Nov 16, 2021Making Sense of the Accounting Cycle
Accounting departments use an eight-step process called the accounting cycle to record and report their company’s transactions. The accounting cycle process is usually standard across different companies, though the period in which it is conducted can vary. This article details how the accounting cycle is managed, and the steps it involves.
Managing the Accounting Cycle
Bookkeepers are primarily responsible for following and understanding the entire accounting cycle process. Their duties allow them to be closely aware of a company’s financial health. Conveniently, there is accounting software that can execute the accounting cycle process. However, bookkeepers should know how to complete the steps manually in case there are technical difficulties.
All accounts are examined over the course of the accounting cycle. Depending on the needs of the company, an accounting cycle’s reporting period can vary. The accounting cycle can be conducted monthly, quarterly, or even annually. Most companies, however, choose monthly accounting cycle periods. No matter the time frame, it is important for companies to establish specific open and close dates for each period.
Accounting Cycle Basics
Some important principles to keep in mind that relate to the accounting cycle are revenue recognition, the matching principle, and the accrual principle. Understanding these principles allows bookkeepers to prepare the financial statements toward the end of the cycle. Bookkeepers follow the specific steps of accounting cycle to allow for greater financial accuracy and transparency.
Companies might modify their process depending on their practice of accrual accounting or cash accounting. Accrual accounting records transactions as they occur. Cash accounting records transactions only when cash is received.
Another factor that affects the accounting cycle is whether or not a company practices double-entry or single-entry accounting. Most companies use double-entry accounting, as it already factors in balancing the accounts between debits and credits. Also, the major financial statements prepared at the end of the accounting cycle stem from double-entry accounting.
Steps of the Accounting Cycle
The following eight steps make up the accounting cycle:
- Identify Transactions—The process begins by properly identifying and recording company transactions. Each transaction during the accounting cycle must be accounted for. Company purchases, debt payments, and any debts or sales acquired from sales usually count as transactions. Other “events” that would not fall under this category include purchase orders or contracts.
- Record Journal Entries—Once each transaction is identified, then a journal entry needs to be created for each. The transaction is listed as either a debit or a credit of its associated account. These journal entries should be in chronological order.
- Post Transactions—The recorded journal entries are then posted to the general ledger, which details each account. The general ledger records all of the company’s financial activity.
- Prepare Trial Balance—Then, a trial balance, or “unadjusted trial balance,” is calculated to catch any errors in the reporting. If the balance of the debit account equals the credit account, then this process was successful.
- Assess Worksheet— Once the unadjusted balances are determined, they are included in a worksheet to find any errors in the entries. If the debit and credit accounts are not equal from the previous step, then the journal entries must be reviewed during this step to find any errors.
- Adjust Journal Entries— If there are errors or discrepancies on a worksheet, the bookkeeper will make the appropriate adjustments during this step. The bookkeeper needs to determine which deferrals and accruals should be factored into the accounting period.
- Prepare Financial Statements—When all errors are resolved and adjustments made, the company is ready to prepare its official financial statements. Usually this results in an income statement, retained earnings statement, balance sheet, and cash flow statement, prepared in that order.
- Close the Books—By this last step, the entries for the accounting period are “closed” and no additional entries can be made for that period without approval. Once an accounting period closes, a new accounting cycle starts. Companies usually do a “soft close” for monthly accounting cycles, which is less permanent than a “hard close” or closing the books at the end of the fiscal year. At the end of the year, temporary accounts on the income sheet are zeroed out and transferred to the balance sheet.
Understanding the accounting cycle should affect the way a business keeps its books. While the cycle is completed most commonly on a monthly basis, bookkeepers have a responsibility to properly handling transactions on a daily basis. Properly conducting the accounting cycle promotes financial efficiency and accuracy.