Resources - Applied Finance / Chapter 6
Transfer to Ledger
Overview
In this chapter, we’ll be looking at the concept of ledger entries & how it helps businesses keep track of their transactions for each accounting period.
Scope:
- Overview
- Types of Ledger Accounts
- Posting a Ledger Entry & Benefits
- Transfer to Trial Balance
Ledger - An Overview
The journal records all the accounting entries relevant to a firm. However, what if we are asked about the transactions or balance of a particular account? It would be difficult to calculate these journal entries that have been posted across different dates. So, this is where ledger entries come in.
The term ledger is used to collectively refer to all the accounts maintained by a company. The ledger is, thus, a book or record used to store, sort and summarize business transactions. Ledgers are prepared from journal entries and are therefore known as the second book of entry (with the journal as the primary book or book of original entry). Ledgers may contain details of all transactions in one type of account or in the case of the general ledger, a summary of all the financial transactions of a company over an accounting period.
The ledger will show an account’s opening balance at the start of the accounting period, all the debits, credits & closing balance. For example, the cash account records all the transactions which involve an increase or a decrease in cash during the accounting period as well as the starting and ending cash balance. In most current-day organizations, the preparation of the ledger from journal entries is automated as part of the responsibilities of accounting software. Therefore, it is not necessary for a prospective manager to know how the ledger is prepared but it’s important to understand the basics of the process and the role played by a ledger in the preparation of financial statements.
Types of Ledger Accounts
There are five main types of ledger accounts:
- Assets
- Liabilities
- Equity
- Revenue/Income
- Expense
Of these five main types, each account may have several subsidiary accounts within them such as cash, savings account, inventory etc are all examples of asset accounts. The definitions of the five main account types have been covered in earlier chapters (Chapter 3).
The number of ledger accounts maintained by an entity will depend on the complexity of the business as well as the level of detail desired by the management. For example, a diversified enterprise operating across different industries will likely require more ledger accounts to effectively follow its business transactions as compared to a simple business operating in only one activity. Similarly, a firm may choose to club all its utility expenses into a single utility ledger or maintain separate ledgers for electricity, water and fuel.
Posting a ledger entry
The process of recording a transaction to the ledger is known as posting ledger entries. Every transaction from the journal is posted to their respective individual ledger accounts. When posting in the ledger account, we follow the journal entries. That is, we debit an account in the ledger if the account was debited in the journal.
Let us take a specific example of a journal entry and see how it is posted to the ledger. Let us consider that a business pays salaries of Rs. 15,000 on 31st March. Immediately after that, it makes a sale of Rs. 5,000 and receives cash in consideration.
The simplified journal entry for the transactions would look something like this:
| Date | Account | Debit | Credit |
|---|---|---|---|
| March 31, 2022 | Salary | 10,000 | |
| Cash | 10,000 | ||
| March 31, 2022 | Cash | 5,000 | |
| Sales | 5,000 |
The respective simplified ledger entries are presented below:
General Ledger
ABC Co Pvt. Ltd.
Jan 1, 2022 - March 31, 2022
| Cash Account | |||||
|---|---|---|---|---|---|
| Reference | Due Date | Amount | Reference | Due Date | Amount |
| Balance B/f | Jan 1, 2022 | 25,000 | Salary | March 31, 2022 | 5,000 |
| Salary | March 31, 2022 | 10,000 | ... | ... | ... |
| Salary Expense Account | |||||
|---|---|---|---|---|---|
| Debits | Credits | ||||
| Reference | Due Date | Amount | Reference | Due Date | Amount |
| Balance B/f | Jan 1, 2022 | 0 | ... | ... | ... |
| Cash | March 31, 2022 | 10,000 | ... | ... | ... |
| Sales Account | |||||
|---|---|---|---|---|---|
| Debits | Credits | ||||
| Reference | Due Date | Amount | Reference | Due Date | Amount |
| ... | ... | ... | Balance B/f | Jan 1, 2022 | 0 |
| ... | ... | ... | Sales | March 31, 2022 | 5,000 |
Here, we see that each transaction affects at least two different ledger accounts and that the total debit and credit entries are balanced. Also, note that the direction of the transaction remains the same in both the ledger and journal entries. Therefore, the rules you learned regarding when an account should be debited or credited apply to the ledger entries as well.
Benefits of Ledger Entry
Preparing a ledger has several benefits such as:
- It reports revenue and expenses, allowing a firm to monitor its running expenses.
- Since the ledger contains all the transactions in a particular account, it makes it easy to find the balance of a particular account in real time which ensures that a firm can monitor individual accounts and maintain sufficient balances to ensure its smooth functioning. For example, a firm which needs to ensure that it maintains sufficient cash to pay its creditors can do so by monitoring its cash and creditor accounts.
- The ledger also helps spot unusual and erroneous transactions
- Lastly, it helps us compile the trial balance and financial statements.
Transfer to trial balance
At the end of a financial period, the balances of the ledger are transferred to a trial balance which is used to prepare the financial statements for the period. Further, balance sheet accounts (asset, liability and equity account) balances are carried forward to the ledger for the next period whereas income sheet accounts (incomes and expenses) balances are reset to zero at the start of each accounting period.
Closing summary
To summarise, the ledger account lists all the transactions in a single account making it easy to find total debits, credits or account balances for each account across the period we are interested in. Ledger entries are prepared from journal entries and in turn, are used for the preparation of financial statements. Ledgers help organize and attain real-time information about the state of individual accounts and thus the financial position of a company which are in turn useful in the preparation of the entities’ financial statements.