction into and out of the business, it’s also the basis for all financial reports generated by the company. If the general ledger is out of balance, it’s impossible to produce accurate information about the company’s finances. That, in turn, makes it impossible to discern stockholders’ equity in the company.
Thankfully, companies following double-entry accounting and Generally Accepted Accounting Principles (GAAP) typically don’t have trouble keeping a ledger in balance. It’s thanks to these same practices that any ledger out of balance is often swiftly corrected. In fact, the general ledger does a lot to simplify the complex practice of accounting and bring transparency to financial transactions.
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