The Nominal Ledger is the backbone of all accounting systems. It is the framework around which all the other parts of the accounting system hang. All transactions entered into your accounting system will affect the Nominal Ledger in one way or another. When a book-keeper runs a Trial Balance so that the accountant can start to prepare the year end accounts, it is basically just a list of all the individual accounts within the Nominal Ledger and the balance outstanding on each one.
All modern accounting systems work by a process known as double-entry book-keeping. This has been around for over 500 years now and the process is still essentially the same as it was when first codified in a book written by an Italian monk named Luca Paciola in the year 1494. Basically, every transaction in an accounting system is entered twice - as both a debit and a credit. One account is debited and simultaneously another account is credited. For example, when a sales invoice is issued you will debit the Sales Ledger control account and credit Turnover. When that invoiced is paid, you will credit the Sales Ledger control account and debit the Cash Book. Therefore, the total value of debits in the accounting system will at all times equal the total value of credits. That is why a Trial Balance always adds up to zero (or should do).
It is important to note that the Sales Ledger, Purchase Ledger and all other parts of the accounting system are merely sub-sets of the Nominal Ledger. For example, the whole Sales Ledger will be shown as just one line on a Trial Balance - the Sales Ledger control account. This will go into your accounts as trade debtors. Likewise, the entire Cash Book will be shown as just one line for the bank account it represents.
The Nominal Ledger should be structured in such a way as to meet your specific accounting requirements. This will normally depend on the type of business you run. For example, a manufacturing company will need a sufficient level of detail in its Nominal Ledger to identify raw material costs and stocks for individual products. On the other hand, a service company will have no need for these lines but may require a greater level of detail for certain types of overheads. For this reason, it is better for the Nominal Ledger to be designed by your management accountant rather than your book-keeper. Although new accounts can be added later, the overall structure should be decided at the outset.
Similar accounts need to be grouped together in a Nominal Ledger so reporting is easier. All Nominal Ledger accounts are given a code, and this code should follow a logical sequence. For example, personnel costs could be allocated codes beginning with P whilst office costs could be prefixed O. That will enable you to run reports or download data to your management accounts grouping relevant items together.
The basic split in any Nominal Ledger is between balance sheet accounts and P&L accounts. It should be immediately apparent from the code which of these 2 types an account is. This may well be indicated by the very first digit in the code, or by the number of digits in the code. For balance sheet lines, you will need to separately identify fixed assets, stock, debtors, creditors, bank accounts, provisions, capital, etc. Again, there will be similar codes for each type of account. You may then want to split fixed assets, stock, debtors or creditors into different groups by refining the account code still further.
For P&L lines, the codes will depend on how you want to present your management accounts. Manufacturing companies will need to identify the various components for Cost of Goods Sold. This will normally include raw materials, wages for production workers, depreciation on plant and machinery, site costs for the factory, energy costs, etc. For a retail company, Cost of Sales will be a more relevant item, with a separate line for the purchase cost of each product or product group. Service companies may want to differentiate between direct costs relating to specific customers and general overheads. They may also need to differentiate between recoverable costs that will be re-charged to customers and similar types of cost that are borne by the company.
The whole coding structure is known as the Chart of Accounts. From this a book-keeper will know a) which account codes are available, and b) which codes should be assigned to particular invoices. It will also enable the book-keeper to set up new nominal codes in the correct format. Most software packages allow management accounts to be automatically generated from the Nominal Ledger by linking the Chart of Accounts to the main headings. For example, a range of account codes can be assigned to a particular line in the accounts, such as IT costs or stock. Each account code must be assigned to a specific line in the accounts so that no transactions are missed. It should also be possible to phase the accounts monthly or quarterly by reference to the transaction date.
Cost centres are another useful feature of the Nominal Ledger and are included in most software packages. These allow you to analyse costs and revenues between departments, clients, products, branches, partners, etc. You can even use multiple cost centres to allow analysis by any combination you choose. Of course, this increases the workload because not only do you need to post invoices to account codes but also to one or more cost centres, and sometimes this may require a highly detailed analysis of the expenses incurred. Common costs applicable to the organisation as a whole such as rent or insurance are usually therefore allocated globally rather than at individual transaction level. This may be done according to standard criteria such as floorspace or headcount, whichever is most relevant to that particular expense.
Most transactions in the Nominal Ledger are generated through the Sales Ledger, Purchase Ledger or Cash Book from individual documents such as invoices or bank statements. In a computerised accounting system the fixed part of the double-entry for these transactions is pre-set and cannot be over-ridden. For example, an invoice posted to a supplier account will automatically be credited to the Purchase Ledger control account. However, certain transactions must be generated by Journals, where the account codes to be debited and credited must be selected manually by the book-keeper. Common examples include accruals and prepayments, depreciation and bad debts. Most software packages allow you to set up Standing Journals, which are very useful if you need to run the journal regularly and the account codes to be posted are much the same each time. All you need to do then is change the amounts and the transaction dates.
Journals are also required for correcting errors, such as items posted to the wrong accounts. However, most software packages will allow you to correct errors without journals by looking up the transaction in the audit trail and either deleting it or changing the details. Every transaction in a computerised accounting system is automatically given a reference number by the system and these are listed sequentially in a log. Any such transactions that are subsequently deleted or amended will not disappear from the system completely but will be shown as "dead" items which no longer affect the balance in the ledger. Amendments made in this way will be generated automatically as new transactions.
It is useful to assign sequential reference numbers to your journals so they can be checked and reviewed more easily and also to look up any supporting documents or calculations that may have been used as back-up. It is surprising how often this turns out to be necessary, particularly when the auditors are in! However, this does not mean you need to write out or print hard copies of journals. The days when book-keepers would laboriously hand-write journals and file them in heavy folders are thankfully over. It is more than sufficient to keep a brief record of journals on a spreadsheet or Word document, and the same goes for the back-up.
Finally, your accounts system should allow you to interrogate your Nominal Ledger by drilling down into account codes at individual transaction levels. This is important when you need to find out why the balance on a particular account has gone up so much, or to produce audit schedules. It is also good practice to cross-reference the transactions in your Nominal Ledger to their source documents by logging internal and external identifiers such as invoice numbers.