What Is The Accounting Cycle? Definition, Steps & Example Guide (2024)
8 Min. Read
February 6, 2023
The accounting cycle is a crucial part of any business. Accounting is made up of all of the ways that a business’s money moves. It documents every transaction, making sure that things are accurate and kept track of. Without accounting, most businesses would be in poor financial health.
As such, as a small business owner, it’s important to understand the accounting cycle. All business transactions should be recorded using accounting. No business model should be without the financial accounting process. To gain a better understanding of the accounting of business activities, keep reading!
Here’s What We’ll Cover:
What Is the Accounting Cycle?
The 8 Steps of the Accounting Cycle
Key Takeaways
What Is the Accounting Cycle?
The accounting cycle involves all of the financial transactions for a business. It refers to recording these transactions, as well as processing them. This includes when a financial transaction occurs, all the way to the creation of financial statements. If it has anything to do with bookkeeping tasks, it’s part of the accounting cycle. From time to time, you may hear it referred to as the bookkeeping cycle.
How Timing Relates to the Accounting Cycle
Accounting happens over a specific period of time. This period of time is often referred to as the accounting period. An accounting period is the time period that financial statements refer to. As such, the passage of time is important to accounting. You have to make sure that all transactions are recorded in a timely manner so that they can be reported.
There are several different amounts of time that a company may choose to report on. Some have a monthly accounting period, while others only report on an annual basis. The accounting cycle periods a business chooses tend to reflect the size of the company. Larger companies can report more frequently. Additionally, many companies have to report on their financial statements due to regulations.
There are 8 major steps involved in the accounting cycle. Each one of them relates to an accounting transaction that has taken place. We’re going to go over all of the steps and provide examples of what each step would look like.
Step 1: Identify Transactions
The first step in the cycle is to identify transactions. Most businesses are going to have numerous transactions each accounting period. It is important that these transactions are identified as they occur. While this used to be done manually, accounting software now makes this task easy. What was once difficult to stay on top of is now easy for anyone to manage.
The identification of transactions is, arguably, the most important step in the process. If transactions aren’t identified, then accounts cannot be made. This can impact a business’s financial statements and financial position. If financial activity goes unidentified, it cannot be reviewed or monitored by the business.
An example of identifying transactions would start with point-of-sale software. Many of these software options automatically identify a transaction. They then communicate it to accounting software.
Step 2: Record Transactions
After transactions have been identified, they have to be recorded. If a transaction is identified but it isn’t recorded, then it’s like it never happened at all. Transactions are recorded in a journal. Each transaction gets its own journal entry.
This is the point in the cycle where the method of accounting has to be chosen. There are a few decisions to be made here. First, you have to choose between cash-basis accounting and accrual accounting. Cash-basis accounting is limited, and transactions are only recorded when cash changes hands. Accrual accounting is more flexible, and it allows you to match revenue and expenses. It does not rely on cash to change hands.
Then, the next choice to make has to do with bookkeeping. There are two options; single-entry accounting and double-entry accounting. Single-entry accounting is simple and goes hand-in-hand with cash-basis accounting. It only records a single entry for each transaction, like a chequebook. Double-entry accounting is more transparent. It records where cash is going, as well as where it’s coming from. It’s the standard for modern accounting.
For example, when a transaction is recorded using accrual accounting, it happens at the time of the sale. This happens regardless of whether or not cash has moved in or out of business. Then, the double-entry method comes into play. It creates a debit for where the money is going, and a credit for where it is ending up.
Step 3: Post to the General Ledger
When a transaction is recorded, it has to be posted to an account on the general ledger. Accounts have to do with business operations, as well as where money is moving. The general ledger allows bookkeepers to monitor a company’s financial position. General ledger accounts are often referenced on financial statements. One of the most common to be referenced is the cash account, which tells a business how much cash is available at any time.
Step 4: Prepare Unadjusted Trial Balance
At the end of any accounting period, a trial balance is calculated for all accounts on the general ledger. This trial balance tells the company the amount of cash each unadjusted account is worth. Calculating these balances is crucial, as they are used for testing and analysis.
Step 5: Analyze a Worksheet / Reconcile Accounts
After the unadjusted trial balance has been calculated, the worksheet can be analyzed. Worksheets allow bookkeepers to identify adjusting entries so that the accounts are balanced. This step is also where bookkeepers will ensure that debits and credits are equal. When discrepancies are found, adjusting entries are created. This step also allows businesses that use accrual accounting to adjust for revenue and expenses. This is only used in accrual accounting.
Step 6: Post Adjusting Journal Entries
When a bookkeeper identifies adjustments that need to be made, they have to create new journal entries. These journal entries have to be made in reference to the original transactions. They shouldn’t be done in bulk, and any adjusting entry needs an original transaction for reference.
To gain a better understanding of this, consider an error in the general ledger. A transaction may have been recorded for an incorrect amount. That entry cannot be erased. Instead, a new journal entry must be placed on the ledger. This entry needs to reference where the error exists so that anyone reviewing it can verify it for accuracy.
Step 7: Create Financial Statements
In many cases, the creation of financial statements is imperative. Financial statements are often regulated, and they have to be created for any public company. Generally speaking, there are three major financial statements that all companies create. These three statements are explained in detail below:
The Income Statement: The statement that shows a company’s revenue and expenses. Sometimes referred to as a profit and losses statement. This tells a company, or an investor, how revenues are turned into net income or net profit.
The Balance Sheet: The statement that shows all of a company’s financial balances. On this sheet you’ll find a company’s total assets and liabilities.
The Cash Flow Statement: The statement that shows how a company’s money moves. It may also be called a statement of cash flows. It tells how a company is making its money, as well as how it’s spending it.
These are not the only financial statements that can be generated, but they are the most important. When a company moves through all of the steps of the accounting cycle, these statements are the results. If they are viewed together, they can paint a picture of the company’s financial health.
Step 8: Close the Books
The accounting cycle ends when a company closes its books. Closing the books takes place at the end of business operations on the last day of the accounting period. Then, the next day, a new accounting period begins, and new books are opened. The accounting cycle is a circular process, and as long as a company is in business it will be active.
Key Takeaways
Understanding the accounting cycle is important for anyone in the world of business. Through accounting, financial responsibility can be taken by a company. It allows them to look at the bigger picture, and see how they’re doing business. Without accounting, the financial position of a business cannot be analyzed. As such, business decisions cannot be made. Nowadays, most accounting is done through accounting software, making the process much easier.
RELATED ARTICLES
The Definitive Guide to Variance Analysis for Businesses
The steps in the accounting cycle are identifying transactions, recording transactions in a journal, posting the transactions, preparing the unadjusted trial balance, analyzing the worksheet, adjusting journal entry discrepancies, preparing a financial statement, and closing the books.
An example of the accounting cycle is a business owner collecting their financial information, journalizing it, posting it to the ledger by account, performing an unadjusted trial balance, making adjustments, performing an adjusted trial balance, preparing financial statements, closing accounts, and finally preparing a ...
The ten steps are analyzing transactions, journalizing transactions, post transactions, preparing an unadjusted trial balance, preparing adjusting entries, preparing the adjusted trial balance, preparing financial statements, preparing closing entries, posting a closing trial balance, and recording reversing entries.
The accounting cycle is a collective process of identifying, analyzing, and recording the accounting events of a company. It is a standard 8-step process that begins when a transaction occurs and ends with its inclusion in the financial statements.
An accountant using the double-entry method records a debit to accounts receivables, which flows through to the balance sheet, and a credit to sales revenue, which flows through to the income statement. When the client pays the invoice, the accountant credits accounts receivables and debits cash.
The first four steps in the accounting cycle are (1) identify and analyze transactions, (2) record transactions to a journal, (3) post journal information to a ledger, and (4) prepare an unadjusted trial balance. We begin by introducing the steps and their related documentation.
The accounting process is a series of activities that begins with a transaction and ends with the closing of the books. Because this process is repeated each reporting period, it is referred to as the accounting cycle and includes these major steps: Identify the transaction or other recognizable event.
Take a look at the three main rules of accounting: Debit the receiver and credit the giver. Debit what comes in and credit what goes out. Debit expenses and losses, credit income and gains.
In its most basic sense, accounting describes the process of tracking an individual or company's monetary transactions. Accountants record and analyze these transactions to generate an overall picture of their employer's financial health.
An accounting worksheet is a document used within the accounting department to analyze and model account balances. A worksheet is useful for ensuring that accounting entries are derived correctly. It can also be helpful for tracking the changes to an account from one period to the next.
The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.
The accounting cycle consists of the steps from recording business transactions to generating financial statements for an accounting period. The operating cycle is a measure of time between purchasing inventory, selling the inventory as a product, and collecting cash from the sales transaction.
The process that begins with analyzing and journalizing transactions, and ends with the post closing trial balance is called an accounting cycle. The most important output of the accounting cycle are the financial statements.
what you end up with is $10,000 for a car and $10,000 that you owe. At the end of it, cash zeros out, and you've got a car for $10,000 and a liability, your borrowing for $10,000. Again, the accounting equation of assets – liabilities = equity balances out.
The principle of accounting is that for every debit there must be a corresponding credit. This principle applies to everyday life. You can use it in relationships or to manage and control behaviour. For instance, you can use the principle to train children on the necessity of work and in setting expenditure limits.
When you post to the general ledger, you record a summary of the activity for each ledger account. Example: If today's transactions included a cash sale of $300, a cash sale of $200 and a cash refund of $100, then the summarized Cash transactions would be a debit of $400.
The main purpose of the accounting cycle is to keep track of all financial activities that occur during a specific accounting period, be it monthly, quarterly or annually. In short, the accounting cycle verifies that every dollar going into or out of the various general-ledger accounts is reported.
The eight steps of the accounting cycle are as follows: identifying transactions, recording transactions in a journal, posting, the unadjusted trial balance, the worksheet, adjusting journal entries, financial statements, and closing the books.
Based on the exchange of cash, there are three types of accounting transactions, namely cash transactions, non-cash transactions, and credit transactions.
A chart of accounts (COA) is an index of all of the financial accounts in a company's general ledger. In short, it is an organizational tool that lists by category and line item all of the financial transactions that a company conducted during a specific accounting period.
What are the differences between Journal and Ledger? Journal is a subsidiary book of account that records transactions.Ledger is a principal book of account that classifies transactions recorded in a journal. The journal transactions get recorded in chronological order on the day of their occurrence.
A contra entry is recorded when the debit and credit affect the same parent account and resulting in a net zero effect to the account. These are transactions that are recorded between cash and bank accounts.
Simple journal entries: Include one debit and one credit. Compound journal entries: Include over two accounts or over one credit and one debit. Adjusting journal entries: Made at the end of an accounting period to resolve issues like unprocessed invoices to make the books balance.
Rule 1: Debit What Comes In, Credit What Goes Out.
By default, they have a debit balance. As a result, debiting what is coming in adds to the existing account balance. Similarly, when a tangible asset leaves the firm, crediting what goes out reduces the account balance.
The purpose of bookkeeping is to maintain a systematic record of financial activities and transactions chronologically. The purpose of accounting is to report the financial strength and obtain the results of the operating activity of a business.
The main purpose of balancing a ledger account is to know that every debit and credit balance is offset from each other. In a double-entry system, all credit totals must equal all debit totals.
A journal is a concise record of all transactions a business conducts; journal entries detail how transactions affect accounts and balances. All financial reporting is based on the data contained in journal entries, and there are various types to meet business needs.
A ledger is a book or digital record that stores bookkeeping entries. The ledger shows the account's opening balance, all debits and credits to the account for the period, and the ending balance.
For-profit businesses use four primary types of financial statement: the balance sheet, the income statement, the statement of cash flow, and the statement of retained earnings.
There are four main financial statements. They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity.
Cost of goods sold is the total amount your business paid as a cost directly related to the sale of products. Depending on your business, that may include products purchased for resale, raw materials, packaging, and direct labor related to producing or selling the good.
Profit And Loss Statement. One of the most fundamental questions first-time startup founders have about the three basic financial statements is, “Is profit and loss the same as income statement?” Fortunately, the answer to this one is exceptionally simple: Yes, they're the same thing.
#3 What happens on the income statement if inventory goes up by $10? Nothing. This is a trick question. The only impact will be on the balance sheet and cash flow statement.
The steps of the accounting cycle are important because they ensure accurate record-keeping and provide a clear framework for finance professionals to understand and interpret the data they work with.
Opening entries. These entries carry over the ending balance from the previous accounting period as the beginning balance for the current accounting period. ...
The accounting cycle consists of the steps from recording business transactions to generating financial statements for an accounting period. The operating cycle is a measure of time between purchasing inventory, selling the inventory as a product, and collecting cash from the sales transaction.
Most businesses produce a cash flow statement; while it's not mandatory, it helps project and track your business's cash flow. These financial statements are the most significant outcome of the accounting cycle and are crucial for anybody interested in comparing your business with others.
Address: Suite 769 2454 Marsha Coves, Debbieton, MS 95002
Phone: +813077629322
Job: Real-Estate Executive
Hobby: Archery, Metal detecting, Kitesurfing, Genealogy, Kitesurfing, Calligraphy, Roller skating
Introduction: My name is Gov. Deandrea McKenzie, I am a spotless, clean, glamorous, sparkling, adventurous, nice, brainy person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
