The Accounting Cycle

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In retail shops, for instance, "Point-of-Sale" systems scan customer purchases during checkout. One touch of a cash register button print's the customer receipt and makes the appropriate accounting system journal entries at the same time. The firm can still enter other kinds of transactions into the journal manually, of course.

The Importance of Not Missing a Step in the Accounting Cycle

Manuel entry may involve salespeople, bookkeepers, or accountants, using an onscreen form on the computer. Cash on hand and Accounts receivable are both asset category accounts. As a result, Grande's total asset base does not change when the customer pays in cash. F or accounting cycle step 3, transaction entries move from the journal to the general ledger in a process called posting. In the "journal," entries accumulate c hronologically —in order as they occur.

The "ledger," however, organizes entries by account.

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Exhibit 4, below, show the ledger versions of eight accounts. Note that the T-accounts in Exhibits 1 and 4 show only one week of transaction histories. The full ledger, of course, would include the entire accounting period history. Exhibit 4. Eight t-account listings in the general ledger showing one-week of transaction histories. The firm's General Ledger contains all active accounts from the Chart of Accounts.

As a result, once journal entries transfer post to the ledger, anyone can ask for the current balance in any of the firm's accounts.

The Accounting Cycle

Note that they turn to the "ledger" for an answer. Historically, with paper-based accounting systems, journal entries and ledger postings were hand-written entries made by bookkeepers and accountants. With hand-written entries, "Posting" occurred periodically, but not necessarily every day. Note, however, that computer-based accounting systems have brought the first three stages of the accounting cycle closer to being a continuously ongoing process.

It is usual now for accounting system software to capture journal entries and post them to the ledger automatically and continuously. The accounting cycle continues until shortly before the period end. At this point, accountants create a trial balance from ledger entries. Exhibit 5 below is an excerpt from Exhibit 1, focusing on the trial balance positioning between ledger posting and the financial statement reporting.

Exhibit 5. Excerpt from Exhibit 1. The trial balance period begins near the end of the accounting cycle.

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  • The trial balance purpose is to check for errors, close temporary accounts, and provide account balances for publication. All of the firm's active accounts are in view for the trial balance. During the trial balance period, accountants close "temporary" accounts, carry out several kinds of error-checking, and correct errors. The name trial balance derives from one kind of error-check in this period.

    By the rules of double-entry accounting, the sum of all debits made during the period must equal the total of all credits. A mismatch between these sums indicates the presence of a transaction error somewhere in the system. The firm performs other kinds of error-checking during this period as well. With the reconciliation process, for instance, they ensure that the firm's bank cash account balances—as the bank reports them—agree with the firms own accounting system. The full accounting cycle diagram is presented in Figure.

    Since his Marines career included several years of logistics, he is also going to operate a consulting practice where he will help budding barbers create a barbering practice. He will charge a flat fee or a per hour charge. His consulting practice will be recognized as service revenue and will provide additional revenue while he develops his barbering practice. Figure shows his transactions from the first month of business.

    The complete journal for August is presented in Figure.

    Once all journal entries have been created, the next step in the accounting cycle is to post journal information to the ledger. The ledger is visually represented by T-accounts. Cliff will go through each transaction and transfer the account information into the debit or credit side of that ledger account. Any account that has more than one transaction needs to have a final balance calculated. This happens by taking the difference between the debits and credits in an account.

    The final debit or credit balance in each account is transferred to the unadjusted trial balance in the corresponding debit or credit column as illustrated in Figure.

    What is Accounting Cycle?

    Once all of the account balances are transferred to the correct columns, each column is totaled. The total in the debit column must match the total in the credit column to remain balanced. Remember, the unadjusted trial balance is prepared before any period-end adjustments are made. On August 31, Cliff has the transactions shown in Figure requiring adjustment. Now that all of the adjusting entries are journalized, they must be posted to the ledger.

    Posting adjusting entries is the same process as posting the general journal entries.

    The Accounting Cycle

    Each journalized account figure will transfer to the corresponding ledger account on either the debit or credit side as illustrated in Figure. We would normally use a general ledger, but for illustrative purposes, we are using T-accounts to represent the ledgers. The T-accounts after the adjusting entries are posted are presented in Figure.

    The final debit or credit balance in each account is transferred to the adjusted trial balance, the same way the general ledger transferred to the unadjusted trial balance. The next step in the cycle is to prepare the adjusted trial balance. Once the adjusted trial balance is prepared, Cliff can prepare his financial statements step 7 in the cycle. We only prepare the income statement, statement of retained earnings, and the balance sheet.

    The statement of cash flows is discussed in detail in Statement of Cash Flows. To prepare your financial statements, you want to work with your adjusted trial balance.

    Key Accounting Steps for Your Business

    Remember, revenues and expenses go on an income statement. Dividends, net income loss , and retained earnings balances go on the statement of retained earnings. For the first month of operations, Cliff welcomes any income. Cliff will want to increase income in the next period to show growth for investors and lenders. Calculate the trial balance by adding all debit balances together and all credit balances together.

    Check to make sure the two totals are the same. A bookkeeper may also have to account for accruals and deferrals in their records as well. Accruals are revenues or expenses that were incurred, but were not previously recorded. Deferrals are receipts of payments made in advance or upcoming expenses.

    The Accounting Cycle -

    If the debit total and credit total on a trial balance are unequal, the bookkeeper will have to adjust their entries and search for errors that are then tracked on a worksheet. Some bookkeepers choose to adjust their entries after they adjust the trial balance. This is a matter of preference, and as long as the trial balance is checked again after accounting for accruals and deferrals, their order does not matter. Once a bookkeeper has adjusted their entries and trial balance, they can use their up-to-date accounts to create financial statements.

    These statements include income statements which compare profits and losses across the accounting period. The statements themselves are a good measure of performance across the period. Your business can review these statements and use them for the basis of goals in the new accounting period. Revenue and expense accounts are zeroed and closed since they are only intended for a single accounting period so a business can track their profit and loss between periods.

    Once books for an accounting period are closed, businesses should start setting up their accounting for the upcoming period. Although they may resemble each other, the accounting cycle and budget cycle are different. The accounting cycle focuses on financial events that have already happened and ensures they have been recorded correctly. The budget cycle, on the other hand, focuses on planning for the financial future of a business. While it seems like a ton of record keeping, adhering to an accounting cycle is crucial for businesses. Here are a couple of reasons why.

    Efficiency — Having a formalized process and tools for financial record keeping ensures that bookkeepers have a clear roadmap to follow when recording information, which streamlines the process and makes it less prone to error. These insights allow companies to locate which processes and practices are the most profitable.