Rebekiah has taught college accounting and has a master's in both management and business.
Accounting isn't just about working with numbers. It is about following guidelines to get the job done. In this lesson, you will learn what the accounting cycle is and the steps to complete it.
Accounting Cycle Defined
There is ebb and a flow to every industry. In accounting, the ebb and flow is the accounting cycle. The term accounting cycle refers to the specific steps that are involved in completing the accounting process. The cycle is like a circle. It begins at one point and revolves through specific steps, before starting again at the same point and then repeating those same steps.
The length of the accounting cycle varies from company to company. It may be monthly, quarterly, semiannually, or annually, depending on when the financial statements of the company are published. Regardless of the timing of the accounting cycle, the processes involved remain the same.
Steps in the Accounting Cycle
There are ten basic steps to the accounting cycle.
1. Collect source documents
The very first step in the accounting cycle is to gather all the documents that are related to financial transactions of the organization. These documents, called source documents, are things like receipts, bank statements, checks, and purchase orders. They are the items that describe what a transaction was for.
2. Analyze transactions
The second step in the accounting cycle is to analyze the source documents. The purpose of this is to look them over and then decide what effect they have had on company accounts.
3. Journalize transactions
The third step in the accounting cycle is to post entries into the journal for the analyzed transactions. A journal is the book or electronic record that documents all the financial transactions for a company and the accounts that are affected by each transaction. When a journal entry is made, the 'double-entry' rule is used. This means that for every one transaction, at least two accounts are affected. There must be a debit and a credit for each transaction, and the total of debits and credits must equal the amount of the transaction. Journal entries are entered in chronological order, and debits are entered before credits.
4. Post transactions
The fourth step in the accounting cycle is to transfer information from the journal to the ledger. A ledger is a book or an electronic record of all the accounts that a company has. These accounts are broken down by account number and class. When the information from the journal is transferred to the ledger, it is transferred to each account that was affected by a transaction.
5. Prepare an unadjusted trial balance
A trial balance is a list of all the company's accounts and their balance at the time the trial balance is prepared. An unadjusted trial balance is a trial balance that is prepared before adjusting entries are made into accounts. This information comes directly from the ledger. The total debit balance and total credit balance must be equal.
6. Prepare adjusting entries
Adjusting entries are entries that are made in the journal and posted in the ledger. The purpose of these entries is to bring account balances to the proper amounts. Not all accounts will have an adjusting entry. Adjusting entries are made at the end of the accounting period but not the end of the accounting cycle.
7. Prepare trial balance
Remember, the trial balance is a list of all accounts and their balances after adjustments have been made. This trial balance is prepared to check and make sure that debits and credits equal after adjusting entries are made. It is used to prepare the financial statements.
8. Prepare financial statements
These are prepared in a specific order because information from one financial statement is often used in preparing another financial statement. The order that the financial statements need to be prepared is:
Over 79,000 lessons in all major subjects
Get access risk-free for 30 days,
just create an account.
Income statement - This statement measures how well a company is performing financially during a specific time period. If the company made money, then it had a net profit. If it lost money, then it had a net loss.
Statement of retained earnings - This statement shows the effect of any profit or loss on the retained earnings of a company for a specific time period.
Balance sheet - This statement summarizes the assets, liabilities, and stockholder's equity of an organization at a given time. Asset accounts are always listed on the left side of the balance sheet, with liabilities and stockholder's equity on the right side. The balance sheet must follow the basic accounting equation formula of Assets = Liabilities + Stockholder's Equity, meaning that the total balance from all accounts on the left side of the balance sheet must equal the total balance from all the accounts on the right side of the balance sheet.
Statement of cash flow - This statement shows how much money is made and spent by a company during a given time period.
9. Prepare closing entries
Closing entries are the entries that are completed after the financial statements have been prepared. The purpose of these entries is to close out temporary items by transferring income and expense items to the balance sheet.
10. Post-closing trial balance
The last step in the accounting cycle is to prepare a post-closing trial balance. The post-closing trial balance should only contain the permanent accounts that are used in the company and their balances. All temporary accounts should have been taken care of with the closing entries. Again, the total balance of all debit accounts must equal the total balance of all credit accounts.
Once all ten steps of the accounting cycle are complete, it is time to begin a new accounting period.
The accounting cycle is a multi-step, complex process. Each step must be completed successfully in order to complete the step that follows it. By having the multiple steps that it does, there is a greater chance of catching errors long before the accounting period is closed. Since the financial statements paint the picture of the financial health for a company, it is very important that all information contained in those statements be accurate. For that reason, it is imperative that anyone working in the accounting field pay close attention to the work that they are doing. Even transposing one number can cause hours of headache for the person trying to balance the books!
Did you know… We have over 200 college
courses that prepare you to earn
credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the
first two years of college and save thousands off your degree. Anyone can earn
credit-by-exam regardless of age or education level.