The accounting cycle is a systematic, 8-step process that monitors, documents, and analyzes all of the company’s financial activity and transactions. It starts with the completion of a transaction and ends with the issuing of a financial statement and the closure of the books.

One of the primary goals of the accounting cycle is to guarantee that all the financial transactions that took place during the accounting period have been correctly recorded and are reflected in the statements. It is similar to a checklist that needs to be finished before the conclusion of an accounting period.

The accounting cycle of a corporation can be performed on a monthly, quarterly, or annual basis, depending on how frequently the organization requires financial reporting.

Regardless, majority of bookkeepers will be aware of the current financial status of the company on a daily basis. In general, choosing the length of time for each accounting cycle is significant since it helps to define exact dates for opening and closing the books. When one cycle of accounting is complete, another one starts, and the process of accounting is repeated in its entirety.

How does the accounting cycle work?

The first phase in the eight-step accounting cycle is to individually record each transaction a company undertakes. A complete report of the operations that a corporation undertook during the cycle’s given timeframe closes the cycle. Many organizations employ accounting software, which frequently automates the accounting process. Because of this, accountants can set the cycle dates and get automated reports.

Depending on the business, there may be more or less technical automation used in the process. Although a bookkeeper may be required to step in at different points along the accounting process, bookkeeping will typically require the engagement of some sort of technological aid.

Each distinct organization will often need to adjust the eight-step accounting cycle in specific ways in order for it to be consistent with the business model and accounting practices utilized by that specific company. One of the biggest difficulties often arises when switching from cash accounting to accrual accounting.

Moreover, companies can choose between double entry accounting and single-entry accounting. All three of the most crucial financial statements, the income statement, the balance sheet, and the cash flow statement, must be created using double-entry accounting for businesses.

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Accounting cycle fundamentals

It is necessary to have a good comprehension of the fundamental accounting principles in order to have a complete understanding of the accounting cycle. You need to have knowledge of revenue recognition, which refers to the time at which a corporation can record sales revenue, as well as the matching principle, which refers to the process of matching expenses to revenues.

You will be able to produce a balance sheet, an income statement, and a cash flow statement with the help of the key principles will be discussed below because these are the most significant steps in the accounting cycle.

The 8 Steps of the Accounting Cycle

The following is a rundown of each of the eight steps of the accounting cycle:

Step 1: Identifying Transactions

The process of recognizing transactions is the initial phase of the accounting cycle. During the course of the accounting cycle, businesses will engage in a great number of transactions. Each one needs to be entered into the company’s books in the appropriate manner.

Keeping accurate records is necessary for accurately tracking any and all forms of financial transactions. Many businesses will link the point-of-sale (POS) technology they use to their accounting software in order to record sales transactions. In addition to sales, there are also expenses, which can be broken down into a wide variety of subcategories.

Step 2: Recording of Transactions in a Journal

The second stage of the cycle is the creation of journal entries for each transaction. The first two procedures can be integrated with the aid of point-of-sale technology, but businesses must still keep an eye on their spending. When transactions are actually entered into the books as part of the accounting system—cash accounting or accrual accounting—will be decided. The matching of revenues and expenses is required by accrual accounting, therefore both must be recorded at the time the sale is made.

Every time cash is received or paid out, transactions must be documented for cash accounting purposes. Double-entry accounting allows for the management of a properly constructed balance sheet, as well as an income statement, cash flow statement, and balance sheet. This is carried out in order to control the company’s bookkeeping.

Every transaction is documented in double-entry accounting with a debit and a credit that are balanced against one another. A checkbook is an analogy for accounting that uses the single-entry technique. It nevertheless delivers a report of the balances despite not requiring numerous entries.

Step 3: Posting

Once a transaction has been recorded as a journal entry, an entry should be posted to an account in the general ledger. A thorough account-by-account overview of all accounting procedures is provided by the general ledger. This allows a bookkeeper to keep track of each account’s financial conditions and status. One of the general ledger accounts that is referenced to the most frequently is the cash account, which shows how much cash is available.

The ledger was traditionally regarded as the gold standard for recording transactions, but now that almost all accounting is done electronically, the ledger is less important because all transactions are automatically recorded.

Step 4: Unadjusted Trial Balance

As the fourth stage in the accounting cycle, a trial balance is computed at the end of the accounting period. A trial balance provides an organization with information regarding the unadjusted balances of each of its accounts. After that, the unadjusted trial balance is taken to the fifth phase to be tested and analyzed.

Once the accounting period has come to a close and all transactions have been recognized, recorded, and posted to the ledger, the first step that needs to be taken is the one referred to as “posting” (usually done automatically and electronically, but not always).

This step’s objective is to check and make sure that the total debit and credit balance are equal. If those figures do not match, this stage has the potential to catch a lot of problems.

Step 5: Worksheet

At the fifth step of the cycle, an analysis of a worksheet and the determination of adjusting entries are performed. The debits and credits are compared on a worksheet that was specifically designed for that purpose. If there are disparities, modifications will have to be implemented.

When employing accrual accounting, it is possible that adjusting entries will be needed in addition to the identification of any problems.

Step 6: Adjusting Journal Entries

Adjustments are made by a bookkeeper in the sixth step of the process. When it is necessary, adjustments are recorded as entries in the journal.

Step 7: Financial Statements

The seventh step in the process involves the generation of the company’s financial statements once the company has completed all adjusting entries. These financial statements will typically consist of an income statement, balance sheet, and cash flow statement for the majority of businesses.

Step 8: Closing the Books

The eighth and last step of the accounting cycle is when a corporation finishes the cycle by closing its books at the end of the day on a specified closing date.  The closing statements comprise a report that can be used for conducting an examination of performance during the period.

Following the close of an accounting period, a fresh reporting period ushers in the commencement of the cycle all over again. Typically, closing is an excellent time to organize and file paperwork, plan for the subsequent reporting period, and look over a schedule of upcoming activities and obligations.

What is the importance of an accounting cycle?

The accounting cycle is the process that companies and other organizations follow in order to record transactions and generate financial statements. The standardized accounting cycle procedure is vital because it assists business owners, small business owners, and established organizations in closing their books for the accounting period. In addition to this, it is helpful in the generation of financial information, which is necessary for the analysis of financial statements and the management of the firm.

The accounting department makes use of a specialized and comprehensive accounting close checklist that outlines the tasks that need to be finished at the end of each accounting cycle. This checklist includes responsibilities and due dates, as well as documentation of the amount of time spent on completing each task and the necessary approvals. In order to promote accountability and process management, the accounting cycle should make use of a checklist that includes due dates.

Accounting firms can perform a review or audit of the financial statements, as well as drill down to the underlying financial activities and accounting records to test account balances.

Analyzing the results of the financial statements for the accounting cycle period is something that can be done by stakeholders such as the Board of Directors, management, lenders, shareholders, and creditors.

Automating the accounting cycle with accounting software

Accounting software helps automate numerous processes in the accounting cycle and allows you to define cycle dates, receive reports automatically, spot mistakes, and reconcile reports in an easy manner. Based on the characteristics of the accounting software, certified public accountants, bookkeepers, and business owners may not need to intervene or manually conduct various accounting cycle phases.

Even if accounting software is functioning in the background to execute crucial accounting cycle duties, it is still essential for bookkeepers and business owners to understand the procedure and adhere to deadlines.

Key Takeaways

• The accounting cycle is a procedure that consists of eight steps that businesses go through in order to recognize and record their financial transactions.
• In order for businesses to be able to close their books, all of their transactions need to be balanced and free of errors.
• Once the accounting cycle has been closed out, it will be possible to prepare financial statements.