Assets, Liabilities, Income And Expenses

This section is intended to give those of you not familiar with the operation of a general ledger some knowledge about its basic operation and function, as well as some explanation of commonly used accounting jargon. It is not intended to teach you double-entry book keeping. In fact, if you are not familiar with basic bookkeeping concepts, you should spend some time reading up on this subject before you attempt to set-up and use this program. A large number of good introductory texts are available from most book stores.

This section only touches on topics that directly relate to CAPITAL GL Controller. If you are already familiar with accounting concepts and procedures, especially general ledger programs, you can skip this section and move onto the next section.

Most students of accounting normally begin with general ledger concepts and expand their knowledge outward from there. Most small business people begin with maintaining a cash book, or lists of debtor and creditor invoices, and then only move towards general ledger concepts as their businesses grow and their reporting requirements need greater levels of control. The bigger a company becomes, the more complex its book keeping requirements, and the more likely it becomes that accounting mistakes occur. Hence the need for better controls as well as time saving automated procedures.

This section discusses the concept of a general ledger from a business person's perspective, rather than a student's of accounting.

What is a General Ledger?

The general ledger is where financial information from all aspects of your business is consolidated. There are good grounds for considering it to be the heart of your accounting system. There are many good arguments, as well, for avoiding the set-up and implementation of a general ledger. If you have some knowledge of accounting principles (even basic knowledge) and you are prepared to invest some effort into learning the operational aspects of an integrated accounting system, then you are likely to benefit from maintaining a general ledger.

At the heart of every general ledger is a table of entries that is typically referred to as the master file. This is a series of totals for each one of the general ledger's "sub-ledgers." The total amount that you owe to your suppliers, or the total amount that your customers owe you, would normally be represented as only a single account balance in the general ledger. The "total" outstanding. When you print an account balances report in CAPITAL, this total would match (if the system was run properly) the total in your general ledger. When you print a customer account balances report, however, or a cash book listing, etc., you have a lot of detailed information on each account that tells you how the total amount owed or owing was arrived at. These are "sub-ledger" details.

A general ledger is not concerned with this level of detail. It's primary focus is on the final balance. Obviously, this balance will change as each transaction is entered. An automated accounting system such as CAPITAL will update not only the sub-ledger (your customer entries, for example), but create special entries called "journals" that will also update the relevant general ledger master file account totals.

The word "ledger" refers to the days when transactions were stored in a series of special books called ledgers. The word "general" refers to the fact that information on all financial accounts are kept in this master file.

General Ledger Account Types

A general ledger holds four types of account: Assets, liabilities, income and expenses. Income and expenses are actually special types of asset and liability accounts. So in fact, there are really only two types of accounts managed by a general ledger (GL): accounts that tell you how much you are owed and accounts that tell you how much you owe. If you add up all your asset accounts and all your liability accounts, then subtract liabilities from assets, you have what is called net worth. Hopefully this adds up to a positive value.

Net worth is equal to another set of balances called total equity. Net worth refers to the total value (in accounting if not real-world market prices) of your business. Equity serves the purpose of describing how the funding of net worth was arrived at. This may be through shareholder or owner loans and investments, profits from trading, issued shares, and so on.

Assets

Liabilities

Current Liabilities

Retained Earnings

Income

Expenses

Calculating Profit

Retained earnings therefore can be expressed in what is referred to as a profit and loss statement. In CAPITAL Office you may have seen one form of this if you have printed a trading statement.

income and expense accounts are referred to as profit and loss accounts.

Another concept that is absolutely fundamental to the way in which CAPITAL operates, and the way most useful accounting systems operate, is the notion of the matching of costs and revenue. In order to print reports that tell you in a fair sense how you arrived at your net profit, you should allocate the sales and the overheads to the periods in which they actually occurred (i.e., The date of your invoice or the date you received the bill). This is different from the idea of recording a sale or an expense only when the cash came in or when you wrote a cheque to pay a bill.

You will notice that with the above example, there was no mention of the cash balances in your bank accounts, or of the total value of your stock, etc. The net profit was calculated without the need to refer to such accounts.

At this point it will be useful to emphasise that the value of your stock, or even your purchases of stock for the period is not relevant in determining your operating profit. If you purchase too much you may end up cash strapped but this is a cash or liquidity problem. Purchasing stock, from an accountant's perspective, is merely turning one type of asset, e.g.., Cash, into another, e.g., Inventory. Now it may be the case that you have made a very good deal and have purchased stock that you will be able to sell at a considerable mark-up. Alternatively you may purchase stock that ultimately proves unsaleable and that you will eventually have to write-off. The fact is, no one knows what will happen until a sale actually occurs or you decide to write-off the goods. At that point our asset will be either a source of revenue or an expense. Either way, we don't really know our gross or net profit until the asset is "converted".