In accounting, a ledger is a place where transactions are recorded. Smaller businesses may still use paper ledger books. Larger businesses, however, typically need to use enterprise resource planning (ERP) software. The records held in ledgers provide the basis for preparing tax returns and (for limited companies) financial statements.
Examples of ledgers
The general ledger is the main repository for all financial transactions. For ease of management, however, general ledgers are usually subdivided into separate accounts. Each account will hold the transactions for a particular type of transaction.
Larger businesses with numerous transactions will often have accounts that reflect key categories in their financial statements, especially their profit-and-loss statement and their balance sheet.
The mechanics of ledgers
In traditional ledger books, pages are divided into two columns. Debit transactions are entered into the left-hand column, with credit transactions entered into the right-hand column. If the records are correct, the debit and credit transactions should always be equal. This is what it literally means to say that ‘the books are balanced’.
If companies still use paper ledger books then a bookkeeper or accountant must periodically check for errors. This is done by creating a trial balance. This is essentially a snapshot of a company’s accounts at a given point in time (similar to a balance sheet).
The credit entries and debit entries in the trial balance should be equal. If they are not, there is a problem with the accounts and hence the general ledger. It is, however, important to note that getting the trial balance correct does not guarantee that the general ledger is correct. This is one of the reasons why it’s important to double-check bookkeeping entries for errors.
Ledgers vs journals
An accounting journal contains the same information as a ledger but is presented in chronological order rather than by category. A company’s general journal is the everyday repository for transactional information.
Companies may also keep special journals that break out information related to specific transaction types. Special journals tend to be used for high-volume transaction types. This helps to stop the general journal from becoming overwhelmed.
As journals fulfil the same purpose as ledgers, physical books tend to be formatted the same way. They have two columns with debits being entered on the left and credits on the right. In some cases, however, companies will use single-entry bookkeeping in journals. This means each transaction will be recorded as either a debit or a credit, not both.
Single-entry bookkeeping is not as robust as double-entry bookkeeping. It is, however, simpler and therefore usually faster. This can make it a practical option for special journals which tend to fill up very quickly.
The importance of ledgers
There are two main reasons why ledgers are hugely important for businesses. The first is the law. Depending on a company’s business sector and structure, this can mean a lot more than just tax. For example, a company’s ledger records can be proof that it presented accurate information to shareholders or creditors.
The second is that details can often make a huge difference to decisions, especially when it comes to financial matters. High-level indicators such as ratios can be useful as a convenient way to make quick and relatively minor decisions. When it comes to important decisions, however, people often want to see a lot more detail. That’s where a company’s ledger comes in.
These two points are actually closely related. When information is summarised errors can be made (or fraud can come into play). Even if it isn’t, summaries, literally by definition, miss out a lot of detail, which can make them highly misleading. Being able to check the original ledger records is, therefore, an important safeguard.