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The Accounting Cycle: Definition, Steps & Examples

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  • 0:07 Accounting Cycle Defined
  • 0:42 Step One: Collection &…
  • 3:04 Step Five: Adjustments
  • 5:03 Step Nine:…
  • 5:22 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Accounting is essential to the proper and efficient functioning of a business. In fact, it is often referred to as the 'language of business.' In this lesson, you'll learn about the steps in the accounting cycle. A short quiz follows.

Accounting Cycle Defined

Cynthia works as an accountant for a medium-sized company that manufactures toys. Cynthia's job is to process the financial information of her company and prepare financial statements. These financial statements will be reviewed by management to help make business decisions. In order to perform her work, Cynthia follows a series of steps for the collection, processing and reporting of financial transactions called the accounting cycle. Let's follow Cynthia through a cycle.

Step One: Collection and Analysis

Cynthia must first collect and analyze all of the financial transactions undertaken by her company. She analyzes each transaction in order to determine how it affects the financial health of the company. For example, Cynthia will review all the sales conducted each day and all payments made to suppliers.

Step Two: Journalizing the Transactions

After collecting all of the financial transactions, Cynthia records each transaction in the general journal. A general journal is a journal where all financial transactions are recorded in chronological order as they occur. For example, Cynthia will record all of the company's sales for each day in the general ledger.

Step Three: Post to General Ledger

Once all the entries have been recorded in the general journal, Cynthia will then post the transactions to the general ledger, which is organized by account. The company has a set of accounts where each type of transaction belongs. The list of accounts is called a chart of accounts. For example, she will record sales in the sales account and bills in expense accounts such as utilities, supplies and marketing. She may post to the general ledger at the end of the week or month.

Step Four: Unadjusted Trial Balance

After all the transactions have been posted to the general ledger in the appropriate accounts, Cynthia will prepare an unadjusted trial balance. Cynthia needs to ensure that the debits and credits in the general ledger are balanced. For every debit entry, there should be a credit entry that keeps the books in balance. For example, if Cynthia finds a receipt for some supplies purchased by her company, she'll debit the amount as an asset in the appropriate account and credit the vendor's account as the amount paid (or payable) to the supplier.

Debits are recorded on the left side of the account, and credits are recorded on the right side of the account. In order for the general ledger to be in balance, the total value of debits must be equal the total value of credits. If Cynthia finds that an account is not in balance, she'll need to find out why and correct the problem.

Step Five: Adjustments

Cynthia will next make any necessary adjustments to bring accounts and balances up to date. Since Cynthia's company utilizes an accrual accounting method, income is recognized when earned, and expenses are recognized when incurred. This means that Cynthia will record income even if the company hasn't received the money, and she will record expenses even if the company has yet to pay the bill. Cynthia needs to make sure that all income earned and expenses incurred are recorded before she proceeds to the next step.

Step Six: Adjusted Trial Balance

It's now time for Cynthia to prepare an adjusted trial balance. Here, Cynthia needs to determine whether the accounts balance after making the adjustments in the previous steps. Again, total debits must equal total credits. If the accounts are not in balance, she'll need to determine why and make the appropriate corrections to put them in balance.

Step Seven: Financial Statements

Cynthia can use the data recorded in the general ledger to prepare the financial statements that the management of her company will use to determine the financial position of the company and to make sound business decisions. For example, Cynthia will prepare a balance sheet, an income statement and a cash flow statement.

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