Ledger
A ledger in accounting is a book or a system (which can be computer-based in modern times) where all the financial transactions of a business are recorded in accounts. The purpose of a ledger is to bring together all the transactions related to every individual aspect of the business into one place so it’s easier to manage and review them.
There are different types of ledgers, including:
- General Ledger: This is the primary ledger that contains all the accounts necessary to prepare financial statements of a business. It includes accounts for assets (like cash, accounts receivable, equipment), liabilities (like accounts payable, bank loans), equity (like common stock, retained earnings), revenues, and expenses.
- Subsidiary Ledger: This is a ledger designed to provide detail for a single general ledger account. For example, an accounts receivable subsidiary ledger would include the individual transactions by each customer.
- Sales Ledger: This ledger records the sales of a business, often broken down into categories like cash sales, sales on credit, etc.
- Purchase Ledger: This ledger records the purchase transactions of a business, again often broken down into different categories.
The process of recording transactions in a ledger is known as posting. Initially, transactions are recorded in a ‘journal’ where they are listed in chronological order. These transactions are then posted to the relevant accounts in the ledger.
The ledger provides a complete history of financial transactions over the life of the organization and helps to form the basis for its financial reporting, making it an essential tool in accounting.
Example of a Ledger
Let’s say we’re looking at the general ledger of a small retail business, “ABC Retail Inc.” Here’s how some of the ledger might look:
Cash Account (Asset)
- Beginning balance: $20,000
- Received from sales: $10,000
- Paid for inventory: $4,000
- Paid for rent: $2,000
- Ending balance: $24,000
Inventory Account (Asset)
- Beginning balance: $8,000
- Purchased additional inventory: $4,000
- Sold inventory: $6,000
- Ending balance: $6,000
Sales Revenue Account (Revenue)
- Beginning balance: $0 (Revenue accounts typically start from zero at the beginning of a new accounting period.)
- Made sales: $10,000
- Ending balance: $10,000
Rent Expense Account (Expense)
- Beginning balance: $0 (Expense accounts also typically start from zero at the beginning of a new accounting period.)
- Paid rent: $2,000
- Ending balance: $2,000
Note: In reality, a general ledger would have many more accounts and the transactions would also be more complex. For instance, when inventory is sold, it not only impacts the inventory account and the sales revenue account but also an account called ‘ cost of goods sold. However, this simplified version should give you a basic understanding of how transactions are posted in a ledger.
This information in the ledger would be used to prepare the company’s financial statements. The balance sheet would show cash of $24,000 and inventory of $6,000 as assets. The income statement would show sales revenue of $10,000 and rent expense of $2,000, leading to a net income of $8,000 (assuming there are no other revenues or expenses).
