15
Oct,24
The Accounting Cycle: A Step-by-Step Guide
The accounting cycle refers to the step-by-step procedure of recording, classifying, and summarizing an organization's financial transactions. It is therefore a guarantee that the financial information is presented accurately, consistently, and in a useful manner for decision-making. It is quite important for a businessperson to understand what the entire accounting cycle consists of.
An accounting cycle begins with the preparation of source documents, which provide proof that a transaction has occurred. Examples of source documents include invoices, receipts, cheques, and bank statements.
Step 2: Journal Entries
The journal entries mark the initialization of recording the transactions. They are recorded in a journal, which is a chronological record of all the transactions. Journal entries then include things like the date, account titles, debits-increase in assets or decrease in liabilities and equity-and credits, which are decreases in assets or increases in liabilities and equity.
Step 3: Posting to the General Ledger
After making journal entries, it posts the information to the general ledger. A general ledger is a book of accounts or similar record that organizes all transactions by account type. Each account has a debit and credit side.
Step 4: Trial Balance
A trial balance is simply a list of all the general ledger accounts and their respective balances. This is used to ensure that the total of all debits amount to the total of all credits. If this does not balance then an error has been made in entering a transaction.
Step 5: Adjusting Entries
Adjusting entries are executed at the end of an accounting period to ensure that revenues and expenses are recognized in the appropriate period. Examples of adjusting entries include recording depreciation, accrued interest, and prepayments.
Step 6 Adjusted Trial Balance
After adjusting entries are made, a trial balance is prepared. A new adjusted trial balance reflects the effects of the adjusting entries.
Step 7: Financial Statements
The financial statements are the end products of the accounting cycle. They summarize the performance and situation of a company in monetary terms. There are three financial statements.
• Income Statement: This account provides information about the revenues, expenses incurred, and net income/loss generated by the company in a specific period.
• Balance Sheet: It is a representation of the financial status of a company regarding assets, liabilities, and equity at any single point in time.
• Statement of Cash Flows: This statement shows the inflow and outflow of cash that an entity generates during a period.
Step 8: Closing Entries
Closing entries are prepared at the end of the accounting period, and it transfers the temporary accounts-revenue, expense, and dividend accounts to Retained Earnings. This prepares the accounts for the following accounting period.
Step 9: Post-Closing Trial Balance
A post-closing trial balance is prepared to ensure that all the temporary accounts have been closed and the total of debits will equal the total of credits.
Importance of the Accounting Cycle
Accounting cycle ensures accuracy and uniformity in financial information. Financial statements provide information to stakeholders on appropriate decisions regarding an organization's profitability, solvency, and liquidity. Businesses have to comply with various accounting standards and regulations, and the accounting cycle aids in ensuring that compliance is achieved. Good financial reporting creates investor confidence and calls in more capital. If a business enterprise follows the steps of an accounting cycle, it will be able to keep accurate records concerning finance and make suitable decisions based on those records.
The accounting cycle, therefore, is an indispensable procedure for any business organization, whether large, medium, or small. The accounting cycle thus lays a foundation for reporting and analysis of finance, allowing businesses to achieve their goals in regard to finances.
An accounting cycle begins with the preparation of source documents, which provide proof that a transaction has occurred. Examples of source documents include invoices, receipts, cheques, and bank statements.
Step 2: Journal Entries
The journal entries mark the initialization of recording the transactions. They are recorded in a journal, which is a chronological record of all the transactions. Journal entries then include things like the date, account titles, debits-increase in assets or decrease in liabilities and equity-and credits, which are decreases in assets or increases in liabilities and equity.
Step 3: Posting to the General Ledger
After making journal entries, it posts the information to the general ledger. A general ledger is a book of accounts or similar record that organizes all transactions by account type. Each account has a debit and credit side.
Step 4: Trial Balance
A trial balance is simply a list of all the general ledger accounts and their respective balances. This is used to ensure that the total of all debits amount to the total of all credits. If this does not balance then an error has been made in entering a transaction.
Step 5: Adjusting Entries
Adjusting entries are executed at the end of an accounting period to ensure that revenues and expenses are recognized in the appropriate period. Examples of adjusting entries include recording depreciation, accrued interest, and prepayments.
Step 6 Adjusted Trial Balance
After adjusting entries are made, a trial balance is prepared. A new adjusted trial balance reflects the effects of the adjusting entries.
Step 7: Financial Statements
The financial statements are the end products of the accounting cycle. They summarize the performance and situation of a company in monetary terms. There are three financial statements.
• Income Statement: This account provides information about the revenues, expenses incurred, and net income/loss generated by the company in a specific period.
• Balance Sheet: It is a representation of the financial status of a company regarding assets, liabilities, and equity at any single point in time.
• Statement of Cash Flows: This statement shows the inflow and outflow of cash that an entity generates during a period.
Step 8: Closing Entries
Closing entries are prepared at the end of the accounting period, and it transfers the temporary accounts-revenue, expense, and dividend accounts to Retained Earnings. This prepares the accounts for the following accounting period.
Step 9: Post-Closing Trial Balance
A post-closing trial balance is prepared to ensure that all the temporary accounts have been closed and the total of debits will equal the total of credits.
Importance of the Accounting Cycle
Accounting cycle ensures accuracy and uniformity in financial information. Financial statements provide information to stakeholders on appropriate decisions regarding an organization's profitability, solvency, and liquidity. Businesses have to comply with various accounting standards and regulations, and the accounting cycle aids in ensuring that compliance is achieved. Good financial reporting creates investor confidence and calls in more capital. If a business enterprise follows the steps of an accounting cycle, it will be able to keep accurate records concerning finance and make suitable decisions based on those records.
The accounting cycle, therefore, is an indispensable procedure for any business organization, whether large, medium, or small. The accounting cycle thus lays a foundation for reporting and analysis of finance, allowing businesses to achieve their goals in regard to finances.
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