Even though using bookkeeping software will help with the daily use of accounting functions for a small business, it’s still important to have an understanding of the basic functions of accounting. Before understanding the relationships between general ledgers and the financial statements, it’s important to understand the functions of debits and credits. Understanding how debits and credits work is the first step into grasping the fundamentals of bookkeeping.
Accounting 101 – What is a General Ledger Account?
The general ledgers are an accumulation of all the company’s financial transaction totals. There are five basic general ledger (GL) categories.
- Assets
- Liabilities
- Owner’s Equity
- Revenue
- Expenses
Within each category there can be a multitude of GL accounts. Assets for example may consist of separate GL accounts like cash, equipment and account receivables, just to name a few. A typical small business can have hundreds of individual accounts. Each one should fall into one of the five categories.
From the Journals to the General Ledger
The financial transactions are first posted to the appropriate journals. The journal postings are then transferred to the appropriate general ledger.
Journal Examples
- Sales Journal – is generally posted from sales invoices
- Purchase Journal – is generally posted from vendor invoices for accounts payable
- Cash Receipts Journal – is where all incoming cash is recorded
- Check Register – is where outgoing cash is recorded
- General Journal – is usually used for miscellaneous transactions and month end adjustments
Let’s use the sales journal as an example. When a sale is made on a product, the financial transactions are posted to the sales journal from a company invoice. The sales invoice can affect several GL accounts. Some of the GL accounts that can be affected from the sales journals are:
- Sales (revenue)
- Cost of sales (revenue to calculate gross profit)
- Inventory (asset)
- Cash or Accounts Receivable (asset)
- Freight Charges (expense)
- Sales Tax (liability)
Depending on the complexity of the sales transaction, there can be many more GL accounts affected.
General Ledger Accounts and Financial Statements
Normally at the end of each month, the GL accounts are tabulated and transferred to the financial statements. The two main financial statements are the balance sheet and income statement. The first step is to create the trial balance, which validates the journal postings. Once the trial balance is validated, the accounts are then transferred to the appropriate financial statement.
General Ledger Accounts and the Balance Sheet
The balance sheets main function is to report owner’s equity. The three main GL categories that are transferred to the balance sheet are assets, liabilities and owner’s equity. All assets must equal or balance the combined total of all liabilities and owner’s equity. The equation for owner’s equity is:
Assets – Liabilities = Owner’s Equity
General Ledger Accounts and the Income Statement
The income statement's main function is to report profit or loss. The two main GL categories that are transferred to the income statement are revenue (or income) and expenses. The income statement does not balance, but the integrity of the revenue and expense account is verified by the trial balance. The equation for the income statement is:
Income – Expenses = Profit (or loss)
To summarize, there are five main GL accounts categories. Within each category there are a multitude of general ledgers. Assets, liabilities and owner’s equity are transferred to the balance sheet. Income and expenses are transferred to the income statement.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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