Businesses follow a series of meticulous steps to prepare financial statements. These steps are designed to transform basic financial data into coherent, complete, and accurate reports. This is known as the accounting cycle and helps business owners make financial reporting simpler.
This article will provide an in-depth overview of the accounting process, including the eight main steps and how the best Accounting Software can automate them.
What is the accounting cycle?
The accounting cycle is a complete process that makes it easier for a company’s owner, accountant, or bookkeeper to manage its financial responsibilities. Accounting cycles break down the responsibilities of a bookkeeper into eight steps that identify, analyze, and record financial information. This guideline is a solid guideline to accurately complete your bookkeeping tasks.
Accounting cycles are a comprehensive process that records all transactions of a company from beginning to end. They help businesses stay organized, efficient, and productive. This cycle includes all company accounts including credit, debits, journal entries, financial statements, book closing, and T-accounts.
The accounting cycle’s primary objective is to make sure that all financial transactions during an accounting period are correctly recorded and reflected in the statements. It acts as a checklist that must be completed at the end of an accounting period.
A business can conduct the accounting cycle monthly, quarterly, or annually based on the frequency that financial reports required by the company.
Modifying the accounting cycle
Companies can also alter the steps of an accounting cycle to suit their business models or accounting procedures. The type of accounting method that a company uses is one of the most important modifications. Businesses can choose to follow accrual or cash accounting. They also have the option of choosing between single-entry or double-entry accounting.
Double-entry accounting works well for companies that create all major accounting reports such as the balance, cash flow statement, and income statement.
Also read: What is Advance Invoicing and How to Use It?
8 steps of the accounting cycle
This is a detailed look at each of the eight steps within the accounting cycle. After you have completed all steps, you are ready to move on to the next accounting period.
1. Identify and analyze transactions in the accounting period.
The first step in an accounting cycle is to identify and gather details about transactions that occurred during the accounting period. You will need to identify the transaction’s impact when you are identifying it. Transactions can include expenses, asset acquisitions, borrowing, debt payments, and sales revenue.
2. Keep a record of transactions in a journal.
Next, you need to log your financial transactions in journal entries within your accounting software. Point-of-sale technology is often used by companies to link their books and record financial transactions. It’s important for businesses to track their expenses.
The accounting method and type you use will determine how income and expenses are identified. Accrual accounting will identify financial transactions as they occur. Cash accounting, however, is the process of looking for transactions when cash changes hands.
Double-entry accounting means that every transaction is recorded as a credit/debit in separate journals. This allows for a proper balance sheet and cash flow statement, as well as an income statement. Single-entry accounting, on the other hand, is more similar to managing a checkbook. This accounting does not require multiple entries, but rather gives a balance report.
3. Post transactions to the general ledger.
Transactions are not only recorded in journals but also posted to the general ledger. The general ledger, which serves as a master record for all financial transactions, is an essential aspect of accounting.
You can track the finances of all company accounts by using the general ledger. It breaks down financial activity across different accounts. The cash account is the most important account in a general ledger. It gives you an overview of how much cash you have at any given time.
4. Calculate an unadjusted trial account.
Although you will be performing earlier steps in the accounting cycle, the unadjusted balance of trial balance will be calculated after the period ends. After you have identified, recorded, and posted all transactions, the period will end. This gives you an indication of the unadjusted balance for each account. These balances can then be carried forward to the next stage for analysis and testing.
A business must have an unadjusted test balance. This helps to ensure total debits equal total credits in your financial records. If they don’t, it means that something is missing or misaligned. This step generally detects anomalies such as payments that you believed were collected or invoices that you believed were cleared.
Whatever the situation, an unadjusted balance of trial balance displays all your credit and debits in one table. Next, you will investigate the problem.
5. Analyze the worksheet to identify mistakes.
The fifth step in the accounting cycle is to analyze your worksheets and identify any entries that should be corrected. Every transaction is recorded as a debit or credit. This step involves ensuring that your total credit and debit balances are equal.
This step, in addition to identifying errors and helping match revenue and expenses when accrual accounting is used, is also helpful. Adjustments are required to correct any discrepancies. This is done in the next step.
6. Adjust journal entries to fix errors.
After the accounting period is over, adjust the journal entries to correct any errors or anomalies discovered during the worksheet analysis. This is the last step before creating financial statements. You should double-check everything using a newly adjusted trial amount.
7. Make and present financial statements.
After all, adjustments have been made, financial statements are created. Companies create balance sheets, income statements, and cash flow statements.
The income statement and balance sheet show business events during the previous accounting cycle. A cash flow statement is a common document in businesses. While it’s not required, it can help protect and track your company’s cash flow.
These financial statements are the most important outcome of an accounting cycle. They are essential for anyone who wants to compare your business with other businesses. These financial statements are extremely valuable for business owners. Financial statements can help you keep track of your finances and develop growth strategies.
8. Close the books to close the accounting period.
Finalizing expenses, revenues and temporary accounts at end of the accounting period is the last step. This involves closing temporary accounts such as revenue and transferring net income to permanent accounts, like retained earnings.
The financial statements that you produce after closing the books provide extensive performance analysis for the period. The accounting cycle begins again for the next reporting period.
This is a great time to prepare paperwork and plan for next year’s accounting period.
Accounting cycle time period
The accounting period of a business depends on many factors, including reporting requirements and deadlines. While many companies prefer to review their financial performance monthly, others are more focused on annual or quarterly reports.
Companies must prepare financial statements at the end of each accounting period. Public entities must comply with regulations and submit financial statements before the deadlines.
The accounting cycle vs. budget cycle
The budget cycle and the accounting cycle are not the same things. An accounting cycle only focuses on specific events and reports financial transactions accurately. A budget cycle, however, is focused on future performance and plans for future transactions.
The accounting cycle provides useful information to external users such as investors and stakeholders, while the budget cycle is used for internal management.
Automating the accounting cycle with accounting software
Accounting software automates several steps of the accounting cycle. It allows you to set cycle dates, receive reports automatically and identify inaccuracies. You can also reconcile reports easily. Depending on the software’s capabilities, bookkeepers, licensed public accountants, and business owners won’t need to manually intervene in some accounting cycle steps.
Accounting software may be working behind the scenes to complete critical accounting cycle tasks. However, it is still important for bookkeepers and business owners to understand the process.