Accounting Cycle

MoneyBestPal Team
A systematic process of recording, summarizing, and reporting the financial transactions of a business.

The accounting cycle is a methodical procedure for documenting, compiling, and disclosing a company's financial transactions. It aids in ensuring that the financial accounts are correct, consistent, and in accordance with the rules and standards of accounting. 

The typical accounting cycle lasts for a set amount of time, like a month, quarter, or year. Each period's end marks the beginning of the next cycle of accounting.

Why is the Accounting Cycle Important?

The accounting cycle is important for several reasons:
  • It makes it easier to keep track of all a company's financial activities and gives a comprehensive picture of its financial performance and position.
  • By adhering to a set of guidelines and instructions, mistakes, fraud, and false assertions are less likely to occur.
  • For internal and external users, including managers, investors, creditors, regulators, and tax authorities, it aids in the preparation of trustworthy and comparable financial statements.

How Does the Accounting Cycle Work?

The accounting cycle is a set of steps that businesses follow to record, process, and report their financial transactions. The accounting cycle helps to ensure the accuracy, consistency, and completeness of the financial statements. The accounting cycle consists of eight main steps:
  1. Identify and analyze transactions. This step entails recognizing the economic events that have an impact on the company and examining how they affect the accounting. Transactions that must be recorded include, for instance, the selling of goods or services, the acquisition of inventory, and the payment of wages.
  2. Record transactions in a journal. In this stage, you'll use the double-entry accounting system to record the specifics of each transaction in a journal entry. Every transaction is recorded in a journal entry, along with the accounts and dollar amounts that are debited and credited. A journal entry for a credit sale of goods, for instance, would credit sales income and debit accounts receivable.
  3. Post transactions to the ledger. In this stage, the journal entries are moved from the ledger accounts—which serve as the records of all changes to each account—to the ledger accounts. Each account's balance is displayed in the ledger accounts at all times. The total sum that clients owe the company might be displayed, for instance, in the ledger account for accounts receivable.
  4. Prepare an unadjusted trial balance. This phase is summing up each ledger account's debit and credit balances and comparing them to see if they are equal. The ledger accounts and their balances are shown in an unadjusted trial balance before any corrections are made. It aids in finding any mistakes or omissions made throughout the recording process.
  5. Make adjusting entries. At this step, some ledger accounts will need to be adjusted to reflect the accrual basis of accounting, which records revenues as they are earned and expenses as they are incurred regardless of when money is actually exchanged. Adjusting entries normally have an impact on one account on the income statement and one account on the balance sheet. They are entered in the journal and posted to the ledger. For instance, a depreciation adjusting entry would credit accrued depreciation and deduct depreciation expense.
  6. Prepare an adjusted trial balance. Once the adjusting entries have been made, this step entails creating a new trial balance. A list of every ledger account's balance after modifications have been made is contained in an adjusted trial balance. All of the accounts' final balances needed to create the financial statements are displayed.
  7. Prepare financial statements. In this step, the income statement, statement of changes in equity, balance sheet, and statement of cash flows are prepared using the data from the adjusted trial balance. The business's financial situation and performance for a given time period are summarized in the financial statements.
  8. Close temporary accounts. At this phase, the temporary accounts—the income statement accounts and dividends accounts—are closed or made zero and their amounts transferred to retained earnings, a permanent account. Closing entries serve to distinguish between the transactions of one period and those of the next since they are written in the journal and added to the ledger.

The accounting cycle is a rational and methodical method of storing and reporting financial data. Businesses may make sure that their financial statements are precise, consistent, and comprehensive by adhering to these eight measures.