General Ledger accounting is the backbone of your small business accounting system.
A General Ledger is, quite simply, a Chart of Accounts that includes all the activity in each account for a certain time period.
Each day you make entries in your
Cash Disbursements Journal and your
Cash Receipts Journal. At the end of the month these entries are totalled up and posted (transferred) to the General Ledger.
Let me explain further.
In the olden days, before computers, a business would have a large "ledger book" that would hold a page for each account in its Chart of Accounts.
A ledger book looks like this:
This product is a nice ledger book to use in a general ledger accounting system. You have a page for each account, with a column for both your debits and credits.
Each page will hold all the activity for one account, like Cash for example. This book makes expanding easy, you can buy extra ledger pages and add them in where you need them.
DEBITS AND CREDITS
The use of debits and credits is vital to your general ledger accounting system. So before we get into the hows and whys of using a general ledger, let me explain debits and credits.
A debit is an entry on the left side of your journal, and it represents an increase to an asset or expense, and a decrease to a liability, equity, or revenue account.
A credit is an entry on the right side of your journal, and is opposite of a debit, so it represents a decrease to an asset or expense, and an increase to a liability, equity, or revenue.
Here's an easy (well, to me anyway) way to keep this straight.
Remember this equation, assets=liability+equity. Assets are on the left side of this equation, and I said debits are on the left side of your journal, so assets have debit balances. Liabilities and equity are on the right side, and have credit balances.
What about revenue and expense accounts? Revenue minus expenses equals profit, and profit increases the worth of your business, which is equity (aka net worth). So.....profit would be like equity, which is on the right side of the above equation, so would have a credit balance. Profit = revenue minus expenses, so revenue (a plus, if you will) would have a credit balance, and expenses (a minus) would be opposite, and have a debit balance.
Now we're ready to get into more detail about the general ledger accounting process.
The General Ledger accounting process was this - each month, the bookkeeper or clerk would transfer the totals from their accounting journals, like the cash disbursements journal, the cash receipts journal, the payroll journal, and the general journal, into the corresponding page in the General Ledger.
This page below is from the account "Sales".
The entry here was posted from the Sales Journal balances for the preceeding month. That entry was an increase in Accounts Receivable (these people owe us) and an increase in Sales (we sold something).
An increase in Sales, as you can see in the example, is a credit entry to the Sales page in your General Ledger.
Below is a General Ledger account for Accounts Receivable.
This shows the entry posted from the Sales Journal, which is a debit, which increases Accounts Receivable.
The second journal entry is from the Cash Receipts Journal, and a credit, which decreases Accounts Receivable because these customers have paid their invoices and no longer owe us.
Now we have computer software programs that do all this for us. But, I think it's important to know what's going on behind the scenes anyway.
Some folks do still keep a manual accounting system.
If you're using a manual accounting system, you should at least have a cash disbursements journal and cash receipts journal. If you have employees, you don't necessarily need a separate payroll journal for just a couple of employees, you can just incorporate that into your disbursements journal.
There is also another journal in the General Ledger Accounting process, a General Journal. This is used for non-cash journal entries. This would be used for entries to book an asset purchased on credit for example (debit Vehicle (to add the asset to your books) and credit Loan Payable (to add a liability to your books).
This journal is also for posting Adjusting Entries and Closing Entries.
Adjusting Entries are entries to correct mistakes, or to book (post) an accrual.
What's an accrual?
The Cash Method of Accounting is used to book revenue (sales) when you receive the money, and book expenses when you pay the bills. Cash in, cash out.
The Accrual Method strives to match revenue and expenses more closely.
So you would recognize revenue (post a sale) when you sell the item, which is what you are doing in a Sales Journal. You post a Sale and a corresponding Accounts Receivable.
Debit: Accounts Receivable (Asset account)....$1000
Credit: Sales (Revenue account)......................................$1000
You book an expense when you purchase office supplies or when you get the utility bill, for example. This is what you're doing when you use a Voucher System in an accounting software system like QuickBooks. But if you just put your bills in a file folder and enter them in your Cash Disbursements Journal when you pay them, that's the Cash Method.
But...the Accrual Method goes farther than that.
You book Depreciation on your assets each month as they are used. That way you are effectively decreasing the value of your assets a little each month as they age.
You book Prepaid Insurance (an asset) for your annual premium on your Business Insurance, then each month you transfer (in your general journal) a portion of the annual premium from Prepaid Insurance to Insurance Expense.
Debit: Insurance Expense (Expense account).......$100
Credit: Prepaid Insurance (Asset account).............................$100
In other words, you recognize expenses as you incur them, or as you use them, rather than when you pay for them.
For simple small business accounting, however, I would say most folks use the Cash Method, or a combination of Cash and Accrual.
As far as correcting mistakes, you might use your General Journal to correct an error in posting your lease payment, for example.
Let's say you posted your lease payment to Lease Expense, then realized part of the bill was for property tax. You would make an entry in your General Journal to debit Property Tax Expense (an increase) and credit Lease Expense (a decrease) by that amount.
Debit: Property Tax Expense (Expense account)....$65
Credit: Lease Expense (Expense account)......................$65
Closing entries are the end of the General Ledger Accounting process.
These occur at the end of the month and the end of the year. Computer software packages do all this for you, but it's really not hard to do manually.
Now in school we learned that on the first day of a new month, you total all the accounts in your General Ledger. Assets and expense accounts have debit balances, and liabilities, equity, and revenue accounts have credit balances. Then you would do an entry in your General Journal to close out all revenue and expense balances to your Net Income account. (we called it Income Summary).
Credit: Auto Expense..............................$500
Credit: Advertising Expense......................$ 50
Credit: Rent Expense.............................$1550
Credit: Phone/Utilities Expense..................$300
Credit: Owners Equity.............................$2600
The journal entry to Owners Equity is your Net Income or Net Profit (same thing just a different wording) for this time period.
But, really you don't need to do this until year end.
All the balances from your asset, liability, and equity accounts go on your Balance Sheet.
All revenue and expense accounts become your Income Statement.
Now let's talk about your General Ledger Accounting process for your year end.
You will balance all your accounts like for a month end, but you will also make that entry in your General Journal to close out all your revenue and expense accounts into your Net Income account.
This is very simplified. Actually, Sole Proprietors and Partnerships will use an Owner's Equity account. Corporations will use an account called Retained Earnings. Consult your CPA on all year end activities.
Just for reference, when the year-end entry is made, revenue accounts should have credit balances, so debit those. Expense accounts should have debit balances, so credit those.
What this does is clear out the current year activity, so you can start fresh in the new year with your new years activity.
If you'd like to read more about how to use a manual accounting system, clickhere.
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