The accounting cycle is a series of actions used to categorize and record an entity’s individual transactions. These transactions are then combined at the end of each reporting period into financial statements. The accounting cycle is fundamentally the core recordation activity that an accounting department participates in on an ongoing foundation and is the basis upon which the fiscal statements are created. Most accounting controls and actions relate to the accounting cycle.
The following discussion breaks the cycle into the treatment of individual transactions, and then closing the books at the end of the reporting period. The following steps are associated with individual transactions:
Identify the event that is causing an accounting transaction. Examples of such events are:
Pay salaries to staff
Apply overhead to inventory and the cost of goods sold
Sell goods to clients
Provide services to customers
Receive compensation from customers
Recognize an expenditure
Prepare the business document connected with the accounting transaction, such as a supplier statement, customer invoice, petty cash receipt, or cash receipt.
Identify which financial records are affected by the business document
Record in the appropriate financial records in the accounting file the amounts noted on the business document. This may involve recording transactions in a precise journal, such as the cash receipts journal, cash disbursements journal, or sales journal, which are later posted to the general ledger. Such transactions may also be posted directly to the general ledger.
The preceding accounting cycle steps were associated with individual transactions.
The following steps are only used at the end of the reporting period, and are associated with the cumulative amounts of the preceding transactions:
Prepare a initial trial balance, which catalogs the debit and credit totals for each account. All debits are listed in the left column, and all credits in the right column. The totals of the two columns should be matching. If not, then there is an error somewhere in the underlying transactions (an unbalanced entry) that should be corrected before proceeding. If the trial balance is being prepared by hand, then possible reasons for unbalanced debit and credit totals are:
Only entering a portion of a transaction
Entering part of a transaction more than once
Entering an incorrect amount
Entering an amount as a debit instead of a credit (or vice versa)
Add accrued items, record estimates, and correct errors in the initial trial balance with adjusting entries. Examples of such items are:
Record expenditures for supplier invoices that have not yet arrived
Record profits for customer invoices that have not yet been billed
Record mistakes spotted in the month-end bank settlement
Adjust for transactions that were initially recorded in the wrong account
Accrue for unpaid wages earned
Prepare an adjusted trial balance, which combines the preliminary trial balance and all adjusting entries. It may require several repetitions before this adjusted trial balance truthfully reflects the results of operations and the fiscal location of the business for which the data is being aggregated.
Prepare the financial statements from the adjusted trial balance. The core elements of the financial statements are:
Statement of cash flows
Statement of retained earnings
Accompanying disclosures (footnotes)
Close the books for the reporting period. If you are compiling accounting information manually, then closing the books includes shifting all brief account balances (e.g., revenue, expenses, gains, and losses) into the income summary account, and shifting the balance from there to the retained earnings account.
Prepare and review a post-closing trial balance. This trial balance should contain zero balances for all the briefly held accounts.
It is also useful to print out the vital documents supporting the completed fiscal statements and store them in a binder. This can contain all journals, as well as source documents for the most important journal entries, such as the depreciation calculations. This information provides backup information for the fiscal statements and is of use when providing evidentiary matter to examiners.
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