What is Accounting Cycle?
The accounting cycle is a collective and systematic process that involves identifying, analyzing, and recording a company’s financial transactions. It represents a complete sequence of accounting activities that begins with the recording of transactions and ends with the preparation of the balance sheet.
The accounting cycle is a series of steps which enables to prepare a full set of financial statements. These steps are cyclical in nature as these steps are repeated in each accounting period whether in quarterly or in annual basis. Each step is interconnected to each other in organized and sequential order as shown below.
9 Step of Accounting Cycle
Analyze Transactions
In this step, transaction is analyzed to determine the accounts affected by the transaction and what is the impact happened after the recording the transaction whether accounts balance increased or decreased in other words every business transaction has a financial impact whether it is a sale, purchase, expense and payments related transaction.
Record transactions in the Journal
In this step after transaction are analyzed and their impact on the accounting equation is determined, now transaction is recorded in the in the journal by applying the golden rules or debit or credit rules of accounting.
Post transaction to the general ledger
In this step each individual debit or credit in the general journal is transferred to the appropriate general ledger accounts and the balance of each account is updated after each posting. In simple words, journal entries are transferred to general ledger.
Prepare a trial balance
A trial balance is prepared after each posting session to ensure that the company books are in balance. It is a list of all accounts in the general ledger which has a balance. trial balance is organized in the same order as accounts appear in the general ledger. Trial balance checks that total debits equal total credits ensuring the books are balanced before adjustments.
Prepare adjusting entries
This step is performed before the preparation of financial statements to ensure that all performance obligations satisfied i.e. goods are delivered or service completed have been recorded and to ensure that all expenses incurred also have been recorded. Adjust entries for accruals, prepayments, and depreciation to match income and expenses with the correct accounting period.
Prepare an adjusted trial balance
This step is preformed to ensure that the company books are in balance after the posting of adjusting entries in the general ledger to list all accounts in the general ledger with balances and titled, “Adjusted trial balance” prior to preparation of financial statements. In simple words, recheck all balances after adjustments this ensures accuracy before preparing financial statements.
Prepare financial statements
After all, adjusting entries have been recorded and posted, the company can prepare an updated:
- Income statement
- Statement of owners’ equity
- Balance sheet
- Statement of cash flows
Prepare closing entries
At the end of a company’s fiscal year and after the preparation of financial statements a company closes their books.
There are four required closing entries as follows:
- Close revenues to income summary account
- Close expense to income summary account
- Close income summary account to owners’ capital account
- Close withdrawals to owner’s capital account
In simple words, Close temporary accounts like revenues and expenses. Transfer their balances to retained earnings to start fresh for the next period.
Prepare a post-closing trial balance
A post-closing trial balance is prepared after closing entries are recorded in the journal and posted to the general ledger contains only balances for assets, liabilities and owner’s capital account. It contains only balances for assets, liabilities and owner’s capital account.
Revenues, expenses and withdrawal do not appear on this trial balance as they have been closed out and have a zero balance. Finally, verify that all temporary accounts are reset, ensuring your books are ready for the next accounting cycle.
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