Prepare final general ledgers

Submitted by coleen.yan@edd… on Wed, 05/22/2024 - 14:18

As indicated previously, the general ledger is the most important component of any financial system. It can be thought of as the heart of any financial record system.

The general ledger is the ‘books’, and any business transaction you make will move through the general ledger at some point, forming a permanent record of all your business transactions throughout your business life.

Every financial transaction involves a flow of economic benefit from a source to a destination.
James Hearle

Sub Ledgers

As well as the general ledger, you will have several sub-ledgers for items such as cash, accounts receivable and accounts payable. Entries in these sub-ledgers help maintain individual records of specific aspects of your business, which are generally summarised in the general ledger.

There are times when you may bypass the sub-ledgers entirely, however. These transactions generally refer to selling assets or adding capital to your business.

The General Ledger

There are two specific statements that we need to create within any organisation, the balance sheet and the profit and loss statement. Each of these statements requires information drawn directly from the general ledger. The general ledger is used to draw information about all business transactions, which is then summarised and transposed into the financial statements at the end of each accounting period.

Sub Topics
A person writing on a calendar

As we have mentioned, balance day adjustments are general journal entries that have been recorded to allow all transactions to be relative to the principle and, therefore, better match revenues and expenses. As a result, a more accurate profit figure will occur at the end of the accounting period.

Balance day adjustments in the general ledger system are typically the following:

  • prepaid expenses
  • prepaid (unearned) revenues
  • accrual expenses revenues
  • accrual revenues
  • doubtful debts
  • depreciation
  • employee entitlements
  • inventory variances
  • stock on hand.

Adjustments to the balances in ledger accounts may be necessary at the end of the accounting period to ensure that all revenue and expenses related to the particular accounting period have been included. Other adjustments may be necessary because the company may not be aware of or be able to calculate certain revenues or expenses until the end of the accounting period.

Because adjustments are completed at the end of an accounting period, they are referred to as balance day adjustments. At the end of the reporting period (balance day), the accounts may only show the amount received or paid during this particular period. For example, electricity may have been consumed in the current period (representing the consumption of an economic benefit – an expense) but will not be paid for until the next period.

For example, adjusting records for prepaid income: Prepaid Income account (Debit) and Income (Credit).

In addition, if the cash did not come to a company and therefore the accountant did not record the transaction, it was not recorded in ledger accounts. However, the changes in revenue and expenses being earned or incurred in the current accounting period will be recorded. This will lead to changes in the balance of ledger accounts and/or the introduction of additional ledger accounts.

Balance day adjustments are considered to be only temporary adjustments to avoid double-counting.

That is, the relevant ledger accounts are adjusted on the balance date, and the financial reports are prepared using the adjusted balances.

Once this has been done, the adjustment has served its purpose and on the first day of the next period, before the cash is issued for the actual payment, the adjustment is reversed. When the money is paid and recorded in the next period, there is no longer any double-counting.

After balance day adjustments have been completed, the account manager will prepare a new trial balance.

This new trial balance is referred to as the Adjusted Trial Balance. The company's financial reports (Income Statement and Balance Sheet) are then prepared using the account balances in the adjusted trial balance.

A warehouse manager taking stock of yet to be deployed computers

Consider an adjustment for laptop computers on hand for The Computer Man.

Jon the owner of The Computer Man has been having difficulty obtaining supplies of laptops. He decides to purchase a bulk purchase of 20 laptops to ensure that he has stock for a large project he has coming up. When Jon purchases the laptops his accountant makes a debit entry in the laptop expense ledger. However, the start date for the project was delayed and only 15 of the laptops were set up and installed by the end of the financial year.

In this instance, the amount left at the balance date should appear in the financial reports as an asset not as an expense. An adjustment needs to be made to temporarily transfer the value of unused laptop computers out of the laptop expenseledger and into the stock of laptop computers ledger.

30/06/20XX

Dr Stock of laptop computers (asset) $5000.00

Cr Laptop computer expense (expense) $5,000.00

The stock of laptop computers is considered an asset at the balance date because it represents the value of the laptops owned by the company.

After an adjustment is made, it would be reversed on the first day of the next period. The unused amount will be used in the next period and therefore cease to be an asset.

01/07/20XX

Dr Laptop computer expense (expense) $5,000.00

Cr Stock of laptop computers (asset) $5000.00

All operations are recorded in the accounting journal or book of original entry.

As mentioned before, there are two types of journals: general journals and special journals. If you are unclear about how these types of journals differ, please review the topic Accounts and Journals in this module for a refresher. After all transactions are ready, they are transferred from the Journals to the General Ledger system.

Transferring the transactions from the journals to the General Ledger accounts is called posting. Posting transactions to a General Ledger means that similar transactions will be grouped and summarised in the same location. Managers use the information from the General Ledger for creating financial reports and making decisions based on the company’s recorded activity. Data from the General Ledger is also used for preparing a Balance Sheet and Income Statement. Usually, companies have a computerised accounting system, and the posting process does not take a lot of time. As a rule, posting is done daily; however, it can depend on the quantity and type of transactions they make.

Take a look at this video by Brandy to help understand how to enter journal entries into the General Ledger.

Remember that a General Ledger system is referred to as a double-entry system that links at least two accounts. A double-entry system means the number of transactions that appear on the debit (left) and credit (right) sides should be in balance.

General Ledger consists of the charts of accounts and typically has the following data:

  • Accounting code
  • Description
  • Balance of an account
  • Transaction currency

After posting all the journal entries, the accountant will prepare the final general ledger accounts to reflect gross and net profits for the reporting period.

These are the following groups of accounts in the Charts of accounts of a General Ledger. Review each of them by selecting the (+) on the right.:

The assets account is an active account, and all assets that the company owns are recorded there. This includes cash, investments, inventories, liquid funds, buildings, machinery, intangibles, etc. Such items as inventories are represented in the current asset account, while buildings and machinery held by the company are recorded in the long-term asset account. Accounts receivable is also an asset account. Assets accounts increase on debit and decrease on credit and would usually have a positive debit balance.

The Liability account has a credit balance and is used to reflect money that company owes to its creditors (investors, suppliers, banks and other financial institutions). These may be credits, bonds payable, obligations, etc. Liabilities are also recorded in the Accounts Payable.

The equity account represents sources of assets contributed by the company's owners. As well as the liabilities account, it has a credit balance and is a part of the Balance Sheet. Assets, Liability and Equity accounts are parts of the financial equation, where Equity is Assets minus Liabilities.

The Revenue account is money earned by the company when it sells goods or services. This is a passive account with a credit balance. Revenue earned during the company's normal activity is called operational revenue, while non-operative revenues represent other money inflow such as interest payments, dividends, rent payments, etc.

The Expenses account records the costs of goods produced and services consumed during the accounting period. Depending on the production process, they may be direct or indirect. Examples of expenses may be public utilities, salaries and wages, administration expenses, rent expenses, depreciation costs, costs of goods sold, marketing and advertisement expenses, etc. The increase of expenses reflects on the debit side and decreases on the credit side.

The company calculates the profit or loss to show the results of its activity at the end of the accounting period.

To calculate profit, the accountant uses two sources of data: the earned revenue and expenses for this period. The difference between a company’s total revenue and total expenses is referred to as net profit or net income. If the result of this equation is negative, then the company lost money in this period.

Total revenue – total expenses = net profit/income

At the end of the accounting period, as part of this process, the revenue and expenses accounts are closed so the balance will be zero at the beginning of the new accounting period. This is because revenue and expense accounts are temporary and hold a balance for only one accounting period. In contrast, an assets account holds a balance for more than one period and transfers the final balance to the beginning of a new accounting period. To achieve this, it is necessary to transfer summarised amounts from the revenue and expenses accounts to a new account called the Profit and Loss account. In the accounting ledger, it will appear as follows:

Transfer summarised amounts for the revenue and expense accounts to the Profit and Loss account $450,000

  Debit Credit
Revenues $450,000  
Income summary   $450,000

According to GAAP, a company’s gross profit is the difference between revenues from sales and the cost of goods sold (COGS).  Cost of sales are the direct costs such as raw materials, direct labour costs of producing goods and services, etc.

Net profit is the amount left after subtracting from the gross profit indirect costs such as administrative costs, financial costs, depreciation costs and other expenses that cannot be directly related to the production of goods and services, such as interest and taxes. All these items are shown in the Profit and Loss Statement of the company and are retrieved from summarised general ledger accounts.

The accountant will credit all expense accounts by their balance to make them zero. The records will be as follows:

  Debit Credit
Wage expenses $100,000  
Expenses   $100,000

 

  Debit Credit
Public utilities expenses $10,000  
Expenses   $10,000
  Debit Credit
Marketing and advertisement expenses $80,000  
Expenses   $80,000
  Debit Credit
Other Expenses $100,000  
Expenses   $100,000

Then, to reach the total amount of expenses, it is necessary to add them together and debit the result to the Income Summary account. If the Income Summary account balance is on the credit side, then a company has ‘net profit’ for the period. That is, all records on the credit side of the account were items that increased net profit and the records on the debit side of the account were items that decreased net profit. If the balance in the Income Summary account is on the debit side, then the company has a ‘net loss’ in this period.

The record is as follows:

  Debit Credit
Total expenses $290,000  
Income summary   $450,000
Balance (Profit)   $160,000

After the balance of the Income Summary account is found, the accountant makes its closing entries because the income summary account has a balance equal to the company's net profit for the particular accounting period. Balance from the income summary account is then transferred to the retained earnings account.

The record is as follows:

  Debit Credit
Income summary $160,000  
Retained earnings   $160,000

If a company pays dividends, the next record is reducing net profit for the dividends paid. The record is the following:

  Debit Credit
Retained earnings $50,000  
Dividend Account   $50,000

Please complete these three questions before moving on to the activity in preparation for your upcoming assessments.

Scenario

Indy’s Ice-creams commenced trading on 1 May 2022. On 31 May, an extract from Indy’s Ice-creams trial balance showed the following balances for selected accounts.

A cup of ice cream from Indy's Ice cream
Indy's Ice-creams Trial Balance (Extract)
Account Number Account name Balance
1100 Prepaid Insurance 4,800.00
1200 Equipment 28,000.00
2000 Bank Loan 30,000.00
2100 Sales Revenue Received in Advance 4,200.00
3000 Sales Revenue 1,800.00

An analysis of data pertaining to Indy’s Ice-creams accounts revealed the following:

  1. Prepaid Insurance included the cost of a two-year insurance policy commencing 1 May 2022.
  2. Depreciation on Indy’s equipment is $500.00 per month.
  3. Indy took out a loan on 1 May for a period of 6 months at an annual interest rate of 10%.
  4. Three clients paid for Indy’s Ice-creams to attend functions and serve ice cream to guests in May. These services were provided in June.
  5. In May, Indy also attended four birthday parties. He charges $300.00 for this service and has not yet invoiced these clients.

Task

As the bookkeeper for Indy's Ice-creams, prepare the five adjusting general journal entries for June 2022 on a spreadsheet.

Check your work, and share your thoughts

After you have worked on your own journal entries, compare it against ours by selecting the (+) on the right.

Date Account Name (narration) Debit Credit
31 May 2022 Insurance expense 200.00  
  Prepaid insurance   200.00
To record expired insurance: $4800 / 24 = $200
 
31 May 2022 Depreciation 500.00  
  Accumulated depreciation equipment   500.00
To record monthly depreciation
 
31 May 2022 Interest expense 250.00  
  Interest payable   250.00
To accrue interest on loan: $30,000 x 10% x 1/12 = $250.00
 
31 May 2022 Sales revenue received in advance 4,200.00  
  Sales revenue   4,200.00
To record revenue received in advance
 
31 May 2022 Accounts receivable 1,200.00  
  Sales revenue   1,200.00
To accrue revenue earned but not yet invoiced or collected: 4 x $300.00 = $1,200.00
 
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A person getting ready to write a final general ledger
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