The Accounting Cycle

Made simple for every business owner!

The accounting cycle refers to the 10 basic steps that set out the procedures required for any business to analyze, record and process and interpret its financial information.

The accounting cycle varies from business to business and the procedures involved may change and may even skip some steps of the cycle. 

An example is when the company is using an accounting software that helps them automate some of the steps in the accounting cycle. 

Also, different types of businesses may adopt a different accounting cycle just like a service business as compared to a manufacturing business. But, the general steps of the accounting cycle remain the same.

STEPS IN THE ACCOUNTING CYCLE

Step 1. Identify and analyze business transaction

Only transactions related to the operations of the business must be recorded. Personal transactions of the owners should not be included. 

After identifying these transactions, each needs to be analyzed to determine the accounts affected in the bookkeeping records of the business. Each of which must be supported by relevant documents. Example: All cash sales must be supported by sales receipts, purchases on account must be supported by purchase invoices, quotation and other documents related to the purchase transactions.

Watch here on how this is done!

Step 2. Journal Entries

The Journal, also referred to as a daybook and also known as the book of original entry, is where the journal entries of the business transactions are recorded and entered in the accounting system.

Step 3. Posting

The Journal entries are then posted to the subsidiary and general ledgers, also known as the book of final entry. Double-entry postings are observed and therefore all debit entries must equal all credit entries.

The General Ledger houses an account for each type of transaction. Examples are fixed assets, accounts payable control, accounts receivable control, utilities expense, etc.

The general ledger is divided into Nominal Ledger for income and expenses and Private ledger for Assets and Liabilities

Step 4. Preparation of the Unadjusted Trial Balance

A Trial Balance is a list of all the balances on the accounts of the general ledgers and is prepared at the end of each accounting period. Total debits must equal total credits.

Remember that the unadjusted Trial Balance is solely used to check the total debits and credits in order to know that the accounting records are balanced and the arithmetic is correct. If the trial balance is unbalanced, correcting entries must be made until it is balanced.

Step 5. Worksheet preparation

A worksheet is a 10 column accounting worksheet template, used as a worksheet to produce the income statements and balance sheet from the unadjusted trial balance. It features the columns for the unadjusted trial balance on the first two columns, followed by the adjusting entries, the adjusted trial balance, the income statement and the balance sheet.

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Step 6. Adjusting entries

Many businesses adopt the accrual-based accounting. This entails adjustments at the end of every accounting period to ensure that income and expenditures are allocated to the correct accounting period and are in compliance with the principles of revenue recognition, matching and time period assumption. These adjustments are made through adjusting journal entries.

Adjusting entries for accruals, prepayments, depreciation and write-offs are prepared so that income and expenditures are completed on the accrual basis and are in compliance with the generally accepted accounting principles.

The adjusting entries are entered on the next two columns of the worksheet but are not entered yet into the accounting records.

Step 7. Preparation of the Adjusted Trial Balance

An Adjusted trial balance is then prepared in the next two columns after all adjusting entries are completed.

Step 8. Preparation of the Financial Statements

From the adjusted trial balance, the Financial Statements can now be prepared. Nominal accounts or those that pertain to the income statements are transferred to the next two columns and the Real accounts or those pertaining to the balance sheet are transferred to the last two columns.

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Step 9. Closing Entries

Closing entries are journal entries to close the temporary accounts for the accounting period and transfer the balance to the retained earnings account.

A temporary account is an income statement account, dividend account or drawing account. It only lasts for the current accounting period. 

The closing Journal entries are made in the accounting ledgers, posted, and are closed to the income and expenditure summary account. The income and expenditure summary account is then closed to transfer the net income or loss for the period to the balance sheet.

The Balance sheet or permanent accounts are not closed and their balances are carried forward to the next accounting period.

Step 10. Post-closing Trial Balance

The post closing Trial Balance is a list of account balances after the closing entries are made. At this stage only the balance sheet accounts are listed here and the accounting cycle starts again with the new opening balances in the balance sheet.

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Now that you know the 10 general steps in the Accounting Cycle, which of these steps are you automating?

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