Accounting Cycle: A Complete Guide With 8 Key Steps

To fully understand the accounting cycle, it’s important to have a solid understanding of the basic accounting principles. You need to know about revenue recognition (when a company can record sales revenue), the matching principle (matching expenses to revenues), and the accrual principle. 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. 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.

The cash flow statement shows a company’s actual cash flow for a specific period of time. Moreover, the cycle also helps companies keep track of their profits and losses. This information is also helpful in making decisions about whether or not to invest in a company. The last step of the accounting cycle is to close the period in the closing month of the accounting year. It involves completing all the accounts and preparing to start the accounting process all over again.

As mentioned, the accounting cycle is made up of 8 well-defined steps that lead to the accurate and timely documentation of a business’s financial performance during a particular accounting period. Temporary accounts, like revenue and expenses, need to be closed out so you can start fresh in the next period. Closing entries transfer these balances to permanent accounts, like retained earnings. Once adjustments are made, it’s time to prepare another trial balance—this one reflecting all the changes. The adjusted trial balance is the launching pad for your financial statements.

How do adjustments affect the accounting cycle?

What makes the accounting cycle so important is that it provides consistency. The process standardizes how companies report their overall financial health and capture and record information about money spent and money earned. Leaders can plan and strategize confidently, knowing that their choices align with the business’ true position, and investors can compare apples to apples when evaluating opportunities. Skipping a step can lead to inaccurate financial statements, making it harder to assess your business’s performance or comply with tax laws. The accounting cycle might seem daunting at first, but once you understand the steps, it’s like following a recipe.

Once transactions are identified, they’re recorded in accounting journals using the double-entry bookkeeping method. For example, a sale would involve recording both revenue and a corresponding increase in cash or accounts receivable. The accounting cycle definition shows that this process relates to past events and ensures that financial activities are recorded correctly. The budget cycle, on the other hand, is focused on future operations and planning for future activities. It is also essential because it helps companies keep track of their cash flow.

How to Successfully Complete the Accounting Cycle

• They must look at the nature of each transaction and how to record it.
• You close these accounts at the end of each accounting period because you’re ready to begin tracking a new month, quarter, or year of business.
• Thus, any increase shall be recorded on the Debit side, and if it decreases, we shall record it on the Credit side.
• The journal entries will then need to transfer into the specific ledger accounts based on the nature of transactions.
• Our suite of accounting degree and certificate programs offer a variety of ways to expand your knowledge or prepare to pursue your first credential in the field.
• These journal entries are known as adjusting entries, which ensure that the entity has recognized its revenues and expenses in accordance with the accrual concept of accounting.

In some computerized accounting systems, there is an option where each accountant or bookkeeper is able to choose or tick so that such entries will be automatically reversed in the following period. This would ensure that there is no chance of missing such a reversal. This step involves the transfer of all temporary accounts to retained earnings.

Calculate the Unadjusted Trial Balance

ABC Co has not received the utility bill yet as of 31 December 20×9. From past experience, ABC Co normally incurs utility expense of US$1,000 per month. However, on 5 January 202x, ABC Co received the utility bill with the actual amount of US$1,200.

How does the accounting cycle relate to various accounting records?

• The accounting cycle ensures accurate financial reporting by providing a structured process to track, record, and analyze all transactions.
• A shorter internal accounting cycle can make bookkeeping more manageable, especially when the company’s finances are complicated.
• Finance professionals use the term “unadjusted trial balance” to refer to this calculation because it’s a first attempt at balancing the books.
• The accounting cycle order for preparing financial statements is the balance sheet, the income statement, the statement of cash flows, and the statement of changes in equity.

After closing temporary accounts and updating the Retained Earnings account, the next step is preparing a post-closing trial balance. It serves as a checkpoint to verify that the debits and credits still balance after the closing process. In accounting cycle steps the posting process, transactions from the journal are organized and categorized into their respective ledger accounts.

Once you’ve identified your transactions, it’s time to get them down on paper—or into your accounting software. This is called journalizing, and it’s where double-entry bookkeeping comes into play. You’d lose track of your cash flow, miss tax deadlines, and struggle to gauge your business’s financial health. Whether you’re a seasoned accountant or a small business owner just getting started, understanding these steps will simplify your financial processes. Before diving into the nuts and bolts of the accounting cycle, let’s get clear on what it actually is. The accounting cycle is like a well-organized checklist for financial record-keeping.

Ferreting out impropriety becomes more straightforward when all companies must follow the same process to prepare their financial statements. Through the accounting cycle (sometimes called the “bookkeeping cycle” or “accounting process”). From small LLCs to large corporations, all businesses use some form of the traditional accounting cycle. Small business owners might manage it via Excel sheets or by hand with a traditional ledger.

Accrual accounting requires revenues and expenses to be matched and booked at the time of the sale, while cash accounting requires transactions to be recorded when cash is either received or paid. Once you’ve identified all possible transactions, you’ll need to record them as journal entries. If your business uses double-entry accounting, be sure that every debit has a corresponding credit in a subledger account. For example, when a company makes a sale on credit, the accounts receivable account is debited, and the sales revenue account is credited. The accounting cycle not only streamlines the process of recording and analyzing financial transactions but also plays a pivotal role in financial reporting and tax preparation. In this article, we’ll unpack the accounting cycle, how it works, and why companies that follow it benefit from increased accuracy, transparency, and consistency in their financial reporting.