General Ledger in Accounting: A Guide

For most businesses of any substantial size, the general ledger acts as the backbone of the company’s accounting system. This is certainly true for legal practices, which rely on general ledger accounting to perform essential requirements specific to the legal industry. Accordingly, law firms must be able to maintain their general ledgers and perform all the accounting functions that go along with them.

This guide will cover the basics of general ledgers in accounting. While most of these basics are applicable to any business, we also cover special considerations for law firms.

The general ledger makes it possible to manage a company’s finances. It is used to track revenue and expenses, as well as provide the status of the company’s financial health. The general ledger is also essential to generate all of the company’s financial reports and statements, in addition to tax compliance.

General ledgers are divided into different accounts, each of which represents a different type of transaction. They are usually listed in a chart of accounts and fall into one of the following five categories: 

1. Assets. This category includes anything of value owned by the business, including cash, accounts receivable, inventory, property, and intellectual property.
2. Liabilities. Any current or future financial debts of the company, including loans, accounts payable, lines of credit, and employee payroll.
3. Equity. The difference between the total value of the company’s assets and the company’s total liabilities, representing the portion of the business’ assets owned by the sole owner, partners, or shareholders.
4. Revenue. Revenue is the income generated by the business, whether through the sale of goods or services, interest income, or investment dividends.
5. Expenses. All the company’s operating costs, such as rent, utilities, and employee salaries.

As businesses grow in complexity and scale, they usually add subsidiary ledgers (subledgers) to their accounting systems. Each subledger is focused on one of the general ledger accounts, such as accounts payable or accounts receivable. Transactions are listed in both the appropriate subledgers and the general ledger. Subledger accounting allows for more accuracy, organization, and audit readiness within a company’s accounting system.

How Does a General Ledger Work? 

General ledger accounting depends on double-entry bookkeeping. Each financial transaction recorded in the general ledger must include at least two entries, one for a credit to one subledger account and another for a debit to a different subledger account. The total amounts of credits and debits for each transaction must be equal. This double-entry method ensures the general ledger is always in balance.

The foundation of double-entry bookkeeping is what is commonly known as the “accounting equation”:

Assets = Liabilities + Equity

As an example, imagine a legal client pays the firm $50,000 toward its balance owed on legal fees. For this transaction, $50,000 would be debited to the firm’s cash account, while $50,000 would be credited to the firm’s accounts receivable. The accounting equation still holds here, since both cash and accounts receivable are assets, and the total amount of assets remains the same.

Accounting software can streamline the entire process of general ledger management. The software can automate the entry of transactions into both the general ledger and subledgers, as well as allow a business to create a customized chart of accounts. In addition, accounting software can quickly generate the financial statements and reports that are based on the general ledger.

Analyzing and Reporting with a General Ledger 

General ledgers are critical for financial analysis and reporting since they are the data sources used to generate statements and reports. The most critical financial reports for a company are the following:

• Balance sheet. This provides an overview of the company’s assets, liabilities, and equity at the current moment.
• Income statement. Provides an overview of a company’s revenues, expenses, net income, and profits for a given range of time, such as a quarter or year.
• Cash flow statement. Reports the company’s cash flow for various activities.

Beyond these essential documents, the general ledger is used to create a host of financial statements for the company, such as the annual report. These statements are audited by government agencies and accountants to ensure accuracy for the purposes of taxes, regulatory requirements, financing, and investment. Accordingly, no company of any substantial size can afford to go without robust financial reporting.

Financial statements are also critical for budgeting and forecasting. They show how the company generates revenues and incurs expenses. They provide an updated view of the company’s assets and liabilities, as well as how efficiently it manages cash. It would be difficult, to impossible, to identify any meaningful trends and patterns, much less prepare for the future, without the financial reporting enabled by general ledger accounting.

Common Mistakes in General Ledger Accounting 

Despite the many advantages of general ledger accounting, mistakes can happen in the process. It is critical to recognize the potential for these errors and guard against them. The following are some of the most common mistakes in this area.

Basic Errors in Journal Entries

Each entry into the general ledger for a single transaction is known as a journal entry. Basic human error can easily find its way into these entries when done manually. A transposed number or misplaced decimal can wreak havoc with accounting accuracy.

Other potential errors include making duplicate entries for one transaction, or neglecting to make an entry at all, known as an error of omission. A credit can also mistakenly be recorded as a debit and vice versa. 

What makes these inaccuracies even harder to catch is the potential for compensating errors. These are errors that unintentionally offset each other, masking the underlying mistake. For example, a mistake resulting in an understatement of $1,000 in accounts payable could be offset by another mistake resulting in a $1,000 overstatement in revenues. Since the company’s balance sheet is still accurate, the two compensating errors could easily be missed altogether.

Misclassifying Transactions

Another common mistake in general ledger accounting is the misclassification of transactions. A fixed asset purchase that was mistakenly posted under operating expenses would be an example of this. These are known as errors of principle, since they result from failing to correctly apply accounting principles. Misclassified transactions can be especially difficult to detect, as debits and credits will typically still remain in balance even with these mistakes.

Overlooking Reconciliation of Accounts

With the nature of the potential mistakes outlined above, there can be no doubt that reconciliation of accounts is an absolute must. The reconciliation process in accounting refers to the comparison of multiple sets of financial records to ensure their accuracy and consistency. A company will generally use external records for reconciliation purposes, such as bank statements and credit card statements, and compare them to their internal records.

Reconciliation is the most comprehensive method of catching the errors and misclassifications that are possible when recording transactions in the general ledger. It will help a company resolve discrepancies, prevent fraud, and avoid issues with regulatory and tax compliance. 

Law firms have an especially heightened interest in this area due to their use of trust accounts. Legal practices often hold client funds in trust accounts, such as for retainer fee payments or settlement funds. Most U.S. jurisdictions have bar rules governing maintenance and reconciliation of client trust accounts. Due to the stringent requirements and general importance of trust accounts, many law firms may opt for a three-way trust reconciliation, where internal records, bank statements, and client records are all reviewed and reconciled.

Failure to Regularly Review and Update the General Ledger

A company should also regularly review and update its general ledger, even when that process does not rise to the level of a reconciliation. Accounting software can be a game-changer in this regard since it can streamline the process so general ledger reviews can be performed frequently.

General ledger best practices for law firms

Law firms should first be sure to follow the general ledger best practices applicable to all companies. As outlined above, this means implementing regular account reconciliations and more frequent reviews of the general ledger. The practice of law is sufficiently demanding that it is easy to lose focus on financial matters, but general ledger accounting with sufficient safeguards should allow even the smallest firms to handle this task.

A legal practice should also be sure to implement the right internal controls for document retention and recordkeeping. These controls must be in place for legal matters, so be sure controls are implemented for the accounting department as well.

Using the right accounting technology is also imperative for law firms. Accounting tools can automate many of these processes and ensure accuracy, helping you to record and track transactions and perform reconciliations in a streamlined way.

Final thoughts on general ledgers

General ledger accounting is essential for modern businesses, and law firms are no exception. While the accounting requirements may seem daunting, they are truly the best way to ensure the financial health of any company. Accordingly, ensure that your firm’s general ledger accounting meets the appropriate standards, and that you are leveraging legal and accounting technology to the fullest. Check out our guide on managing trust accounting to learn more.

We published this blog post in January 2024. Last updated: March 18, 2024.

Categorized in: Accounting