A bookkeeper is assigned to complete all the tasks aligned under the accounting cycle. It is termed as a “cycle” because the process or workflow is circular in nature by summarizing steps as entering and manipulating the transactions of the cycle, closing the original books at the end of accounting period, and then starting the cycle all over again for the next cycle. Now let’s discuss each of the eight steps in details to grasp a better understanding of the accounting cycle.
1. Financial Transactions
Financial transactions initiate the process. Transaction amounts generate from the company’s activities such as sale of a product, the purchase of supplies—in short any activity that involves an exchange of money on the company’s assets, the incurring or paying off a liability, or depositing money to the owners.
2. Entries in Journal
This step applies the transactions amounts to be recorded in their respective journal and importantly maintaining the order of transactions in a chronological manner. The journal is also termed as the “book of original entry” as this is the first item where a transaction is listed.
The transactions are then posted in the relevant account. All these accounts constitutes to form the General Ledger where you can locate the summaries of all the business’s accounts.
4. Trial Balance
A trial balance is prepared at the end of the accounting period (that could be on monthly, quarterly or yearly basis) which lists the closing balances of ledger accounts. A trial balance is used with the purpose of ensuring arithmetical accuracy, locating any accounting errors, for preparing financial statements, and many more.
Unfortunately sometimes trial balance highlights that the entries in books are mismatching. In such instances, accountants need to locate errors and make necessary corrections or adjustments tracked on a worksheet.
These types of adjustments are also made to keep the depreciation of assets in check along with the adjustments of one-time payments like insurance, which should be managed on monthly basis. After all the required adjustments are done, the trial balance step is repeated again to check if all the accounts are in balance now.
6. Adjusting Journal Entries
Adjusting journal entries is done once the accounting trial balance satisfies that all the relevant adjustments have been done and the closing balances are now correctly placed in their respective accounts.
7. Financial Statements
These corrected account figures or balances are now used to prepare financial statements such as balance sheet and income statement.
8. Closing of Books
In the last stage the books of revenue and expense accounts is closed. This marks the end of the accounting period and hence, the cycle is now ready to be started all over again with zero balances in new accounts.
Not all businesses tend to follow the same duration of accounting period but may complete it on monthly, quarterly, or yearly basis depending on factors such as business needs, nature, pace and amount of transactions, etc. It is important to remember that whatever the duration of the accounting period, the revenue and expense account must initiate from zero at the start of each period. Whereas, the case with asset, equity and liability account balances is otherwise, where they are carried over cycle to cycle.