General Ledger and General Journal
An accounting system is a way of keeping track and telling the story of economic events that occurred to an individual or an organization. Accountants use the double-entry accounting system as part of the system to keep track of events. The creation of financial statements begins with transactions as the starting point of an accounting system, and the financial statements are the end. Transactions will be recorded in the accounting books of a person or organization. Even though they are databases today, think of an accounting book as a book with many pages. Each page is for a separate account. The book with the accounts on separate pages for each account is called the general ledger. The general journal is a book or database where economic events are recorded. A transaction entry in the general journal, called a journal entry, is made using double-entry accounting. Finally, these are all the pieces needed to create financial reports. This is a basic accounting system.
Jim has earned $299 in wages. To create an entry for his wages earned, he needs a debit and a credit. Jim recorded his wages earned as credits. To make his entries balance, he needs a debit, likely to cash.
Wages Earned Log
| Date | Description | Debit | Credit |
|---|---|---|---|
| 2018-04-18 | Worked 5 hours for Bob @ $20/hr | $100.00 | |
| 2018-04-19 | Worked 8 hours at store @ $14.5/hr | $116.00 | |
| 2018-04-20 | Worked 4 hours at store @ $14.5/hr | $58.00 | |
| 2018-04-20 | Mowed lawn for Mr. Simpson | $25.00 | |
| Wages for week | $299.00 |
Cash Paid for Wages Earned Log
| Date | Description | Debit | Credit |
|---|---|---|---|
| 2018-04-18 | Worked 5 hours for Bob @ $20/hr | $100.00 | 2018-04-19 | Worked 8 hours at store @ $14.5/hr | $116.00 |
| 2018-04-20 | Worked 4 hours at store @ $14.5/hr | $58.00 | |
| 2018-04-20 | Mowed lawn for Mr. Simpson | $25.00 | |
| Wages for week | $299.00 |
Chart of Accounts
The chart of accounts is a list of all accounts including assets, liabilities, revenues, expenses, and equity, as a means of keeping track in the general ledger. To set up the pages of the general ledger, some educated guesses will need to be made in order to determine what groupings of economic events need to be tracked. For example, a company that will make improved mousetraps will need to create a series of accounts. All businesses have cash, so that account should be created. Hopefully, the company sells some mousetraps, so the sales account would be required. The company would also need an account to track the mousetraps, so the inventory account would be necessary. Some of the sales will be on credit, so the business would need to track how much money to collect. This account is called receivables.
The following is an example of the accounts to consider:
- Cash
- Sales
- Cost of goods sold
- Inventory
- Receivables
- Common stock
- Bank loan
- Interest expenses
- Bank charges
- Land
- Buildings
- Machinery
- Marketing expenses
- Salary expenses
- Benefits expenses
- Administration expenses
- Accounts payable
- Tax expenses
- Taxes payable
A common form of business is the corporation, and ownership of a corporation is through shares or common stock. An account is needed for that. There may be a bank loan on which to pay interest, which means there will be bank charges to pay on the bank account. The bank loan will be put into the cash account to buy land, buildings, and machinery to make mousetraps.
To sell the mousetraps, money will be spent on marketing. Employees will be paid a salary and may be provided with health benefits, as well. There will be other administrative expenses, and not all expenses may be paid in cash. Especially if granting credit to customers, it makes sense for the company to buy from its suppliers on account, so the amount due to each supplier will be listed. Those are called accounts payable.
Of course there will also be taxes. It will be necessary to keep track of tax expenses and how much tax is still payable. As a business grows and new things need to be tracked, new accounts can be added. However, a business should not have too many accounts. Having too many accounts makes it harder to see the big picture and also tends to take a lot of time to maintain.
There is one more step to take to finish generating a journal entry, and that is to decide whether a normal entry to an account will be a debit or a credit. To do this, cash is the starting point. An addition of cash is a debit.
The initial source of cash was issuing common stock, so to make the double entry work, if cash is a debit, then common stock would be a credit. This can be visualized by using T accounts. Entries to common stock must normally be credits.Cash and Common Stock T Account Example
Cash T Account Example
Sales T Account Example
Receivables T Account Example
Grouping Accounts
There are different ways to classify and number general ledger accounts. For example, numbers can be grouped to represent assets or similar expense codes such as operating assets. Accounts should be grouped into useful classifications, making it easier to identify account codes and what type of account they are (asset, liability, expense, equity, etc.). Some accounts are normally credits, and some are normally debits, which is one way to group accounts. Also, cash is there until it is spent and payables are there until they are paid. Once the goods have been transferred to the buyer, the basic sales process is complete. Another way to group accounts may be by longevity. For example, assets are grouped by how long they will be used. Assets used for only a short time are called current assets. Assets that will be used for a long period are called noncurrent assets. Liabilities are also grouped by longevity based on when they must be paid. Liabilities that must be paid soon are called current liabilities. Liabilities that don't need to be repaid soon are called noncurrent liabilities.
It makes sense to reorder accounts to match financial reports, making it easier to create those reports later. The balance sheet represents the value, ownership, and obligations of a company. Within the balance sheet, accountants group accounts that are normally debits together as assets. Accounts that are normally credits are grouped as either liabilities or as equity if the accounts record ownership interests. A liability is an obligation or amount owed to another individual or entity as a result of a past transaction, such as a sale or loan.
The income statement represents the operations of a period that then add to or subtract from the earnings of the company. The income statement is split between sales (also called revenues) and costs (also called expenses). Revenue is money or resources received or expected to be received by the company in exchange for goods or services rendered. An expense is the cost of buying materials, paying employees, or any other type or purchase in order to generate revenue. In short, expenses are the cost of doing business.
Chart of Accounts Part 1
| Better Mousetraps Corporation: Basic Chart of Accounts | |||||
|---|---|---|---|---|---|
| Balance Sheet of Accounts | Assets | Current Assets | Cash | Debit | |
| Receivables | Debit | ||||
| Inventory | Debit | ||||
| Long Term Assets | Land | Debit | |||
| Buildings | Debit | ||||
| Machinery | Debit | ||||
| Liabilities | Current | Accounts payable | Credit | ||
| Taxes payable | Credit | ||||
| Long Term | Bank loan | Credit | |||
| Equity | Common stock | Credit | |||
Chart of Accounts Part 2
| Income Statement Accounts | Revenue | Sales | Credit | ||
| Expenses | Product | Cost of goods sold | Debit | ||
| Operating | Salaries | Debit | |||
| Benefits | Debit | ||||
| Marketing expenses | Debit | ||||
| Administration expenses | Debit | ||||
| Finance | Interest expense | Debit | |||
| Bank charges | Debit | ||||
| Tax | Tax expense | Debit | |||
Account Types and Ranges
Remember: the structure of the accounts supports the accounting equation: Assets = Liabilities + Equity.