- The accounting cycle has eight basic steps that ensure that a business performs its bookkeeping functions correctly.
- Process monthly, quarterly or annually depending on how often your company requires financial reports.
- Companies can modify steps in the accounting process to fit their business models and accounting procedures.
- This article is intended for business owners, accountants and bookkeepers who want to accurately process their company’s bookkeeping tasks.
When preparing financial statements, businesses take a number of careful steps designed to transform basic financial data into consolidated, complete and accurate reports. This systematic process is called the accounting cycle, and it helps make financial reporting easier and more straightforward for business owners.
Here’s an in-depth look at the accounting cycle, the eight primary steps involved and how the best accounting software can automate the process.
What is the accounting cycle?
The accounting cycle is a comprehensive process designed to make the financial responsibilities of a company easier for its owner, accountant or bookkeeper. The accounting cycle divides a bookkeeper’s responsibilities into eight essential steps for identifying, analyzing and recording financial information. It serves as a clear guideline for carrying out bookkeeping tasks correctly.
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The accounting cycle is a holistic process that records business transactions from start to finish, helping businesses stay organized and efficient. This cycle includes all of the company’s accounts, including T-accounts, credits, debits, journal entries, financial statements and book closings.
One of the main objectives of the accounting cycle is to ensure that all finances during the accounting period are correctly recorded and reflected in the statements. It is like a checklist which has to be completed at the end of an accounting period.
A business may conduct monthly, quarterly or annual accounting cycles, depending on how often the company requires financial reports.
FYI: Even after choosing the right accounting software to automate the stages of the accounting cycle, it is still essential for business owners and bookkeepers to know and understand the process.
modifying the accounting cycle
Companies also modify the stages of the accounting cycle to fit their business models and accounting procedures. A major revision is made according to the type of accounting method used by the business. Companies can follow cash accounting or accrual accounting, or choose between single-entry and double-entry accounting.
Double-entry accounting is ideal for companies that produce all of the major accounting reports, including balance sheets, cash flow statements and income statements.
did you know? If you are wondering whether to use cash or accrual accounting, cash accounting is suitable for freelancers, small businesses and sole proprietorships. But all businesses with more than $1 million in inventory or revenue must follow the accrual method.
8 Stages of the Accounting Cycle
Here’s an in-depth look at the eight stages of the accounting cycle. Once you have checked all the steps, you can move on to the next accounting period.
1. Identify and analyze transactions during the accounting period.
A business begins its accounting cycle by identifying and collecting details about transactions during the accounting period. When identifying a transaction, you need to determine its impact. Transactions include expenses, asset acquisitions, borrowings, loan payments, debt accrued and sales revenue.
Tip: Consider using receipt-tracking software to properly organize transactions and expenses.
2. Record transactions in a journal.
The next step is to record your financial transactions as journal entries in your accounting software or ledger. Some companies use point-of-sale technology attached to their books by combining steps one and two. Still, it’s essential for businesses to keep track of their expenses.
Your accounting type and method determines when you recognize expenses and income. For accrual accounting, you will identify financial transactions when they are incurred. Cash accounting, on the other hand, involves looking for transactions whenever cash changes hands.
Double-entry accounting suggests recording each transaction as a credit or debit in separate journals to maintain a proper balance sheet, cash flow statement and income statement. On the other hand, single-entry accounting is like managing a checkbook. It does not require multiple entries, rather it gives a balance report.
Tip: Bookkeeping is essential for all types of transactions. Be sure to record transactions throughout the accounting period rather than waiting until the end and struggling to find receipts and other pertinent information.
3. Post transactions to the general ledger.
Once the transactions are recorded in the journals, they are also posted in the general ledger. A general ledger is an important aspect of accounting, serving as a master record of all financial transactions.
The general ledger breaks down the financial activities of the various accounts so that you can keep track of the various company account finances. A cash account is by far the most important account in a general ledger, as it gives an idea of the cash available at any given time.
4. Calculate an unadjusted trial balance.
While the first accounting cycle phases occur during the accounting period, you will calculate the unadjusted trial balance after the period ends and you have identified, recorded and posted all transactions. Trial Balance gives you an idea of the unadjusted balance of each account. Such balance is then carried to the next stage for testing and analysis.
Creating an improper trial balance is important for a business, as it helps ensure that total debits equal total credits in your financial records. If they don’t, then something is either missing or misaligned. This step typically identifies discrepancies, such as payments that you may have thought were collected and invoices you thought were cleared but actually weren’t.
Whatever the scenario, an unadjusted trial balance displays all your credits and debits in one table. In the next step, you will investigate what went wrong.
5. Analyze the worksheet to identify errors.
The fifth stage of the accounting cycle involves analyzing your worksheets to identify entries that need to be adjusted. Since each transaction is recorded as a credit or debit, this step requires ensuring that the total credit balance and debit balance are equal. [Read related article: Direct Costs vs. Indirect Costs]
In addition to identifying errors, when accrual accounting is used, this step helps to reconcile revenue and expenses. Any discrepancy should be addressed by making adjustments, which happens in the next step.
6. Adjust journal entries to correct errors.
When the accounting period ends, you will adjust the journal entries to correct any mistakes and discrepancies found during the worksheet analysis. Since this is the last step before preparing the financial statements, you should double-check everything with the help of the newly adjusted trial balance.
7. Create and prepare financial statements.
Once the company has made all the adjustment entries, it prepares the financial statements. Most companies prepare balance sheets, income statements and cash flow statements.
The balance sheet and income statement reflect business events in the previous accounting cycle. Most businesses present a cash flow statement; While this is not mandatory, it helps to project and track your business’s cash flow.
These financial statements are the most important result of the accounting cycle and are important to anyone interested in comparing your business with others. They are also highly valuable to business owners. Interpreting financial statements helps you stay on top of your finances and devise growth strategies.
8. Close the books for the accounting period.
The final step in the accounting cycle is to make closing entries by finalizing the expense, revenue and temporary accounts at the end of the accounting period. This includes closing temporary accounts, such as expenses and revenues, and transferring net income to permanent accounts such as retained earnings.
After you close the books, the financial statements produced provide a comprehensive performance analysis for the time frame. Then the accounting cycle begins again for the new reporting period.
This is a good time to do paperwork and plan for the next accounting period.
did you know? Business owners and bookkeepers must understand accounting standards as well as the accounting cycle. Accounting standards can guide your financial record keeping and help your business comply with state and federal laws.
accounting cycle time period
A business’s accounting period depends on a number of factors, including its specific reporting requirements and deadlines. Many companies prefer to analyze their financial performance every month, while others focus on quarterly or annual reports.
At the end of the accounting period, companies should prepare financial statements. Public entities must comply with regulations and submit financial statements before the specified deadline.
accounting cycle vs budget cycle
The accounting cycle is not the same as the budget cycle. Whereas an accounting cycle focuses on events during a specific period and ensures that financial transactions are reported accurately, a budgeting cycle is tied to future performance and helps to plan for future transactions. .
The accounting cycle helps to produce useful information for external users, such as stakeholders and investors, while the budget cycle is used exclusively for internal management.
Tip: Keep your accounting cycle on track with the Daily Accounting Checklist. Steps include refreshing your financial data, recording payments, and categorizing expenses.
Automating the Accounting Cycle with Accounting Software
Accounting software helps automate many steps in the accounting cycle and allows you to specify cycle dates, receive reports automatically, identify inaccuracies, and reconcile reports with ease. Depending on the characteristics of the accounting software, bookkeepers, certified public accountants and business owners may not need to intervene or manually perform certain accounting cycle steps.
Even though accounting software is working behind the scenes to perform important accounting cycle tasks, it is still essential for business owners and bookkeepers to understand the process and adhere to deadlines.