The accounting cycle is a step-by-step process of recording, classification and summarization of economic transactions of a business. It generates useful financial information in the form of financial statements, including income statement, balance sheet, cash flow statement and statement of changes in equity.
The time period principle requires that a business should prepare its financial statements on a periodic basis. Therefore the accounting cycle is followed once during each accounting period. The Accounting Cycle starts from the recording of individual transactions and end on the preparation of financial statements and closing entries.
Major Steps in the Accounting Cycle
A financial transaction starts the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets.
The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. The journal is also known as the “book of original entry” and is the first place a transaction is listed.
The transactions are posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.
At the end of the accounting period, you calculate a trial balance.
Unfortunately, many times your first calculation of the trial balance shows that the books aren’t in balance. If that’s the case, you need to look for errors and make corrections called adjustments, which are tracked on a worksheet.
Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.
Adjusting journal entries
You post any corrections needed to the affected accounts once your trial balance shows the accounts will be balanced once the adjustments needed are made to the accounts. You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been taken care of.
You prepare the balance sheet and income statement using the corrected account balances.
Closing the books
You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.