Accounting Cycle is a continuous process followed to accurately record, classify and report the financial activities of an organization. This process takes place over a period of time (usually a year or a quarter). The steps in the accounting cycle are as follows:
1. Identifying Transactions:
Among the financial activities of the organization, those that need to be recorded are identified. For example, sale, purchase, repayment of debt, payment of salary etc.
Example 01: A company purchased goods for $50,000 in cash.
2. Journal Entries (Journalizing Transactions):
Transactions are recorded in the journal, i.e. debit and credit entries are made for the transactions.
Example 02: Goods purchase in cash,
Debit: Goods $50,000)
Credit: Cash $50,000
3. Posting to Ledger:
Each transaction is transferred from the journal to the ledger, where it is recorded on a separate page for each account. It helps in classification of transactions.
Example 03:
The debit entry to the product account will be $50,000.
Credit entry to cash account will be $50,000.
4. Adjustment (Adjusting Entries):
Some transactions or accounts need to be reconciled due to timing and other reasons. For example, inventory depreciation, prepaid expenses etc.
Example 04: Depreciation of a machine $10,000 is adjusted as:
Debit: Depreciation Expense $10,000)
Credit: Accumulated Depreciation $10,000)
5. Preparing Trial Balance:
A trial balance is created to verify the equality of debits and credits. This is a list of all ledger account balances.
Example 05:
Debit Balance in Product Account: $50,000.
Credit Balance in Cash Account: $50,000.
6. Adjusted Trial Balance:
After the adjusting entry, an adjusted trial balance is created, which is used to prepare the financial statements.
7. Preparing Financial Statements:
Financial reports such as income statement, balance sheet, cash flow statement are prepared from the adjusted trial balance.
Example 06: The income statement showed that the net profit of the company was $20,000.
8. Closing the Books:
At the end of the year all temporary accounts (such as income and expenditure) are closed and transferred to permanent accounts.
9. Post-Closing Trial Balance:
After closing all the accounts, a post-closing trial balance is created which contains the balance of the permanent accounts.
Thus, the accounting cycle is completed, and it is ready for the next accounting year.
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