Are you curious to know, what is Ledger in Accounting? Also, let us look into its features, types, objectives, and importance. Then, let's dive right into it. Let us understand it in simple terminology.
What is the meaning (definition) of Ledger in accounting?
A Ledger is a bound book containing all the different accounts such as cash account, sales & purchase account, etc. It is also called the book of secondary entry because all the business transactions are recorded in Ledger after they have been recorded in Journal primarily. It is also called the Principal book of accounts. It is also called the book of final entry.
What is Ledger Posting and balancing of an account?
Ledger posting: It is the process of transferring transactions entered in
the journal to the respective accounts and they are balanced, accordingly. The ledger contains all the different types of accounts like cash, bank, debtors, plant&machinery, creditors, long-term liabilities, expenses and incomes. Each account has
a T shape format where the left side is debit and the right side is credit. It also has either a debit balance or a credit balance. Generally, ledger posting is done weekly or monthly as per the requirement of the business entity.
Ledger Balances : Each ledger account has a ledger balance at the end of the account. ledger accounts are totalled and balances are obtained. It may have either debit balance or credit balance. All assets, expenses and losses have debit balance. All income, liabilities, capital, and provisions account have a credit balance.
DEBIT BALANCES: All assets, expenses, and losses have debit balances such as cash a/c, machine a/c, debtors account, inventory account, investments account, and purchases account.
CREDIT BALANCES: All liabilities, incomes, sales, and capital accounts have credit balances like capital account, sales account, creditors account, provisions account
All the ledgers accounts having debit or credit balances are taken to Trial balance and Trading, profit&loss account, Balance sheet. Ledger accounts helps in preparing financial statements and to finalise the accounts at the end of the financial year.
What are the main objectives of maintaining a Ledger?
The main objectives or purpose of preparing ledgers are as follows
1. To record the Business Transactions in books of accounts in a systematic manner.
The main objective of the ledger is record keeping of business transactions. Once the transactions are recorded in the journal, they are transferred to different ledger accounts. In this way, the books of accounts are maintained to ensure that all the business transactions are recorded in a systematic manner.
2. Ledger consists of different types of accounts
It consists of different types of accounts such as cash a/c, bank a/c, debtors a/c, and creditors a/c. These accounts are totalled and balanced to find the balance of each account. The account has T shape where the right side is represented as Debit - Dr and left side is represented as Credit - Cr. The balances of assets, liabilities and capital are carried forward to next financial year. But the balance of an income and expense account is transferred to Profit and loss a/c, and not carried forward to next year.
3. Classification of accounts as Assets, Liabilities, Income, Expenses & Capital
Here, different accounts are mainly classified under Assets, Liabilities, Capital, Expense and Income. This is to make the classification easy and to record them easily in financial statements. For example, the balance of all assets, liabilities, and capital is taken to the Balance Sheet. Whereas the balance of expenses and incomes is to be taken into the Profit and loss account.
4. Helps to know the ledger account balances
As we know, it helps us to know the different ledger account balances. This helps us to analyse the different accounts and make useful decisions. For example, Debtors' balance helps us to know the balance amount due from debtors, this helps to take steps to collect the amount due from debtors. Similarly, Cash balance helps us to know the amount available in liquid cash.
5. Assists in the preparation of Trial Balance
It also assists in the preparation of trial balance, once the accounts are balanced. The next step after posting and balancing is preparing a trial balance. The trial balance contains all the account balances. Trial balance is prepared to ensure the arithmetical accuracy of books of accounts. The total amount of debit balance must be equal to the total amount of credit balance in a Trial balance
6. Basis for preparation of Financial Statements
It also helps in the preparation of financial statements. As we know, the financial statements include the trading & profit and loss account, balance sheet with notes to accounts, and cash flow statement. The balance sheet depicts the financial position. The cash flow statement gives the picture of the cash position. The profit and loss statement helps to ascertain the financial performance i.e, profit earned or loss incurred during the period.
7. Provides reliable financial information to users of financial information
It provides reliable and useful information to the users of financial statements. The users would include debtors, creditors, competitors, government, credit rating agencies, investors, and shareholders. They are interested to know the financial information of the business enterprise. For example, Government is interested to know the sales account balance to levy tax on sales.
8. To reduce frauds, errors and omission of financial transactions
It helps to record all the business transactions without the omission of any transaction. This also helps to minimize the errors, frauds, and thefts in the business organisation. This helps to maintain the books of accounts without any errors or omissions.
9. Adhere to the double-entry system of bookkeeping
This is to comply with the double-entry system of bookkeeping to make record-keeping complete, reliable, and useful. Under the double-entry system of bookkeeping, both the aspects such as debit and credit are recorded. This system is reliable, scientific and authentic. The books of accounts are prepared by complying with the double-entry system.
10. To ascertain the effect of all business transactions
One of the objectives of maintaining ledgers is to ascertain the effect of all transactions in the books of accounts. For example, assets recorded will give a debit balance and the asset balance is shown on the asset side of the balance sheet. Similarly, liabilities and capital is shown on the liability side of the balance sheet.
What are the characteristic features of Ledger in Accounting?
The most relevant features are as follows:
1. A Ledger is a book containing all the different types of accounts such as assets, liabilities, revenues, expenses, and capital. It is the book of secondary entry because transactions are recorded in Ledger after they have been recorded in Journal. It is also called the Principal book or book of the permanent record of all transactions.
2. All the transactions are transferred to Ledger from Journal. This process is called "Ledger Posting". In simple words, the transactions recorded as journal entries in Journal are transferred to Ledger as individual Accounts. Generally, ledger posting is done weekly or monthly as per the requirement of the business entity. It means, that all the transactions are first recorded in Journal as Journal entries in chronological order. Journal is the book of Primary Entry of all transactions.
3. Each account has a T shape format where the left-hand side is debit and the right-hand side is credit. Debit is denoted as "Dr" and Credit is denoted as "Cr". It has a T shape format where the left side is denoted as Dr and the right side as Cr. This is the format, Specimen, and design of an account.
4. Each ledger account has a debit or credit balance at the end of the account. The totals are calculated and balances are obtained. It may have either a debit balance or a credit balance. All assets, expenses and losses have a debit balance. All income, liabilities, capital, and provision accounts have a credit balance.
5. Generally, there are 3 types of Ledgers. They are
Sales (Debtors) Ledger - Here, Debtors/Customers' information is accumulated and stored. This is the information relating to the sale of goods/services to customers on credit. This is also called Accounts Receivable/Debtors.
Purchase (Creditors) Ledger - Here, Creditors/Suppliers' information is accumulated and stored. This gives the information relating to the purchase of goods from suppliers on credit. This is also called Accounts Payables/Creditors.
General Ledger - This book has various accounts such as Capital, Assets, Liabilities, Expenses and Revenues. This gives the information relevant for preparing the Trial Balance, Profit and loss a/c and Balance Sheet.
6. Each Ledger account has 4 columns on each side. For example, on the right-hand side, we have four columns and also on the left-hand side four columns. They are the Date column, particulars column, Journal folio column, and amount column.
7. Each ledger account has a separate name or heading for that particular account. For example, cash a/c is the name of the cash ledger account shown on the top of that T shape account. Similarly, we have sales a/c, purchases a/c, machinery a/c, discount received a/c, discount allowed a/c, debtors a/c, and creditors a/c as the title or name shown above T shape account.
8. It helps in reducing errors, frauds, and omission of transactions in the books of accounts. This has become easier due to the double-entry system of bookkeeping, which is a reliable and scientific method for recording business transactions. Thus, it helps in minimizing the errors and fraud that happen while maintaining the books of accounts.
What are the 3 different types of Ledgers in Accounting?
Generally, there are 3 types of Ledgers. They are
1. Sales (Debtors) Ledger
It contains all the information related to customers/clients to whom goods/services have been sold/delivered on credit. This is the book which has all the debtors' information at one place. This helps to know the total amount due by customers/debtors to the business. They are also referred to as Accounts Receivables and Debtors.
Sales (Debtors) Ledger gathers the information from the Sales Journal. The main purpose is to gather and accumulate the information pertaining to Debtors/Customers. This helps us to know the amount due from each debtor/customer to the business organization. The accounts receivable department may use this information to collect the amounts due from customers. This also helps to manage accounts receivables/debtors while providing credit periods to customers.
2. Purchase (Creditors) Ledger
It contains all the information related to sellers/creditors from whom goods have been purchased on credit. This is the book which has all the creditors' information at one place. This helps to know the total amount due by the business entity to creditors/sellers. They are also referred to as Accounts Payables and Creditors.
Purchase (Creditors) Ledger gathers the information from the Purchase Journal. The main purpose is to accumulate the information pertaining to Creditors/sellers. This helps us to know the amount due to creditors/sellers for the goods purchased on credit. This also helps us to manage the suppliers/creditors to make timely payments to Suppliers/creditors. This would enable to extend the credit period while making payments due to creditors/suppliers.
3. General Ledger
It contains mainly 5 different types of accounts such as assets, revenues/incomes, expenses, liabilities and capital. This helps to know the balances of different accounts as well. General Ledger can be found as the centralized compilation of all the ledger accounts of any business entity. It is again divided as Nominal Ledger and Private Ledger.
Nominal Ledger contains different nominal accounts such as incomes, expenses, losses, and gains. Private Ledger contains confidential information relating to Capital, Drawings, additional capital, Salary & Wages.
General Ledger accumulates and obtains the information from Journal. Each month these journals are totalled and then posted to General Ledger. The main purpose of General Ledger is to summarize, gather, and organize the information relating to all the transactions contained in Journal.
What are the advantages (importance) of maintaining Ledgers?
The advantages, benefits or uses of maintaining the Ledgers are as follows:
1. It helps in recording the business transactions in the books of accounts in a systematic manner
2. It helps to classify the accounts as Assets, Liabilities, Capital, Expenses, Incomes
3. It follows the double-entry system which is a reliable, scientific, and logical one to record the transactions
4. It forms the basis for the preparation of Trial Balance
5. Also, it forms the basis for the preparation of Financial Statements
6. It helps to analyse the recorded financial information using different ledger accounts
7. It helps to minimize the errors, frauds and omission of transactions in books of accounts
8. It helps to collect and store the financial information in different ledger accounts
9. It also helps in ascertaining the effect of the recorded transactions on the Trial balance & Financial statements as well
10. It helps to depict the different ledger account balances for making useful decisions
What are the disadvantages of maintaining Ledgers?
The limitations, demerits, or disadvantages of maintaining ledgers are as follows:
1. Maintaining the Ledgers will be a cumbersome, expensive, complex and complicated task
2. Recording the transactions, posting the ledger accounts and ascertaining the ledger account balance involves clerical work. It is also a time-consuming task.
3. Information contained in the ledger accounts is much sensitive and confidential. Access to this information by any third party/stranger may involve risk or leakage of secret information.
4. Hiring the Bookkeepers & Accountants for record-keeping and maintaining the Ledgers is highly expensive and involves much complex work. It may not be suitable for small business units or sole trading concerns
Conclusion
Hope you all are familiar with the concept of, What are Ledgers? Its features, objectives, types, and importance as well. Finally, in simple terms, it is a book containing different types of accounts such as assets, liabilities, capital, incomes, and expenses. This concept was explained in simple terms. Also, feel free to comment below on your views or opinion on this topic.
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