The Accounting Cycle
The "accounting cycle" is the name of a procedure or process of recognizing, recording, summarizing, and analyzing economic events of a business. For any business entity, recording its financial and non-financial information is important. The accounting cycle fulfills the purpose of record-keeping and serves for analysis as well.
The accounting cycle provides accounting information and is recorded in a specific period. Such period could be a fiscal year of a firm, or a month, or any other specific accounting period of a firm. All the recordings made are based on some standard accounting principles system like GAAP and IFRS.
Steps in the Accounting Cycle
The accounting cycle comprises of eight collaborative steps. They are:
1. Identifying the transactions
2. Recoding these transactions into the general journal
3. Posting these transactions into the ledger
4. Preparing a trial balance
5. Making adjusting entries
6. Making a worksheet
7. Preparing financial statements
8. Closing accounts
Let's take a closer look at each individual step of the accounting cycle:
The 1st step: Identifying the Transaction
A transaction is a business event of a firm that involves money or has a monetary value. It could be an agreement between seller and purchaser about the exchange of goods or services with some assets of the same monetary value or money (Meigs, Williams, Haka, & Bettner, The Accounting cycle: Capturing economic events). For identifying a transaction two things should be considered. The first one is that it should concern an exchange of goods or services and the second one is that it should have a monetary value on which both parties agreed. For instance:
Mr. A purchases a car from Mr. B for £100,000 on the 5th of November.
In the above example, two persons are exchanging a car for money with a monetary value of 100,000. That is a transaction.
The 2nd step: Recording in Journal
After identifying a transaction, it is recorded as an entry in a general journal. All transactions are recorded in the journal. A recorded transaction depicts the double effect of the entry as debit and credit of accounts. A maintained journal provides the full details of a transaction; date of transaction, the title of accounts involved in the transaction, a brief description of the event, debited and credited amounts of cash or credit, and reference numbers of the accounts.
The 3rd step: Ledger posting
The next step is to post the entries in the ledger accounts. That is a book of accounts in which the details of every account are recorded in a distinct account with a reference number. It provides brief information about the increase and decreases in an account. It keeps the record of all accounts such as assets, liabilities, capital, income or loss, and expenses (Meigs, Williams, Haka, & Bettner).
The 4th step: Trial Balance
The next step is to prepare a trial balance of the recorded entries. It is a list of all accounts of the business entity which shows the balances of the listed accounts. Both the debit and credit sides of the trial balance must be equal in the total sum. It is prepared at the end of the reporting period for ensuring the accuracy of the entire records.
The 5th step: Worksheet
A worksheet is a tool for accountants that helps in making corrections and adjustments. It is like a spreadsheet where all the accounting information is put together to ensure the accuracy of accounts and statements. If there is any discrepancy, it will be adjusted with the help of adjusting entries.
The 6th step: Adjusting Entries
In the next step adjusting entries are prepared to accomodate entries of expenses and revenues which have an effect in two or more accounting periods (Franklin, Graybeal, & Cooper, 2019). For example, a business firm has purchased a substantial amount of supplies that will last for months or ta firm purchased insurance for a year that will have an impact on 12 months of accounting records and the assets purchased will depreciate slowly with the passage of time or usage that will require to record as depreciated. All transactions like this need to be adjusted at the end of the reporting period.
The 7th step: Financial Statements
Financial statements are the formal reports that are summarized and presented to experts, managers, and other users for analysis and decision making. Financial statements depict the financial performance and show the financial position of a business firm. They also help in knowing the credibility of a firm (Wahlen, Baginski, & Bradshaw, 2010). In fact, there are 4 different financial statements:
- Cash Flow Statements
- Income Statements
- Statements of Owner's Equity
- Balance Sheets
The 8th step: Closing of Accounts
The last step of the accounting cycle is to close the accounts that are temporary in nature and do not impact the next accounting period. Such accounts are the expenses and revenues accounts, expenses are used and nothing remains for the next period so they do not need to move into the next accounting periods. Similarly, revenues that are earned and utilized do not need to be forwarded into the next accounting period.
Franklin, M., Graybeal, P., & Cooper, D. (2019). "Principles of Accounting Volume 1-Financial Accounting". 12th media services.
Meigs, R. F., Williams, J. R., Haka, S. F., & Bettner, M. S. (n.d.). "Accounting: Information for Decision making". In R. F. Meigs, J. R. Williams, S. F. Haka, & M. S. Bettner, Accounting: The basis for decision making (Vol. Eleventh edition).
Meigs, R. F., Williams, J. R., Haka, S. F., & Bettner, M. S. (n.d.). "The Accounting Cycle: Capturing economic events". In R. F. Meigs, J. R. Williams, S. F. Haka, & M. S. Bettner, Accounting: The basis for decision making (Vol. Eleventh edition).
Wahlen, J. M., Baginski, S. P., & Bradshaw, M. (2010). "Overview of financial reporting, financial statement analysis, and valuation". In J. M. Wahlen, S. P. Baginski, & M. Bradshaw, Finacial Reporting, Financial Statement Analysis, and Valuation: A strategic perspective.