The Accounting Cycle is a nine-step standardized practice used by organizations & CPA firms to record and calculate financial transactions & activities. The Accounting Cycle steps list the process of analyzing, monitoring, and identifying a company’s financial transactions. It is used for its efficiency and compliance with federal regulations and tax codes.
The Nine Steps in the Accounting Cycle
Follow these 9 steps of the accounting cycle in order to analyze the company’s financial transactions-
Step 1: Analyze Business Transaction
First, the source documents are analyzed to determine the nature of the accounts or transactions. Examples of source documents are checks and bank statements, and other financial measures relevant to be journalized in the next step.
For example, the sale or return of a product, the purchase of supplies(raw materials or finished goods) for business operations, or any other activity. An analysis of the business transaction forms the first step in the accounting cycle.
Step 2: Journalize Transaction
In the second step of the accounting cycle, the transactions are journalized in a journal book/Book of Original Entry. The accountant uses double-entry accounting, where each transaction is recorded in two accounts, namely debit and credit. The CPA firms generally do journal entries. The Journal entries consist of Debit and Credit amounts, the transaction date, and a description of the transaction. It can also be called a summary of all business accounts. The transactions that cannot be entered in special journals are recorded in the general journal.
Step 3: Posting To Ledger Account
After journalizing, the information is posted to General Ledger accounts. Ledgers/Books of Final Entry are a detailed collection of all accounts. The information recorded in Journal Ledger is used to create financial statements of the company. This information assures that the company has a complete accounting transaction record. Each transaction impacts the subsidiary ledgers, and a collective sum can be seen in the general ledger.
Step 4: Preparing Trial Balance
Here, entries of a particular period(from the ledger) are summarized. This does guarantee no errors were made. This is done to verify that the sum of debits is equal to the sum of the credits. Sometimes, there is a difference between these two values. These are fixed by making adjustments in the unadjusted trial balance.
The debit balances are recorded in the left column, and credit balances are recorded in the right column. The total of both the columns must match. Even if the columns get balanced, there might be the possibility of an error. So the entries are checked repeatedly to ensure equal balances.
Step 5: Journalize & Post Adjustments
Adjustments are made for accrued and deferred items. The entries are journalized and posted in the ledger. Basically, these adjustments are made to know the actual position of the company. Journalization and Post Adjustments follow the principle of matching from a double-entry bookkeeping system. Therefore, at last, it tells about the relevant accounts.
For example, taxes will have to be recorded periodically for the business or supply chain, etc. Such entries are also recorded in the journal and general ledger.
Step 6: Prepare Adjusted Trial Balance
After the new entries are made, a new trial balance is calculated to test if the debts are equal to the credits. The trial balance shows the balance of all the accounts, including “adjusted entries” at the end of an accounting period. After this, the next step will help us to analyze the financial events that happened in the company throughout the accounting cycle. If you find any errors in the adjusted trial balance, correct them immediately.
Step 7: Prepare Financial Statements
The four financial statements (income statement, statement of changes in owners equity, balance sheet, and statement of cash flows) summarize the changes that occur from business transactions in the accounting period. It is one of the last phases in the company’s reporting period that tells the company’s financial condition with its cash flow. The company has primarily three financial statements:
- Income statement – This tells about the expenses and revenue of a company. Also known as Profit and Loss Statement.
- The Balance Sheet– That contains the assets and liabilities of a company. Assets are listed in the right column, and Liabilities are listed in the left column.
- Cash Flow Statement– It tells how much the company has generated and utilized in the accounting system’s given time. It has three categories: Operating activities, investing activities, and financing activities.
Step 8: Journalize & Post Closing Entries
Here, balances in temporary accounts are closed or reduced to zero, and the net income or loss is transferred to the capital accounts to prepare for the next financial accounting period. The balances at the end of the year will be the basis for the next fiscal year as an opening balance. Closing entries are only made for temporary accounts and not for permanent accounts nor the account of the balance sheet.
Step 9: Preparing Post-Closing Trial Balance
This is done to determine that all revenue and expense accounts have been properly closed and ensure total credit and debt are equal after putting closing entries. The only entries in the book are permanent entries, namely, assets, liabilities, and the owner’s equity. Recheck them so that if you find any errors, go ahead and correct them.