The accounting cycle is an eight-step process essential for bookkeeping. The accounting cycle includes all the responsibilities and basic steps that a bookkeeper and accountant must take note of when recording financial data. It is a bookkeeper’s guide for the recording, analyzing, and reporting of a business’s financial transactions and activities throughout an accounting period.
Though today, many accounting software can be used to automate this process, it is still important for every individual and business owner to be aware of these steps. Knowing how to do it assures you can audit and spot mistakes. It is also helpful for small companies and firms that rely on manual input. If you would like to know more about this cycle and how you can apply it to your company, read on.
Steps in the accounting cycle:
1. Identifying the Transaction
The first thing to do when carrying out the accounting cycle is the identification of transactions. Recognize if the transaction is a sale or a purchase. Make sure to keep evidence of these transactions such as receipts and invoices for reference later on in the cycle.
2. Make Journal Entries for the transactions
The journal thoroughly records all transactions, under what account they were received, how they were paid, and what they are for.
Using the accrual principle of accounting, record transactions on the journal as they are, on the day they occurred, regardless if it has been paid for. You may opt to use the cash accounting method that records transactions when they are paid if that is your preference.
Suppose you use the double-entry bookkeeping method that records transactions on credit and debit. In that case, you must recognize under what account each transaction should be placed, whether asset, liability, or equity account. Moreover, it is important to recognize the real balances of each account, assets (cash, inventory, etc.) on debit and liabilities (payables) and equity (capital) on credit.
3. Posting on the General Ledger
Transactions recorded on the journal entry must be posted to the general ledger. The ledger provides the breakdown of each account and allows proper monitoring of these accounts. Make it a point to keep the ledger organized and neat for easy auditing and evaluation.
4. Calculate the Trial Balance
At the end of each period, trial balances are calculated to match both debit and credit under each account. Again, the total amount of the credits and debits in each accounting must match. This is a way to verify if something is missing. When they don’t match, further investigation may be necessary to see where the discrepancy lies.
5. Check the Worksheet
Checking and analyzing the worksheet ensures you can figure out where debit and credit discrepancies come from (if any). If you find discrepancies, adjustments must be made. Any discrepancy would require step 6. Noteworthy, apart from identifying errors in matching, adjusting entries may be necessary to match revenues and expenses if you are using the accrual method.
6. Adjusting Journal Entries
You must make adjustments to erroneous entries weeded out in step 5. Record the needed adjustments where necessary.
7. Generate Financial Statements
Once all entries have been double-checked and rectified, you may proceed to prepare your financial statements, which includes: statement of financial position, a statement of comprehensive income/ income statement, a statement of changes in equity, and a statement of cash flows. These statements matter when the time comes to file tax returns, file for loans, assess expansion plans, and more.
8. Close the Books
Once all financial statements have been reported, you may end the accounting cycle by closing the books. You may provide a closing analysis and report of your business financial health and overall performance for the period ended. Then, the cycle begins again with a new reporting period. Closing is the best time to file the necessary paperwork, prep for the next period, and review your calendar for upcoming tasks.
The 8-step accounting cycle is a vital process that must be applied to all businesses as it allows you to track your financial situation, make sound business decisions, and create future plans. It takes the guesswork out of your finances, assuring better financial health. It is a tricky task, but with careful organization and diligence, it is doable.
However, if you feel it may be too taxing and time-consuming for you and your team, you can always seek professional help. Call our team for a free 30-minute consultation. We will conduct efficient financial performance analysis and make sure your books are consistent and accurate.