What are the Nine Steps in the Accounting Cycle?

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

• Purpose: Identify and analyze business transactions and determine their impact on the company’s accounts.
• Process: Review source documents like invoices, receipts, and bank statements to identify relevant financial transactions.

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

• Purpose: Record each transaction in the accounting journal.
• Process: Enter transactions as journal entries, noting the date, accounts affected, and amounts debited and credited. A brief description should accompany each entry.

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

• Purpose: Transfer journal entries to the General Ledger.
• Process: Update the Ledger by posting debits and credits from journal entries to their respective accounts, ensuring each account reflects its current balance.

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

• Purpose: Ensure debits equal credits after posting all transactions to the Ledger.
• Process: List all ledger accounts and their balances to confirm that total debits equal total credits. This helps identify any discrepancies or errors.

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

• Purpose: Adjust account balances to reflect accrued and deferred items accurately.
• Process: Adjust entries for accrued expenses, accrued revenues, prepaid expenses, and depreciation. These adjustments ensure that costs and revenues are recorded in the correct accounting period.

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

• Purpose: Verify that debits are still equal credits after adjusting the entries.
• Process: Prepare a new trial balance using the adjusted figures from the Ledger. This adjusted trial balance ensures the accuracy of the financial statements.

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

• Purpose: Create formal reports summarizing the company’s financial performance and position.
• Process: Use the adjusted trial balance to prepare the financial statements, including the income statement, balance sheet, statement of retained earnings, and cash flow statement. These statements provide insights into the company’s financial health.

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

• Purpose: Reset revenue, expense, and dividend accounts to zero for the next accounting period.
• Process: Transfer the balances of temporary accounts (revenues, expenses, and dividends) to permanent accounts (retained earnings or capital accounts). This step ensures that these accounts start with a zero balance in the next accounting period.

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

• Purpose: Ensure that debits still equal credits after closing entries.
• Process: Prepare a final trial balance that includes only permanent accounts. This post-closing trial balance verifies that the Ledger is balanced and ready for the next accounting cycle.

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.

This accounting cycle/process may be done manually or with the help of accounting software. Should you seek further accounting tips or need accounting services, consult your local CPA firm.

FAQ: Nine Steps in the Accounting Cycle

1. What is the accounting cycle?

The accounting cycle systematically identifies, records, and processes a company’s financial transactions to produce accurate financial statements. It typically consists of nine steps.

2. What are the nine steps in the accounting cycle? A2: The nine steps are:

1. Analyzing Transactions
2. Journalizing Transactions
3. Posting to the Ledger
4. Preparing a Trial Balance
5. Adjusting Entries
6. Preparing an Adjusted Trial Balance
7. Preparing Financial Statements
8. Closing Entries
9. Preparing a Post-Closing Trial Balance

3. Why is analyzing transactions the first step in the accounting cycle?

Analyzing transactions is the first step because it involves identifying and understanding the financial transactions that need to be recorded. This step ensures that all relevant data is captured accurately from source documents.

4. What is the purpose of journaling transactions? \

Journalizing transactions involves recording each financial transaction as a journal entry in the accounting journal. This step ensures all transactions are documented with details such as dates, accounts affected, and amounts.

5. How does posting to the Ledger differ from journalizing transactions?

Posting to the Ledger involves transferring the journal entries to the General Ledger. While journaling records transactions chronologically, posting organizes them by account, updating the balances of each account.

6. What is a trial balance, and why is it important?

A trial balance is a report that lists all ledger accounts and their balances at a specific time. It is essential because it helps verify that total debits equal total credits, ensuring the accuracy of the Ledger before making adjustments.

7. What are adjusting entries, and why are they necessary? 00.1452102

Adjusting entries are journal entries made at the end of an accounting period to update account balances for accrued and deferred items. They must ensure that revenues and expenses are recorded in the correct period, reflecting the company’s actual financial position.

8. What financial statements are prepared during the accounting cycle?

The financial statements prepared include the income statement, balance sheet, statement of retained earnings, and cash flow statement. These statements provide insights into the company’s financial performance and position.

9. What is the purpose of closing entries?

Closing entries reset the balances of temporary accounts (revenues, expenses, and dividends) to zero at the end of an accounting period. This ensures these accounts start fresh in the next period while the balances are transferred to permanent accounts.

10. What is a post-closing trial balance?

A post-closing trial balance is a report prepared after closing entries have been made. It includes only permanent accounts and verifies that the Ledger is balanced and ready for the next accounting cycle.

Conclusion

Following these nine steps in the accounting cycle helps maintain accurate financial records. It ensures that financial statements provide an accurate and fair view of the company’s financial performance and position. By adhering to this structured process, businesses can effectively manage their financial reporting and make informed decisions.