Accounting Cycle is the process to keep all financial records of any organization. The process starts with recording each and every business transactions and drops up at the making of final financial statement. The process of Accounting Cycle shows the purpose of financial accounting clearly. The terminal purpose of financial accounting is to build financial information, acknowledge a financial statement, to provide financial information of the company in a brief manner. In others terms, we can say, the purpose of keeping records of financial transactions, tracking expenses and incomes is to use these data in the making of making of financial information. The financial information represents – balance sheet, income statements, cash flow statement and other useful financial information.
The Accounting Cycle is made up of several steps, which are repeated in every financial year. Some firms prefer to prepare financial statements every quarter; it makes their job of compiling the annual financial statement easier whereas some do it annually.
The steps of Accounting Cycle are discussed below –
Journal Entries – Journal Entry is the first step one of Accounting Cycle. In this step, all transactions are recorded in the accounting system of the company. A Journal Entry usually takes three steps – Identifying Transactions, Analyzing Transactions and Journalizing Transactions.
At the first step, financial transaction is to be identified. If you do not know what kind of transaction it was, you cannot record it. So you have to identify whether it was an outgoing transaction or an incoming one. When a transaction is sanctioned and has the result in the accounts, then it must pass through analyze process to check the impact of it on the accounting equation. When the transaction is identified and analyzed, now it’s time to record the transaction. Debits and Credits are registered in the record separately.
T-Accounts – We are now on the second step of Accounting Cycle. Once we have finalized journal entries, now it’s time to post the entries posted to the T-Accounts. T-Accounts are also distinguished as ledger accounts. Ledger Accounts are used to categorize the journal entries into credit or debit in different accounts. This categorization at Ledger Account helps to get useful information about budget and performance reports. Management uses these Ledger Accounts – so they are updated with journal entries regularly. Ledger Accounts display the balance of every account. The debits are added to the left side whereas the credits are added to the right side.
Unadjusted Trial Balance – Unadjusted Trial Balance is a list of the business accounts to be appeared on the financial statements prior to annual adjusting journal entries are computed. The reason behind calling it unadjusted is – it is prepared before adjusting the annual journal entries. Unadjusted Trial Balance is the third step in Accounting Cycle. Once all the journal entries are transferred to the ledger accounts. Unadjusted Trial Balance has three columns – account name, credit and debit.
Adjusting Entries – Adjusting Entries is the fourth step of Accounting Cycle. Adjusting Entries is performed at the end of each period to rectify the accounts. Once all accounts are adjusted – financial statements are made. This action is used to match the revenue and expenses of that particular period. Usually three types of Adjusting Journal Entries are performed – each of them adjusts the expense with income to match with a particular period. This is used to keep records of prepaid expenses, accrued expenses and revenues and non-cash expenses.
Adjusted Trial Balance – Now we have reached the fifth step. Adjusted Trial Balance is the list of all accounts of a company that will reflect in the financial statements after annual adjusting journal entries are done. This is the final step before the final financial statements can be made. It is formatted same as Unadjusted Trial Balance. The credit and the debit are calculated at the bottom.
Preparing the Financial Statements –
Financial Statement includes –
• Balance sheet
• Statement of retained earnings
• Statement of cash flows
• Income statement.
As the financial statement represents the sole purpose of accounting, it is the most important step in Accounting Cycle. This step lets users access to the useful financial information in the form of financial statement. Making a Financial Statement is neither simple nor complex, it all depends upon the company size and its turnover.
Accounting Worksheet – Accounting Worksheet is a valuable tool in Accounting Cycle. It helps accountants finishing the accounting cycle. It has a great impact on making annual reports like financial statements, adjusting journal entries, unadjusted trial balance, and adjusted trial balances.
Closing Entries – Closing entries, also known as closing journal entries, are made at the closing period of a business year to turn the value of all temporary accounts into zero and transfer the balance to permanent accounts. In other words, passing accounts of the company are reset or closed at the end of each year. This step is also known as closing the books.
Income Summary Account – Income Summary Account is a temporary account. It is used to store income statement account balances, expense and revenue accounts at the first step of Accounting Cycle. In short, income summary account checks the data of all accounts at the end of the accounting period, when all accounts are renewed with closing entries.
Post Closing Trial Balance – Post Closing Trial Balance is the list where you can find the details of all accounts, account balances. This step is done after the closing entries are posted to the ledger. This account holds the statements, which are there in the balance sheet. It is made because at the time all of the income statement, accounts are closed.
Reversing Entries – The journal entries made at the beginning of the accounting period is called Reversing Entries. Reversing Entries is the final step of Accounting Cycle. This step is made because accruals and prepayments are to be paid off during the current financial year. And moreover pervious financial year’s accruals and prepayments don’t need to be considered as liabilities or assets. Reversing entries are made to keep the bookkeeping process simple. Reversing entry clears out previous year’s accruals.