What is Ledger?
Before knowing What ledger accounts are? Let us take a brief introduction to Ledger. Journal is used to record the transactions chronologically. But Journal only gives the effect of individual transactions. The owner of a business, however, is not only interested in knowing about the effects of individual transactions on financial statements but also accumulated effect of each Account.
For example, if he wants to know the total amount of purchases relating to a particular accounting period, then it will be a hectic job to find it from the Journal as it contains a large number of transactions relating to purchases at different places according to their respective dates of occurrence. However, he can easily find the amount of total purchases from “Purchases Account“. Therefore, it is needed that transactions of a similar nature should be sorted out and accumulated at one place. This place is a ledger.
The ledger system of double-entry bookkeeping involves the use of a number of account-ruled books (known as a set of books) for the purpose of recording accurate information, in money values, of the day-to-day trading operations of a business. From these permanent records, periodical statements are prepared to show the trading profit or loss made by the business and its assets and liabilities, at any given date.
In the past, these records would quite literally have been kept in bound ledger books. However, even before the widespread introduction of computers, mechanized systems based upon mechanical accounting machines were used by many larger companies. In smaller organizations, looseleaf systems with multipart forms and carbon paper reduced the number of times that bookkeepers had to write out the same data.
Now any business with a full-time bookkeeper is likely to have computerized its accounting. However, computerization can only speed up the arithmetic of accounting, it cannot replace an understanding of the concepts. Underlying all modern computer accounting programs is the same double-entry system.
Ledger – The second phase of accounting
The ledger is the principal book of accounts where transactions of similar nature relating to a particular person or thing are recorded in classified form.
Ledger (or general ledger) is a book in which all accounts relating to a business enterprise are kept. In other words, it is a collection or group of all accounts of a business enterprise. The accounts kept in the ledger are sometimes termed as ledger accounts. One account usually occupies one page in the ledger but if the account is big one, it may extend to two or more pages. All entries recorded in the general journal must be transferred to ledger accounts.
The ledger may be in a bounded form or loose-leaf form. It is the master reference book of the accounting system. It provides a permanent and classified record of every element in the business operation. Because of these features, ledger is sometimes called the king of all the books of accounts.
Advantages of ledger
- Double-entry system is successfully applied through ledger because it records the twofold aspect of each transaction.
- Through ledger information related to various persons or things are recorded separately in the account. This enables business to look at the accumulated figure of each account.
- Ledger has made it possible to analyze the total incomes and expenses of a business for a particular period (Trading and Profit & Loss account).
- By opening separate accounts for various assets and liabilities it is also possible to see the financial position of a business.
- The transaction is recorded in Journal at first. Ledger is the second stage where transactions are posted, thus minimizing the chance of errors and omissions.
- It helps the management by providing important information, which helps in running the business smoothly.
What is posting?
The process of transferring information form general journal to the general ledger for the purpose of summarizing is known as posting. Entries relating to a particular account are all collected in that account, so its position may be known when needed.
The record of trading transactions is kept on the folios or pages of these account books, called ledgers. The ledger folios have special rulings to suit the needs of the business. The bank statement style lends itself to modern accounting, but for the time being, double entry will be explained by the older traditional method.
Format of Ledger Accounts
This is the ordinary ruling for the older style of ledger account:
In practice, separate ledgers are kept for the different classes of accounts (customers, suppliers, business property, trading revenue and expense, etc.). Batches or groups of similar accounts are kept together, and ledgers are indexed so that information with regard to any particular account may quickly be obtained.
It is important to check the accuracy of entries made in ledger accounts at regular intervals as failing to debit a customer’s account for goods bought on credit, for instance, could result in not sending out a reminder for payment.
Forms/types of ledger accounts
There are two popular forms of ledger accounts. These are:
- Standard form of ledger account or T shape form of ledger account
- Self balancing form of ledger account
Standard Form or T Shape Form of Ledger Accounts
In standard form of ledger account, the page of the ledger is divided into two equal halves. The left-hand side is known as the debit side and the right-hand side as the credit side. As it takes the shape of capital letter “T”, it is also known as T Shape of the ledger account. The debit side is used for recording debit entries and credit side is used for recording credit entries. The title of the account is written in the center at the top of the page. The account number is written in the extreme right-hand corner.
The standard form of ledger account does not show the balance after each entry. The balance is found out after certain period or when needed so this form of account is also called periodical balance form of ledger account.
Format of standard ledger account
Notice that each side of ledger account is divided into four columns. The purpose of these columns is briefly described below:
(1). Date column: In this column year, month and date of the entry is recorded in the same manner as in the general journal.
(2). Description: In this column the title of the corresponding account, i.e., the other account account included in the journal entry.
(3). Posting reference: In this column, the general journal page number is recorded.
(4). Amount: In this column, the amount of the account is recorded
Method of posting
The posting process consists of the following steps:
- Trace the ledger account in which the entries are to be posted.
- If an account is debited in the general journal, it will be posted on the debit side in the ledger account and if it is credited in the general journal, it will be posted on the credit side.
- In description column, the title (name) of the account included in other part of the journal entry is written. For example, if we are posting an account included in the debit part of the journal entry, the account or accounts in the credit part will be written in description column.
- The amount of the entry is written in the amount column of the ledger account.
Balancing the ledger account
Balancing means finding out the debit or credit balance of a ledger account. This process may be divided into the following steps:
- Total the debit and credit sides of the account.
- Find out the difference between the two totals found in step one.
- Put the difference on the lighter side. The difference so placed is the balance of the account. If the debit side of account is heavier than its credit side, the account is said to have a debit balance. In case the credit side of the account is heavier than its debit side, the account is said to have a credit balance. If the total of two sides of account is equal, the balance will be zero.
Record the following transactions in general journal and post them into ledger accounts.
Jan. 01: Mr. A started business with cash $45,000.
Jan. 04: Purchased merchandise for cash $4,500.
Jan. 10: Sold merchandise to Mr. John $1,450.
Jan. 31: Cash received from Mr. John $1,400 and allowed him a discount of $50.
Self-balancing Form of Ledger Accounts
The standard form of ledger account does not provide balance after each transaction. In organizations where account balances are required after each transaction, the self-balancing or running balance form of ledger account is used. The main advantage of this form of ledger account is that it provides current balance at a glance. Banks and other financial institutions are examples of business organizations that use self-balancing ledger accounts.
A proper format of self-balancing ledger account is given below:
Posting and balancing
The method of posting and balancing for a self-balancing ledger account is similar to that of standard form of ledger account. The only difference is that the balance is ascertained after each entry and is written in debit or credit column of the account. The following example is useful to clarify the whole procedure of posting and balancing.
Journalize the following transactions and post therefrom into ledger accounts. Use self-balancing/running balance form of ledger accounts.
Mar. 01: Started business with $40,000 cash .
Mar. 04: Purchased machinery for $4,000 cash .
Mar. 08: Purchased merchandise for $1,400 on account from S Brothers.
Mar. 12: Sold merchandise to a customer for $700 cash .
Mar. 15: Paid $1,380 cash to S Brothers and received a cash discount of $20.
Recording Transactions in Ledger Accounts
Once, the opening balances, i.e. the amount at the beginning of an accounting period, have been recorded in the ledger account, the next step is to record transactions at they take place. Transactions result in increasing and decreasing the value of various individual Balance Sheet items. The following rules are applied to recording these increases and decreases in individual ledger account.
Assets are recorded on the debit side of an account. Any increase to an asset are recorded on the debit side. Any decreases in an asset are recorded on the credit side of its account.
For example, the amount of cash in hand at a particular date (first day of the accounting period) is recorded on the debit side of Cash in Hand Account. Whenever an amount of cash is paid out, an entry is made on the credit side of Cash in Hand Account.
Liabilities are recorded on the credit side of an account. Any increases in a liability are recorded on the credit side. Any decreases in a liability are recorded on the debit side of its account.
For example, the amount payable to United Traders on the first day of the accounting period is recorded on the credit side of United Traders Account. If more goods are bought from United Traders (thereby incurring an additional liability to United Traders), an entry is made on the credit side of United Traders Account. If an amount is paid to United Traders (thereby reducing the liability to United Traders), an entry is made on the debit side of United Traders Account.
Capital is recorded on the credit side of a ledger account. Any increase in capital is also recorded on the credit side. Any decrease in the capital is recorded on the debit side of the respective Capital Account.
For example, the amount of capital of John (in the previous example), on the first day of the accounting period will be shown on the credit side of John’s Capital Account. If he introduces any additional capital an entry will be made on the credit side of his Capital Account. If he takes any money or goods from the business, that will reduce his capital and Therefore an entry will be made on the debit side of his Capital Account.
Note that the treatment for assets is exactly opposite to the treatment for liabilities and capital. Another important fact to note is that since the total of assets is equal to the total of liabilities and capital at any given time, the 10tal of the amounts entered on the first day of’ the accounting period on the debit side of accounts (in respect of various assets) will be equal to the total of all the amounts entered on the credit side of various accounts (in respect of various liabilities and capital).
The Double Effects of Transactions in Ledger Accounts
As we know how a Balance Sheet remains in balance after each transaction. This is so each transaction affects the Balance Sheet in such a way that an increase on one side of the Balance is off-set either by a decrease on the same side or by an increase on its other side. It follows therefore that:
- Since increases in assets are debited and decreases in assets are credited, a transaction resulting in an increase in one asset and a decrease in another asset will in effect have equal debit and credit entries. These entries will, of course, be made in two different asset accounts but will be equal in amount. For example a receipt of $3,000 from Adam, a debtor, will be recorded on the debit side of Cash in Hand Account (as this asset is increasing) and on the credit side of Adam Account (as the amount due from him is decreasing). Entries in both these asset accounts will be of $3,000 each.
- Since increases in assets are debited and increases in liabilities are credited, a transaction resulting in an increase in an asset and an equal increase in a liability (or capital) will in effect have equal debit and credit entries. For example, when furniture is bought on credit for $4,000 from Fine Furniture Co., we will make an entry of $4,000 on the debit side of Furniture Account (because this asset is increasing) and also an entry of $4,000 on the credit side of the Fine Furniture Co. Account (because our liability to this creditor is increasing).
- Since decreases in liabilities are debited and decreases in assets are credited, a transaction resulting in a decrease in a liability (or capital) account and an equal decrease in an asset account, will in effect have equal debit and credit entries. For example, when the owner of the business takes $500 in cash from the business cash box for his personal use, wé will make an entry on the debit side of Capital Account (as his capital in the business is now reduced) and also an entry of an equal amount on the credit side of Cash in Hand Account (as this asset is decreased in so far as the business is concerned).
It is apparent from the above examples that each transaction affects at least two accounts in the ledger. One of these accounts must be debited and the other credited, both with equal amounts. Now since, opening entries have equal debits and credits and all the transactions also result in equal debit and credit entries, it follows that, barring any errors, the total of all entries on the debit side of various accounts in the ledger is always equal to the total of all credit side of various accounts in the ledger.
This is a very important fact and is called the golden rule of keeping books: debits must always equal credits. Since every transaction affects at least two accounts, to fully record its impact on the ledger, we MUST MAKE TWO ENTRIES FOR EACH TRANSACTION, one of the entries is a debit entry and the other a credit entry, both of equal amounts. This is what we call the DOUBLE ENTRY SYSTEM OF BOOKKEEPING. Very simply, double-entry system states that at least two entries must be made for each transaction, one a debit entry and another a credit entry, both of equal amounts.