General Ledger in Accounting Explained for Dummies

What is a general ledger?

In accounting, a general ledger (GL) is a record of all the financial transactions of a business for a given financial period, recorded in general ledger accounts.

The crucial importance of a general ledger for a business is expressed in term such as:

• master document for all the financial transactions of a business,
• the foundation of the double-entry accounting (bookkeeping) system,
• master accounting document that encompasses all the financial transactions of a business,
• an essential accounting record for preparing financial reports, and
• the complete record of every financial transaction a business performs.

Prior to the computer era, accountants and bookkeepers recorded financial transactions in the general ledger by hand. Nowadays, most advanced, and highly developed accounting software is used.

What are general ledger (GL) accounts?

General ledger (GL) accounts are accounts that record all the financial transactions of a business, presenting detailed information about each financial transaction, such as the date, the description of the transaction, and the amount involved.

A general ledger comprises five different types of accounts such as:

• assets like cash, accounts receivable, property, inventory, and investments,
• liabilities such as accounts payable, loans, and customer deposits,
• owners’ (shareholders’) equity-like ordinary shares, preference shares, and retained earnings,
• income (revenue) such as sales of goods and/or services rendered, and
• expenses, for example, salaries, rent, maintenance of equipment, depreciation, and advertising.

Typically, GL accounts are arranged with the balance sheet accounts (assets, liabilities, and owners’ equity) appearing first, followed by the income statement accounts (revenue and expenses).

All the GL accounts with their closing balances are listed in a trial balance, validating the general ledger’s accuracy, and confirming that all the debit balances equal the credit balances.

After the validation of all the GL accounts, a business is ready and able to compile its financial statements such as the income statement, balance sheet, and other financial reports as deemed necessary.

Usually, in small businesses, all the data pertaining to financial transactions are recorded directly in the general ledger accounts.

Contrarily, a big company with a large number of transactions makes use of general ledger control accounts that contain summaries of detailed information derived from subsidiary ledgers.

Simply put, when there is a GL control account for a certain type of transaction, there is a corresponding subsidiary ledger.

What is a subsidiary ledger?

A subsidiary ledger, also referred to as a sub-ledger, records detailed information of related financial transactions and accounts. The information is summarised from time to time and posted to a general ledger control account.

Hence, a subsidiary ledger summarises and reports the totals of all related accounts with a single entry, supporting the balance in a particular GL control account. For instance, the inventory sub-ledger supplies the details to support the balance of the inventory general ledger control account.

Typically, subsidiary ledgers are used when high transaction volumes occur regarding specific types of transactions. Therefore, sub-ledgers are not used for all types of transactions.

Examples of subsidiary ledgers (sub-ledgers) are:

• Inventory ledger, containing transactions concerning raw materials, movement of stock, and absolute inventory.
• Fixed assets ledger in which transactions regarding assets like land, buildings, and furniture, including depreciation, are recorded.
• Accounts receivable ledger provides detail of all the credit sales transactions, as well as payments received from customers regarding credit sales.
• Accounts payable ledger in which all the purchases on credit and payments to creditors are processed.
• Purchases ledger records all types of purchases, on credit as well as cash purchases.
• Sales ledger records all the cash and credit sales.
• A cash ledger is used by a business to record types of transactions involving cash, such as expenses paid in cash.

Key concepts in the general ledger process

The following two key concepts, double-entry accounting, and the accounting equation are crucially important in the general ledger process.

Double-entry accounting

Financial transactions are posted in the general ledger accounts or accounts in the sub-ledgers by making use of double-entry transactions, referred to as journal entries.

Each journal entry is based on the double-entry system, requiring that every transaction must be recorded in a minimum of two accounts. One account is debited (the left-hand side of the account) with a certain amount and the second account is credited (the right-hand side of the account) with the same amount.

A journal entry can also comprise more than one debit and/or more than one credit. However, the total of all the debits and credits of a journal entry must always be in balance.

Accounting equation

The purpose of double-entry accounting[1], also referred to as balancing the books, is to ensure that the accounting equation (assets = liabilities + owners’ equity) is always in balance.

The accounting equation is the foundation of double-entry accounting. If the sum of the debits for all the accounts is not equal to the sum of all the credits of the accounts, the equation will not balance, indicating that one mistake or more has been made in the recording process.

Reasons why to use and reconcile a general ledger

There are various reasons that can be mentioned to indicate the importance of a general ledger.

Reconciling a general ledger is to ensure that each financial transaction has an equal and opposite transaction, confirming that all the debit and credit entries are recorded correctly.

Reasons, why a general ledger (GL) is important, are, among others:

• It provides an accurate record of all the financial transactions of a business.
• It indicates real expenses and revenue, enabling a business to manage to spend.
• It provides a basis to compile a trial balance from which all the necessary financial statements can be compiled.

The regular reconciliation of the general ledger is important for the following reasons:

• It provides a basis to check that all other financial statements are accurate.
• It enables owners and managers to timely identify unusual transactions.
• It helps to identify theft and fraud and to take the necessary steps to stop it.

[1] See the article, ‘Accounting Equation Explained for Dummies,’ for a detailed explanation of the equation.