Accounting Cycle: a periodic process of identifying, evaluating, and recording all financial events of a company.
Accounting Cycle Details
The accounting cycle prompts bookkeepers to record and process any accounting events a company incurs during a period. These events range from when a transaction occurs to the final representation of transactions on the financial statements and, lastly, the accounts' closing. At the beginning of the next period, the cycle begins anew.
There are eight essential steps in the accounting cycle; these steps provide a clear guide for bookkeepers to stay organized and ascertain financial statements' accuracy. Nowadays, accounting software automates most of these processes, but it's still good to know how the accounting cycle works.
- Identify Transactions: First, bookkeepers need to identify which events are transactions. Transactions come in all kinds of forms, including sales, purchases, debt payments, and so on.
- Journal Entries: For each transaction, the bookkeeper needs to record it in the form of journal entries. Some companies make journal entries once transactions are initially confirmed, while others record them only when cash is received or paid. Companies may also choose to adopt single-entry or double-entry bookkeeping.
- Posting to General Ledger: After the bookkeeper records a transaction as a journal entry, it then gets posted to an account in the general ledger. General Ledger provides a summary of all transactions by account. For instance, the journal entry of sales is added towards cash under the general ledger's asset account.
- Calculate Trial Balance: At the end of a determined accounting period—whether monthly, quarterly, or yearly, a trial balance is calculated to identify if there's anything incongruity in the compiled balance of debit and credit account from the ledger.
- Check Worksheet: The next step after calculating the trial balance is to ensure accuracy and equality of debits and credits. The bookkeeper needs to review any discrepancy in the trial balance resulting from bookkeeping errors during journal entries or posting to the general ledger. If the bookkeeper detects anything amiss, then adjustments need to be conducted.
- Adjust Journal Entries: This step refers to the entry into the general ledger that records any unacknowledged income or expenses during the period. Bookkeepers adjust journal entries after he/she is confident that any bookkeeping errors have already been identified and corrected. Adjusting journal entries usually accounts for accruals and deferrals that companies may or may not include in the current period's total income (depending on which accounting method is being used).
- Financial Statements: After posting the adjusting journal entries to the ledger, the company may now begin to prepare the financial statements consisting of a balance sheet, income statement, and cash flow statement.
- Close the Books: Once the bookkeeper finalizes the financial statements, the accounting cycle's last stage is to end the period using closing entries. These entries include the transfer of net income to the retained earnings account to reset the income statement back to zero for the next period. The balance sheet is left as is as a record.
Accounting Cycle Example
The accounting cycle begins when a transaction occurs. Let's say a company earns $400 as sales revenue for one of its products. Once the bookkeeper confirms the transaction, he/she enters it into the journal as raw accounting entries ordered by date. Afterward, the bookkeeper also needs to post the transaction to the ledger with a $200 debit to one asset account (cash) and $200 credit to another asset account (inventory). This process repeats for all other transactions.
Once the fiscal period is reaching its end, it's time to calculate the trial balance. The bookkeeper adds up all of the debit and credit accounts to ensure the equality of both accounts. The bookkeeper may need to adjust accounts on the ledger and/or journal if any discrepancy is found.
After checking and adjusting for errors, it's time to make adjusting journal entries. The bookkeeper posts additional entries to the ledger resulting from corrections and accruals and deferrals (e.g., accrued income and accrued expenses). Next, the company prepares financial statements. It closes the books afterward to ensure that all of the temporary accounts of revenues and expenses from the income statement are transferred to the balance sheet.