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A Beginner’s Guide to General Ledgers

Financially minded people and businesses frequently use ledgers to fastidiously document their money that they are being paid or paying out. Especially, when it comes to business, we cannot simply rely on a snapshot of the transaction you just made, rather it is required that every single transaction that is made in a business is recorded in detailed ledgers, so as to conduct all the financial transactions accurately and legally. This blog post aims to serve you as a beginner’s guide to general ledger. Here, you will learn about how a business can document and measure its financial record while using a general ledger. Also, you will get to know about basic ledger accounts-general ledger services and how they can help a business track its financial health and growth over time.

General Ledger

In bookkeeping, a ledger is a key component of managing an entity’s dual accounting system. The book concentrates on all accounts and records all financial and non-financial movements of the entity. A general ledger tracks all the accounts and transactions of a company and also serves as a foundation for its accounting system. It is typically divided into five main categories which include Assets, Liabilities, Equity, Revenue and Expenses. All these five categories contain the accounting data that is derived from various sub-ledgers of the company, such as Account Receivable, Accounts Payable. The general ledger also records every amount of money on a regular basis, that is debited and credited to the company’s account.

Just like a personal chequebook, a general ledger must always be in balance, between the debit and credit amount. Also, all the information that is recorded against these transactions must hold the necessary account information about the company over a certain period of time, that is required to prepare the financial statements. A general ledger provides details about all the financial transactions made in each of the business accounts, to ensure the fact that a precise forecast about the business’ health and growth can be made. In simple words, general ledger serves as the core databased of your firm’s financial information and records, with other important financial documents that are being derived from the information recorded in General Ledger. Let’s dig deep in the five basic elements of a general ledger.

Assets

An asset is defined as the resource that is controlled by an entity, and which tends to generate economic benefits for the entity. In financial accounting, an asset is defined as a resource that is owned by a corporate entity. Anything intangible or tangible that is controlled or owned by a business to generate economic value is assets to the entity. Putting it in a simple way, asset represents a property value which is convertible to cash (although cash itself is considered as an asset). The monetary values of the assets owned/controlled by a business are recorded in its balance sheet. Assets are mainly classified into two main categories i.e. Tangible Assets and Intangible Assets. All the properties, plants, equipment lands etc. falls under the tangible assets’ category. Tangible assets are further divided into Current Assets and Fixed Assets. Inventory is classified under the current assets category, whereas fixed assets include items like equipment, land and building etc. On the other hand, intangible assets are defined as the non-physical rights and resources that are valuable to a company because they offer some market advantage. Intangible assets include items like copyrights, goodwill, computer programs, software, financial assets, trademarks, parents, shares, bonds and account receivable etc.

Liability

Financial accounting defines liability as a sacrifice that an entity is bound to make to other entities in future in terms of its economic benefits, as a result of some events or transaction. The settlement of a liability may result in using other provision of services, assets or any other economic benefit that is available at the disposal of the entity whenever the liability is due to be paid. A liability is defined by the following characteristics:

  • It includes any sort of borrowing from a financial institution, bank or people, which intends to bring improvement to the performance or profitability of the business, due for shorter or longer period of time
  • A liability is an obligation to another entity that is required to be settles by the provision of services, transfers or any other economic benefit that is available at the disposal of the entity whenever the liability is due to be paid, on a determinable or specific, upon demand or on the occurrence of a certain event.An event or transaction that is an obligation of an entity that has already occurred.

Probably the most accepted accounting definition of liability is that used by the International Accounting Standards Board (IASB). The following is a quote from IFRS, “A liability is a present obligation of the enterprise resulting from past events, the settlement of which should result in the exit of the enterprise from resources representing economic benefits”.)

Equity

Equity is an accounting term that represents the surplus of the company’s assets on its liabilities, in accordance with its balance sheet. Equity is defined as the difference between the total assets of the company and its total liabilities. If assets exceed liabilities, equity is positive. If the situation is reversed, equity is negative and there is a capital deficit. In this situation the company usually has accumulated losses. Often, companies with a capital deficit are in a state of insolvency. As a general rule, the two most important components of shareholders’ equity are share capital (or the initial investment in the corporation by its owners) and surpluses, which are the total profits the company has ever accrued and which have not yet been distributed back to its shareholders. In some cases, there is a third important component of equity: capital funds. Equity is of great importance. It represents the right of equitable right of the owners of the company (as opposed to its creditors) towards its portfolio of assets. For valuation purposes, equity generally does not represent the value of the company, as it does not hold goodwill and other intangible assets. However, equity can be treated as a minimum amount that can be demanded for the company, because if a lower amount is offered, the realization of all assets and liabilities may yield higher value, up to the total equity. At times, the company’s value may actually be lower than shareholders’ equity. This is when there is reason to assume that the company is going to lose money, including in the case where assets are listed in the balance sheet at a value higher than their true value.

Revenue

Revenue is the receipt of cash or cash equivalents over a given period of time, which is usually measured in months, quarters or years. For individuals and households, the sum of all salaries, profits from transactions, dividends, interest rates and any other form of payment receipt are described as revenue or income. However, in the business and accounting world, there is no definite definition of the term and is sometimes used as a synonym for redemption, while in other cases it is used to describe profit. In simple words, it is the income that is derive from the sale of the products or service. In business, interests, royalties, sales and any other fees that a business collects falls under the revenue category.

Accounting collection and reporting needs to be done objectively and neutrally so that external entities relying on such information can be confident that the information is free of any bias and inconsistency, whether intentionally or not. Among other things, accounting deals with the question of when the income is received. For example, the question is asked at what date should the revenue be recognized as a result of a transaction signed today, which expenses associated with its execution are collected in the current year while the payment on it will only be made next year. There are a number of accounting standards that deal with such issues, but according to generally accepted accounting principles, the basic principles that determine when to recognize income and how to record related expenses for income is the Principle of Income Recognition.

The ‘Income Recognition Principle’ presents guidelines by which it is possible to determine when income should be recognized for the purpose of measuring the profit to be reported in the statement of income. Because there are different types of firms, which have different monetization processes, each firm may recognize revenue at different times. This principle aims to ensure that this timing is fixed and set to prevent the firm from being manipulated when presenting the periodic profit. Each company and company must establish a principle that clarifies when revenue should be recognized – at the date of production, at the date of sale, at the collection date or at another suitable date. For example, a company that sells a product of high demand and a known price, such as oil, may already recognize revenue at the time of oil production, as it will surely have buyers. In contrast, an uncertain clothing store if you manage to sell all of its clothing inventory is likely to recognize its revenue only at the time of sale.

Expenses

An expense account is the right to reimbursement of money spent by employees for business purposes. Some current expense accounts are: administrative expenses, depreciation expense, bad debts, cost of goods sold, depreciation charges, freight-out, income tax expense, business expenses, insurance, interest expense, loss on asset disposal, maintenance and repairs, rental fees, salary and wages, sales, supplies and utility costs.

To increase an expense account, it must be debited. To decrease an expense account, it must be credited. The balance in the normal expense account is a debit. In order to understand why expenses are debited, the accounting equation should be noted, Assets = Liabilities + equity. Expenditures appear under the equity portion of the equation because equity is common stock, and retained earnings and retained earnings are earned less expenses less dividends. Expenses are considered temporary accounts in this equation, because at the end of the period the expense accounts are closed. Since expense accounts reduce the credit balance of equity, expenses must be debited.

At the end of the year, expense accounts must be closed or reset. The expense accounts must be closed because they are temporary, which means that they relate only to a given accounting period and will not continue into the next one. When the expense accounts are closed, they close to another temporary account, known as the Income Summary. Thus, the expense accounts must be credited, and the income summary will be debited. The net gain or loss in this account transfer to retained earnings, which is a permanent account.

Double-Entry Bookkeeping

Duplicate Bookkeeping, Dual Entry Bookkeeping or Double-sided bookkeeping) is the most common bookkeeping method. Drafted by Luca Pacholi in the late 15th century, and its basic principles have hardly changed since then. Double-Entry Bookkeeping is based on recording each accounting operation in the way that one account is debited and against which another account is credited, so that there is always a balance between the outstanding balances and the balances. According to double accounting, the balance sheet is constructed from two columns. On one side, the obligation side, the assets stand, and against them the right side are liabilities and capital. Any logging of a journal entry in the balance sheet will leave the balance in place. If an asset balance is added, another asset will be subtracted or added to a liability or equity. For example, in the acquisition of fixed assets for cash, the balance of fixed assets in the balance sheet is on the assets side, and against it, the cash balance is also smaller on the assets side. By contrast, its acquisition in credit increases the balance of fixed assets, on the assets side, and increases the balance of suppliers, or creditors, on the liabilities side, and the balance is maintained.

 

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