Accounting Cycle
The accounting cycle is the process of recording and
processing all financial transactions of a company,
from, when the transaction occurs, to its representation
on the financial statements, to closing the accounts.
The cycle repeats itself every fiscal year as long as a
company remains in business.
Steps in accounting cycle:
• Analyze and record transactions in Journal
• Post transactions to the ledger
• Prepare an unadjusted trial balance
• Prepare adjusting entries at the end of the period
• Prepare an adjusted trial balance
• Prepare financial statements
• Closing the books of accounts
Analyze and record transactions in Journal
The first step in the accounting cycle is gathering records of financial
transactions of business such as receipts, invoices, bank statements, etc.
of the current accounting period.
Then these financial transactions should be entered into a journal. This
should be done by following a chronological order.
As journal entries include debits and credits, the person entering the
transactions data into the journal must make sure that the debits and
credits are balanced.
Post transactions to the ledger
Transactions recorded in the journal are then posted to the ledger
accounts.
Journal entries are usually posted to the ledger on a continuous basis, as
soon as business transactions occur,
to make sure that the company’s books are always up to date.
A ledger shows the summary of all the financial transactions related to
particular accounts.
Prepare an unadjusted trial balance
Next an unadjusted trial balance, is prepared to investigate and find the fault or prove
the correctness of the previous steps before proceeding to the next step.
The first step in preparing an unadjusted trial balance is totaling up all the debits and
credits in each of the company’s accounts, and calculating a total balance for each
individual account.
According to the rules of double-entry accounting, all of a company’s debits must equal
all credits.
If the sum of the debit entries in a trial balance doesn’t equal the sum of the credits, that
means there’s been an error in either the recording or posting of journal entries.
Searching for and fixing these errors is called making correcting entries.
Prepare adjusting entries at the end of the period
At this juncture, the unadjusted trial balance is ready.
In this step, the adjusting entries are prepared.
The adjusting entries are typically related to accrual adjustments,
periodical depreciation adjustments, or amortization adjustments.
These adjusting entries are required to prepare an adjusted trial
balance.
Preparing an adjusted trial balance
After passing the adjusting entries, it’s time to create a new trial
balance.
This trial balance is called adjusted trial balance since it is prepared
after passing the adjustment entries.
This trial balance helps in preparation of many critical financial
statements.
Preparation of financial statements
This is the most important step of the accounting cycle. The financial statements
are made at the very last of the accounting period.
Cash flow statement, income statement, position statement and statement of
retained earnings are the financial statements that are prepared at the end of the
accounting period.
Profit and Loss account and Balance sheet are the two key financial statements.
Profit and loss account: Profit and loss accounts is a financial statement prepared
to know the profitability of the business. This is also known as Income Statement.
Balance sheet: Balance Sheet is a financial statement prepared to know the
financial position of the businesses. This is also known as Position Statement.
Closing the books of accounts
This step is the penultimate step in the accounting cycle.
Closing the books means that all financial statements are prepared, and
all transactions have been recorded, analyzed, summarised, and
recorded.
After closing the books, a new accounting period would start, and the
accountant would need to start repeating the above steps once again.
