Accounting Cycle - Explained
What is the Accounting Cycle?
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Table of ContentsWhat is the Accounting Cycle?How is the Accounting Cycle Used?Steps Involved in an Accounting CycleThe Accounting PeriodThe General Ledger
What is the Accounting Cycle?
An accounting cycle is the comprehensive process of identifying, analyzing, sorting, recording and crediting the payments made and received by a company or any other business entity during a specified period of time, referred to as the accounting period.
An accounting cycle usually initiates with the occurrence of a transaction, and culminates in the inclusion of the transaction in the financial statements of the business.
An accounting cycle typically includes all the accounts, journal entries, T Accounts, debits and credits of the business that correspond to the particular accounting period.
Additionally, an accounting cycle may also employ accounting records such as general ledgers and trial balances.
How is the Accounting Cycle Used?
An accounting cycle can be considered a holistic process that verifies the validity and compliance of financial statements such as cash flow reports, profit and loss statements, and balance sheets. Whereas manual accounting systems were the order of the day not too long ago, todays accounting systems are largely computerized and managed by sophisticated accounting software.
The accountant only needs to enter adjusting entries into the system in order for the software to provide an instantaneous and accurate set of financial statements. The accountant then reviews the statements and makes the necessary adjustments in order to obtain a set of revised reports. Whats more, the software prepares, records, and posts the closing entries and even reverse adjusts the designated entries.
Steps Involved in an Accounting Cycle
An accounting cycle starts with the initiation of a business event such as sale of inventory, purchase of raw materials and processing of lease payments. The process typically comprises the following ten steps:
- Identifying, collecting and analyzing documents and transactions (a.k.a. business events).
- Recording the transactions in journals, i.e creating journal entries.
- Posting the journalized amounts to applicable T-accounts or ledger accounts in the general and subsidiary ledgers.
- Preparing an unadjusted trial balance from the general ledger. In certain instances, a worksheet may also be prepared.
- Analyzing the trial balance, and determining and recording end-of-period adjusting entries.
- Preparing an adjusted trial balance after posting adjusting journal entries.
- Preparing the financial statements using the adjusted trial balance.
- Recording and posting closing entries in order to close all temporary income statement accounts.
- Preparing a post-closing trial balance for the subsequent accounting period.
- Recording reversing entries in order to cancel temporary adjusting entries as applicable.
The Accounting Period
An accounting period is the duration during which an accounting cycle commences and completes; in other words, it is the specific period of time in which financial statements are prepared. Accounting periods vary widely from company to company, and are influenced by several different factors. Internal financial reports typically consider monthly accounting periods, while some businesses prefer to have four-week accounting periods, or 13 accounting periods per year. However, the annual period is by far, the most common type of accounting period. Accounting periods are crucial for investors since they enable them to compare the results of a company over successive time periods.
The General Ledger
The general ledger (GL) is a set of numbered records that holds information pertaining to all financial transactions within a business. While traditionally, all such transactions were recorded in a physical document, nowadays businesses predominantly use accounting software for the same purpose.
- What is the Accounting Cycle? – Financial Accounting
- Accrual vs Cash Basis Accounting – Financial Accounting
- What are Accounting Adjustments? – Financial Accounting
- What is an Adjusted Trial Balance – Financial Accounting
- Completing the Accounting Cycle - Creating Financial Statements
- What is the Trial Balance Closing Process – Financial Accounting
- Example of the Closing Process