What is Ledger: Format and Steps of Creation

This collection of accounts includes all records of account transactions where each account consists of the opening or carry-forward balance. Each records every transaction separately in credit or debit.

In this article on what is ledger, we will be discussing the format and steps of creating this book of accounts. 

Table of Contents

• What is ledger?
• Types
• Format
• Steps of creation
• Ledger account
• How does ledger help businesses?

What is Ledger?

Ledger is a book of accounts or a second book of entry where account transactions are recorded. Here, each account has an opening or carry-forward balance. This book of account records every transaction as either credit or debit in separate accounts with a closing balance. 

It can contain detailed transaction information of one account or may contain summarised information of the company’s financial transaction over a time period. This book of accounts consists of information that is required for preparing financial statements. 

Companies maintain ledgers for different types of balance sheet and income statement accounts which include accounts payable, accounts receivable, sales and payroll. Transactions from subsidiary ledgers are periodically summarised and transferred to general ledger that contains transaction data for every account in the chart of accounts. Transactions flow from one journal to one or more ledgers. Ledgers include the following:

• Purchase ledger is used for recording money spent for the purchases by the company.
• Sales ledger consists of financial transactions made by customers to the company and also records the accounts receivable.
• General ledger represents five main types of accounts, including liabilities, assets, capital, income and expenses. 

For every debit that is recorded in this book of accounts, a corresponding credit must be there so that credits and debits must be equal in grand total. 

Types

This book of accounts is of the following are three types: 

1. Sales Ledger

It is an account meant for customers in a business where money owed and received for products, and services are recorded. This is represented in balance sheets and annual accounts as trade debtors or accounts receivable. 

2. Subsidiary Ledger

It refers to a group of similar accounts with a combined balance equal to the balance available in a specific general account. Here, the general ledger is the control account or master account that summarizes the subsidiary ledger’s account balance. Posting a credit or debit to subsidiary account or to a general account does not violate the rule where total credit and debit entries must balance since subsidiary account is not a part of the general ledger.  

3. Nominal Ledger

It is a type of book of accounts that contains a nominal account, profit and loss, balance sheet and all other accounting records. All accounting transactions are recorded in the nominal ledger. It consists of a record of every expense, payment and asset of business. It also consists of the information required to compile financial reports. Nominal ledger also includes the chart of account.

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4. Fixed Asset Ledger

This book of accounts is used for recording all the financial activities that are related to fixed assets. It includes details of the asset lifecycle such as purchase, audits, depreciation, revaluation, impairment and disposal. In the company’s book, every asset has an account where all financial activities related to fixed assets are recorded.

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Format

In accounting, it has a tabular double-entry system format that consists of two columns with a debit and credit side. Both sides are segregated into date, folio numbers, and particular and amount columns. Credit side indicates every credit increase of the account whereas the debit side indicates an increase in all debit. 

Steps for Creating Ledger

To create the book of accounts, the following steps must be followed: 

• All journal entries must be approved and tallied for accuracy.
• Format should be formulated by drawing credit and debit sides into three to four columns, where each column must be labelled. 
• Every journal entry must be posted into individual ledger accounts.
• The final balance of each account must be calculated at the end of the accounting year. 

Ledger account

The ledger account is the record of every transaction that affects a specific account within general ledger. Individual transactions are identified within the account with date, transaction number and description so that it becomes easier for business owners and accounts to research financial transaction reasons.

Some of the common types of ledger accounts include the following:

• Asset accounts: Prepaid expenses, accounts receivable, cash
• Liability accounts: Accounts payable, notes payable, accrued expenses, lines of credit
• Revenue accounts: Sales and service fees
• Equity accounts: Retained earnings, paid-in capital, common stock and shareholder distributions
• Expense accounts: Utilities, salaries and wages as well as supplies
• Income and expenses: Interest, gains and losses from asset disposal, investment income

How Does Ledger Help Businesses?

A ledger is an essential component of a company's accounting system. It helps businesses in several fundamental ways:

Financial Record Keeping

• Tracks Transactions: A ledger records all the financial transactions of a business, providing a detailed account of all the inflows and outflows of money.
• Organizes Data: It categorizes financial data into different accounts, making it easier to locate and understand specific financial activities.

Financial Management

• Budgeting and Planning: By maintaining a clear record of all transactions, ledgers assist businesses in budgeting and financial planning.
• Monitoring Cash Flow: Ledgers help in monitoring cash flow, which is crucial for managing day-to-day operations and ensuring that the business has enough cash to meet its obligations.

Reporting and Analysis

• Financial Statements: Ledgers serve as the foundation for preparing financial statements, including the balance sheet, income statement, and cash flow statement.
• Performance Analysis: They allow businesses to analyze financial performance over time, identifying trends and areas for improvement.

Compliance and Audit

• Tax Reporting: Accurate ledgers are vital for tax reporting purposes, ensuring that all taxable income and deductible expenses are properly documented.
• Audit Trail: A well-maintained ledger provides an audit trail, which is necessary for both internal audits and external audits by regulatory bodies.

Decision Making

• Informed Decisions: With comprehensive financial information, management can make more informed decisions regarding investments, cost-cutting, and strategic growth.
• Transparency: Ledgers create financial transparency, which can build trust with stakeholders, including investors, creditors, and employees.

Risk Management

• Error Detection: Regularly updated ledgers can help in early detection of errors, fraud, or mismanagement of funds.
• Internal Controls: They are a part of internal controls that help in safeguarding the assets of the business.

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Efficiency

• Consolidation: Modern electronic ledger systems allow for the consolidation of financial information across different departments or segments of the business.
• Time-saving: Automated ledger systems save time and reduce errors in recording transactions as compared to manual entry.