Accounting Cycle

Objectives

Upon completion of this topic you should be able to:

1. State and explain the steps in the accounting cycle
2. Illustrate the accounting cycle in the form of a diagram

Steps in the accounting cycle

The accounting cycle is a series of steps that is followed to ensure that the records of a business are true and fair. Each business transaction goes through these steps. Let’s have a look at these steps in detail.

http://www.slideshare.net/JacquelineRichardson/introduction-to-business-accounting
Step 1 - Collecting and analyzing data from source documents.
When a transaction occurs, a document is produced. Most of the time, these documents are external to the business (e.g. purchase orders, sales slips, etc.), however, they can also be internal documents, such as inter-office sales, cheques, bills from providers, etc. These documents are referred to as source documents. Some additional examples of source documents include:

• The receipt you get when you purchase something at the store.
• Interest you earned on your savings account which is documented in your monthly bank statement.
• The monthly electric utility bill that comes in the mail.
• The telephone bill.
• Invoices from other service providers, contractors, etc.

Step 2 – Journalizing transactions.
The source documents are recorded in a Journal. This is also known as a book of first entry. The journal records both sides of the transaction recorded by the source document. These write-ups are known as Journal entries.

Step 3 – Post to the Ledgers.
The Journal entries are then transferred to a Ledger. The group of accounts (described earlier) is called ledger. A ledger is also known as a book of accounts. The purpose of a Ledger is to bring together all of the transactions for a similar activity. For example, if a business has one bank account, then all transactions that include cash would then be maintained in the Cash Ledger. This process of transferring the values is known as a posting.
Once the entries have all been posted, the Ledger accounts are added up in a process called Balancing. Balancing implies that the sum of all Debits equals the sum of all Credits.

Step 4 – Unadjusted Trial Balance.
A particular working document called an unadjusted trial balance is created. This lists all the balances from all the accounts in the Ledger. Notice that the values are not posted to the trial balance, they are merely copied.
At this point accounting happens. The accountant produces a number of adjustments, which make sure that the values comply with accounting principles. These values (such as depreciation of equipment) are then passed through the accounting system resulting in an adjusted trial balance. This process continues until the accountant is satisfied.

Steps 5 – Prepare adjustments.
Period-end adjustments (usually quarterly) are required to bring accounts to their proper balances after considering transactions and/or events not yet recorded. Under accrual accounting, revenue is recorded when earned and expenses when they are incurred. An entry may be required at the end of the period to record revenue that has been earned but not yet recorded on the books. Similarly, an adjustment may be required to record expense that may have been incurred but not yet recorded.

Step 6 – Prepare an adjusted trial balance.
This step is similar to the preparation of the unadjusted trial balance but this time the adjusting entries are included. Correction of any errors must be made.

Step 7 - Prepare Financial Statements.
Financial statements are drawn from the trial balance and are presented in the following forms:

• Income statement: prepared from revenue, expenses, gains and losses
• Balance sheet: prepared from assets, liabilities and equity accounts
• Statement of retained earnings: prepared from net income and dividend information
• Cash flow statement: derived from the other financial statement using either the direct or indirect method.

Finally, all the revenue and expense accounts are closed.

Step 8 – Closing entries.
Revenues and expenses are accumulated and reported by period, monthly, quarterly, or yearly. To prevent them not being added to or co-mingled with revenues and expenses of another period, they need to be closed out- that is, given zero balances at the end of each period. Their net balances, which represent the income or loss for the period, are transferred into owners’ equity. Once revenue and expense accounts are closed, the only accounts that have balances are the asset, liability, and owners’ equity accounts. These balances are carried forward to the next period.

Step 9 – Prepare post-closing trial balance.
The purpose of this final step is two-fold: to determine that all revenue and expense accounts have been closed properly and to test the equality of debit and credit balances of all the balance sheet accounts, that is, assets, liabilities and owners’ equity.

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Topic Summary

You have just looked at the accounting cycle and the steps in the accounting cycle. As you continue with the other topics in this unit you will examine the accounting cycle in more detail. We will now continue and look at the business accounting processes and procedures.

We will now examine the handout on Business Accounting Processes and Procedures