Accounting Cycle Explained : 8-Step Process

The information produced by the accounting cycle allows businesses to measure their financial performance and conduct internal analyses at regular intervals corresponding with accounting periods. Accurate financial statement data enables a company’s senior management to make a broad range of decisions relative to financial strategies and budget forecasting. The accounting cycle is a process used to document and report on all financial transactions during an accounting period, which is commonly quarterly or annually. Usually, an accounting cycle is managed by a bookkeeper, who may use accounting software to make the process simpler. Double-entry accounting is ideal for companies that create all the major accounting reports, including the balance sheet, cash flow statement and income statement.

  1. The first step to preparing an unadjusted trial balance is to sum up the total credits and debits in each of your company’s accounts.
  2. In most accounting software systems, it is impossible to have transactions that do not result in matching debit and credit totals.
  3. If you use accounting software, this usually means you’ve made a mistake inputting information into the system.
  4. Companies will have many transactions throughout the accounting cycle.
  5. A worksheet is created and used to ensure that debits and credits are equal.

Permanent accounts cover assets, liabilities, and the owner’s capital accounts. Instead of closing, the business transfers its balance into the next accounting period. After finding the net income of the business, the next step is preparing the owner’s equity statement. There you have to list the owner’s investments and withdrawals, as well as the net income and expenses. The goal is to show you how much your financial contribution to the company has changed, and why.

Identify transactions

This can provide businesses with a clear understanding of their financial health and ensure compliance with federal regulations. Words used to describe the double-sided nature of financial transactions. Debit is cash flowing into an account, and credit is cash flowing out of it. A business’s accounting period depends on several factors, including its specific reporting requirements and deadlines.

Troubleshoot errors quickly

Accruals have to do with revenues you weren’t immediately paid for and expenses you didn’t immediately pay. Think of the unpaid bill that you sent to the customer two weeks ago, or the invoice from your supplier you haven’t sent money for. If you have your sights set on career advancement in either accounting or finance, DeVry and our Keller Graduate School of Management can help you get started. Our suite of accounting degree and certificate programs offer a variety of ways to expand your knowledge or prepare to pursue your first credential in the field. You might find early on that your system needs to be tweaked to accommodate your accounting habits. Moreover, if you have inaccurate information, you might inadvertently mislead your lenders, creditors and investors, which can have serious legal consequences.

Step 3: Identify Impacted Accounts

The first step in the accounting cycle is identifying transactions. Companies will have many transactions throughout the accounting cycle. Every individual company will usually need to modify the eight-step accounting cycle in certain ways in order to fit with their company’s business model and accounting procedures. Modifications for accrual accounting versus cash accounting are usually one major concern. The accounting cycle is started and completed within an accounting period, the time in which financial statements are prepared.

Step 1: Analyze and record transactions

This can include all journals, as well as source documents for major journal entries, such as the depreciation calculations. This information provides backup information for the financial statements, and is of particular use when providing evidentiary matter to auditors. Compliance is another area where the accounting cycle is beneficial. Companies of all sizes must file financial reports in compliance with federal regulations and tax codes. The accuracy and uniformity enabled by the accounting cycle and its steps allow any company to accurately calculate the taxes owed on the profits they generate and produce the necessary documentation. Each step in the accounting cycle is equally important, but if the first step is done incorrectly, it throws off all subsequent steps.

All popular accounting apps are designed for double-entry accounting and automatically create credit and debit entries. Meanwhile, the remaining five steps are the bookkeeping tasks you do at the end of the fiscal year. Fortunately, nowadays, you can automate these tasks with accounting software, so doing all this isn’t as time-consuming as it might seem at first glance.

Most companies seek to analyze their performance on a monthly basis, though some may focus more heavily on quarterly or annual results. The accounting cycle incorporates all the accounts, journal entries, T accounts, debits, and credits, adjusting entries over a full cycle. During the accounting cycle, many transactions occur and are recorded. At the end of the fiscal year, financial statements are prepared (and are often required by government regulation). This step of the process is pretty straightforward because you already have the needed data on the adjusted trial balance. The adjusted trial balance has all of the data your business needs to prepare financial statements.

The accountant can enter adjusting entries into the software and can instantaneously obtain a complete set of financial statements by simply selecting them from a menu. After reviewing the financial more detailed update statements, the accountant is able to make additional adjustments and almost immediately obtain the revised reports. The software will also prepare, record, and post the closing entries.

Guide to Understanding Accounts Receivable Days (A/R Days)

The information presented here is true and accurate as of the date of publication. DeVry’s programmatic offerings and their accreditations are subject to change.

Creating an unadjusted trial balance is crucial for a business, as it helps ensure that total debits equal total credits in your financial records. This step generally identifies anomalies, such as payments you may have thought were collected and invoices you thought were cleared but actually weren’t. From identifying transactions to preparing financial statements, the 8 steps in the accounting cycle ensure accurate record-keeping.

The accounting cycle is critical because it helps to ensure accurate bookkeeping. Skipping steps in this eight-step process will likely lead to an accumulation of errors. If these errors aren’t caught and corrected, they can give you and your employees an inaccurate view of your company’s financial situation. The fundamental concepts above will enable you to construct an income statement, balance sheet, and cash flow statement, which are the most important steps in the accounting cycle. To learn more, check out CFI’s free Accounting Fundamentals Course. The last step in the accounting cycle is to make closing entries by finalizing expenses, revenues and temporary accounts at the end of the accounting period.

The unadjusted trial balance is the initial version of the trial balance that hasn’t been analyzed for accuracy and adjusted as needed. The general ledger is a central database that stores the complete record of your accounts and all transactions recorded in those accounts. You need to identify all transactions that occur throughout the fiscal year. The best approach to do that is to create a system where every transaction is automatically captured because that prevents human error. Typically, companies integrate their accounting software with their payment processor and point-of-sale (POS) software to capture revenue.

Following the eight-step accounting cycle can help you accurately record all financial transactions, catch and correct errors and balance your books at the end of each fiscal year before you close them. The accounting cycle is an eight-step process that accountants and business owners use to manage a company’s books throughout a particular accounting period—typically throughout the fiscal year (FY). The federal government’s fiscal year spans 12 months, beginning on October 1 of one calendar year and ending on September 30 of the next. Regardless, most bookkeepers will have an awareness of the company’s financial position from day to day. Overall, determining the amount of time for each accounting cycle is important because it sets specific dates for opening and closing. Once an accounting cycle closes, a new cycle begins, restarting the eight-step accounting process all over again.

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