The accounting cycle is the process performed during the accounting period to analyze, record, classify, summarize and report financial information.
The workflow for accountants is often considered to be cyclical in that it follows a cycle which includes entering transactions, adjusting entries as necessary, closing the books at the end of the accounting period.
The basic steps in the accounting cycle are detailed as follows:
Transactions can include the sale of a product, purchase of supplies for business activities, or any other financial activity that involves the exchange of assets, the establishment or payoff of a debt, or deposit from or payout of money to the company’s owners.
– Account Entries –
Accountants often use a system called the “double entry” or “dual entry” system where T-accounts are used to document any movements.
2. Journal entries
The transactions is listed in the appropriate journal in chronological order.
The transactions are posted to the general ledger into the accounts that they impact. The ledger is a summary of all the business’s accounts. The posting of journal entries can be done at the time the transaction is journalized; at the end of the day, week, or month, or as each journal page is filled.
4. Trial balance
At the end of the accounting period (typically a month, quarter or year) a trial balance is calculated. The trial balance proves that the company’s General Ledger is in balance, ensuring that the debits equal the credits.
5. Completion of adjusting entries
If the accounts do not balance, the accountant must look for errors and make corrections known as adjustments.
For accounting purposes, adjusting entries are journal entries made at the end of an accounting period. Adjusting entries allocate income and/or expenses to the period in which they actually occurred. The revenue recognition principle states that income and expenses must match. This is why adjusting entries need to be made under an accrual based accounting system. Based on this, revenues and associated costs are recognized in the same accounting period. However, the actual cash may be received or paid at a different time. These adjustments are tracked on a worksheet.
6. Preparation of adjusted trial balance and financial statements
Accountants then prepare the balance sheet and income statement using the corrected account balances.
The process of preparing the financial statements begins with the adjusted trial balance, which requires “closing” the book and making the necessary adjusting entries to align the financial records with the true financial activity of the business. The process of preparing the financial statements begins with the adjusted trial balance. Preparing the adjusted trial balance requires “closing” the book and making the necessary adjusting entries to align the financial records with the true financial activity of the business.
7. Closing the books
The books are closed for the revenue and expense accounts and the entire cycle begins again with zero balances in those accounts.
There are basic steps to closing the books:
– Closing the revenue accounts, transferring the balances in the revenue accounts to a clearing account called income summary.
– Closing the expense accounts, transferring the balances in the expense accounts to the income summary account.
– Closing the income summary account, transferring the balance of the income summary account to the retained earnings account (also known as the capital account).
– Closing the dividends account, transferring the balance of the dividends account to the retained earnings account.
This period’s ending balance in the retained earnings account will be the beginning balance for the next period’s account.