The first section below explains journals and why economic activity is recorded to the journal. From there, the information is transferred to the ledgers. In the second section below, ledgers are described in more detail and how information is organized within the ledger. The final section explains how the journals and ledgers work together to create a set of reports for the owners that provide them with financial feedback for their respective business.
Similar to a diary, the journal is the original source of record for economic activity related to the business. The entries are customarily recorded in chronological order. To assist in speeding up data entry, most businesses use several journals based on the respective type of transaction. The four core journals are:
- Sales – records the transaction associated with customers.
- Purchases – this journal is used to enter data related to buying materials or administrative items to conduct business.
- Payroll – anything related to employees and compliance is written in this journal.
- General – the catch all book that is used if one of the other journals doesn’t seem like the correct fit.
Larger business operations have many more journals based on functions. For businesses that purchase materials on account, an additional journal known as the disbursements journal is used to record actual payments made for those purchases. On the flip side, when the customer has an account, upon collection of the money the receipts journal is used to record this activity. I’ve seen journals for taxes, owner activity and so forth. But the above four are pretty much universal for all businesses. However, for really small business operation, you only need one journal (general journal) because the level and volume of activity is relatively limited.
Most accounting software programs have these journals built in as a sub-routine of the program. For example, when you receive payment from a customer the entry is posted to the receipts journal. Just remember, the four journals above are built into every accounting software program available on the market today.
All entries are made under the dual entry accounting system. Thus, both the debit and credit are recorded together in the journal. For example, suppose a customer comes into the store and buys an item and pays cash to the clerk. This entry is recorded to the sales journal as follows:
Date Trans # Ledger ID Description DR CR
Today 123456 Sales Sold 1 Widget 10.00
. 123456 Cash Sold 1 Widget 10.00
Notice the debit equals the credit. The entry is made in accordance with the customary posting of debits and credits related to the type of account. Also, notice something really critical to the system, there is a ledger ID column that identifies which ledger will receive this line of entry. This is the connection between journals and ledgers. This is similar in the ledger as the data is transferred to that particular book.
Right up until the 1980’s, bookkeeping was a manual activity for almost every company in the world. Only the large publicly traded companies could afford accounting technology to assist in recording the thousands of transactions each day. Each day, the accountant would take each journal one by one and transfer the lines of entry to the respective ledgers. For the entry above, the bookkeeper would record in the sales ledger one line for the sale of that widget. The entry would look like this:
Date Journal Trans # DR CR
Today Sales 123456 10.00
For most companies, there will be tens or possibly hundreds of lines of credits each day. They would be summed up each day and then summed again at month’s end to determine total sales for that accounting period.
On the flip side, the cash ledger would receive the debit value. And just like the sales ledger, the day’s activity is summed and again at month’s end.
Thus, unlike a journal which records data in chronological order and has both sides of the entry, the ledger records one side of the entry based on the type of account. For example, revenue ledgers will have credit entries, asset ledgers will have debit entries. Please don’t think this rule is pure, it is possible for the sales journal to have a debit line entry in its activity. Why? Think about a customer returning the item, the journal records the entry in reverse; thus the ledger will have a debit line entry in its register. By the way, there’s a new term for you to understand. Those lines of activity in the ledger are often referred to as a register.
So how is this information finally relayed to the financial statements? The next section will explain how the journals and ledgers come together to get information reported to the financial statements.
Journals and Ledgers – Working Together
Above I explained how the ledgers are summed each day and this value is then added to the starting balance that day for that respective ledger and an ending balance is determined. The accountant takes those balances from all the ledgers for that day and places them on a worksheet called the trial balance. It is merely a list of the accounts in groups and the values are placed in their respective columns. Look at this example:
Ledger ID DR CR
Fixed Assets 14,200.00
Accounts Payable 2,304.18
Cost of Sales 9,821.15
Expenses 5,020.40 -0-
Totals 36,878.07 36,878.07
Notice how all debits combined equals all credits combined?
Once the trial balance reconciles (debits equals credits), the information can be formatted and transferred to the respective financial statements. The income statement will report sales, offsetting cost of sales and overhead expenses for a net profit of $2,366.85.
The balance sheet will look like this:
. Balance Sheet
Fixed Assets 14,200
Total Assets $22,036
Accounts Payable 2,304
Retained Earnings 17,365
Current Earnings 2,367
Sub-Total Equity 19,732
Total Liabilities and Equity $22,036
Per the accounting formula, total equity equals assets minus liabilities. Another way to say this is that the two halves of the balance sheet are equal. All of this information started in the journals and via transfers to the ledgers then to the trial balance ends up reported in the financial statements.
Modern day technology does this automatically. Every entry made automatically adjusts the ledgers and the respective financial reports.
Some final thoughts for you to consider. A set of journals and ledgers is referred to as a set of books for a company. There is a set of books for every accounting year for a business. Thus, now you understand where these terms originated and why they are still used today. You will hear them used among bookkeepers and accountants mostly, but at least now it makes sense. ACT ON KNOWLEDGE.