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Overview of the Accounting Cycle

1065 words (4 pages) Essay in Accounting

08/02/20 Accounting Reference this

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The accounting cycle is a sequence of steps starting with recording transactions and takes it to the preparation of financial statements. The main purpose of recording transactions and keeping track of expenses and revenues. The accounting cycle is a set of steps that are repeated in the same order every period. The highest of these steps is the preparation of financial statements. Some companies prepare financial statements every three months while some complete twelve months.

 The first step is to analyze and record transactions in the journal. This step is where information must be carefully read to determine if a transaction is an asset, liability, common stock, retained earnings, revenue, dividend, or expense. In this step, each account must be determined to see if the amount increases or decreases. Those increases and decreases should be recorded as a credit or debit before entering the transaction to Journal. Step two is the transactions recorded in the journal are posted to the journal ledger. When posting transactions, one must ensure that the date is entered into the date column, the amount of the transaction is entered the debit or credit column of the account, and the journal page number is entered in the posting reference column of the journal. The transactions should be entered in the order that they occur. For step three the unadjusted trial balance should be prepared to if any errors have been made in the ledger when posting debits and credit. The unadjusted trial balance does not provide clear accurate information in the ledger and only shows that the debit and credit are equal. If the totals in the trial balance are not equal, then an error has been occurred and must be discovered. Step four is the assembling and adjusting the data. This happens when accounts must be updated prior to the preparing of financial statements. Expense accounts such as accrued expenses and prepaid expenses as well as revenues such as accrued and unearned usually require adjustment. Fixed assets except for land must be adjusted for depreciation. Step five is preparing an optional end of the period spreadsheet. This step is not required (Carl S. Warren, James M. Reeve, Jonathan E. Duchac) however, it can provide information an unadjusted trial balance to an adjusted trial balance. Another important use of this step is the ability to see if any potential adjustments could have a significant impact. Step six is journalizing and posting adjusting entries, this happens by writing in the adjustments which affect one account in a balance sheet and in the income statement. The seventh step is preparing an adjusted trial balance. Once accounts are up to date and equal financial statements can now be prepared. If the adjusted trial balance is not balanced, then an error has occurred and must be discovered. Preparing financial statements is step eight. This step is where financial statements are finally started. The first statement is the income statement followed by the retained earnings and the balance sheet. The statement can go back to steps two, three, and five and be developed from the adjusted trial balance, ledger, or the end of the period spreadsheet. These statements all support each other, an example of this is how net income or loss on an income statement is reported on a retained earnings statement. Step nine is journalizing and posting closing entries. This step comes into play with four closing entries. The first is debit each revenue account for its balance and credit the income summary for the total revenue. The second one is crediting each expense account for its balance and debit income summary the total expenses. Closing entry three is debiting the income summary its balance and credit the retained earnings statement. The final closing entry is debiting the retained earnings account for the dividends account balance and credit the dividends account. The final step in the accounting cycle is preparing a post-closing trial balance. In this step, the post-closing balance consists of only assets, liabilities, and the owner’s equity. The balance shows that everything has been properly entered in a journal and correctly posted.

For the accounting cycle, there are three major outputs to discuss: the income statement, balance sheet, and the statement of retained earnings. The income statement is developed from the revenue and expense transactions for the current period that’s being inputted into the journal. This output is prepared from the adjusted trials balance column of a spreadsheet. The next output is the balance sheet, which shows the assets, liabilities, and equity. The balance sheet does not show activities over time but is more of a snapshot of a certain period. Sometimes this is unreliable since it doesn’t show the current financial performance (My Accounting Course, 2018) over a year but a certain day. The last output is the statement of retained earnings, this statement is built from retained earnings which are earnings from the net income that the company chooses to keep then distribute among its shareholders.

The accounting cycle is very useful to companies (Anastasia, 2017) and businesses as it allows them to track everything from, among many other things, expenses, assets, liabilities, and revenue. While the cycle may seem complicated, it helps to provide an accurate picture of the status and growth of the company. Helping a company to discover that it is helpful (Carl S. Warren), it is very useful for companies and businesses of all shapes and sizes to close the accounting cycle. It helps them track their successes and failures and by showing a paper trail helps them stay out of any possible legal trouble. The cycle cannot be completed in 10 steps and it can sometimes be completed in 8 or 9 steps. This is a risk that businesses need to look at to ensure that there are no errors.

References

  • Anastasia. (2017, January 2). Cleverism. Retrieved from Understanding the Accounting Cycle: https://www.cleverism.com/understanding-accounting-cycle/
  • Carl S. Warren, James M. Reeve, Jonathan E. Duchac. (2017). Corporate Financial Accounting. Boston: Cengage Learning.
  • My Accounting Course. (2018). My Accounting Course. Retrieved from My Accounting Course, Income Statements: https://www.myaccountingcourse.com/financial-statements/income-statement
  • My Accounting Course. (2018). My Accounting Course. Retrieved from My Accounting Course, Financial Statements: https://www.myaccountingcourse.com/financial-statements
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