The eight-step accounting cycle is important to know for all types of bookkeepers. It breaks down the entire process of a bookkeeper’s responsibilities into eight basic steps. Many of these steps are often automated through accounting software and technology programs. However, knowing and using the steps manually can be essential for small business accountants working on the books with minimal technical support.
Key Takeaways
- The accounting cycle is a process designed to make the financial accounting of business activities easier for business owners.
- There are usually eight steps to follow in an accounting cycle.
- The closing of the accounting cycle provides business owners with comprehensive financial performance reporting that is used to analyze the business.
- The eight steps of the accounting cycle are as follows: identifying transactions, recording transactions in a journal, posting, the unadjusted trial balance, the worksheet, adjusting journal entries, financial statements, and closing the books.
- Although almost all accounting is done electronically, it still must be thoroughly checked.
What Is the Accounting Cycle?
The accounting cycle is a basic, eight-step process for completing a company’s bookkeeping tasks. It provides a clear guide for the recording, analysis, and final reporting of a business’s financial activities.
The accounting cycle is used comprehensively through one full reporting period. Thus, staying organized throughout the process’s time frame can be a key element that helps to maintain overall efficiency. Accounting cycle periods will vary by reporting needs. Most companies seek to analyze their performance on a monthly basis, though some may focus more heavily on quarterly or annual results.
Regardless, most bookkeepers will have an awareness of the company’s financial position from day to day. Overall, determining the amount of time for each accounting cycle is important because it sets specific dates for opening and closing. Once an accounting cycle closes, a new cycle begins, restarting the eight-step accounting process all over again.
Understanding the 8-Step Accounting Cycle
The eight-step accounting cycle starts with recording every company transaction individually and ends with a comprehensive report of the company’s activities for the designated cycle timeframe. Many companies use accounting software to automate the accounting cycle. This allows accountants to program cycle dates and receive automated reports.
Depending on each company’s system, more or less technical automation may be utilized. Typically, bookkeeping will involve some technical support, but a bookkeeper may be required to intervene in the accounting cycle at various points.
Every individual company will usually need to modify the eight-step accounting cycle in certain ways in order to fit with their company’s business model and accounting procedures. Modifications for accrual accounting versus cash accounting are usually one major concern.
Companies may also choose between single-entry accounting versus double-entry accounting. Double-entry accounting is required for companies to build out all three major financial statements: the income statement, balance sheet, and cash flow statement.
The 8 Steps of the Accounting Cycle
The eight steps of the accounting cycle include the following:
Step 1: Identify Transactions
The first step in the accounting cycle is identifying transactions. Companies will have many transactions throughout the accounting cycle. Each one needs to be properly recorded on the company’s books.
Recordkeeping is essential for recording all types of transactions. Many companies will use point of sale technology linked with their books to record sales transactions. Beyond sales, there are also expenses that can come in many varieties.
Step 2: Record Transactions in a Journal
The second step in the cycle is the creation of journal entries for each transaction. Point of sale technology can help to combine steps one and two, but companies must also track their expenses. The choice between accrual and cash accounting will dictate when transactions are officially recorded. Keep in mind that accrual accounting requires the matching of revenues with expenses so both must be booked at the time of sale.
Cash accounting requires transactions to be recorded when cash is either received or paid. Double-entry bookkeeping calls for recording two entries with each transaction in order to manage a thoroughly developed balance sheet along with an income statement and cash flow statement.
With double-entry accounting, each transaction has a debit and a credit equal to each other, common in business-to-business transactions. Single-entry accounting is comparable to managing a checkbook. It gives a report of balances but does not require multiple entries.
Step 3: Posting
Once a transaction is recorded as a journal entry, it should post to an account in the general ledger. The general ledger provides a breakdown of all accounting activities by account. This allows a bookkeeper to monitor financial positions and statuses by account. One of the most commonly referenced accounts in the general ledger is the cash account which details how much cash is available.
The ledger used to be the gold standard for recording transactions but now that almost all accounting is done electronically, the ledger is less of an active concern as all transactions are automatically logged.
Step 4: Unadjusted Trial Balance
At the end of the accounting period, a trial balance is calculated as the fourth step in the accounting cycle. A trial balance tells the company its unadjusted balances in each account. The unadjusted trial balance is then carried forward to the fifth step for testing and analysis.
This is the first step that takes place once the accounting period has ended and all transactions have been identified, recorded, and posted to the ledger (this is usually done electronically and automatically, but not always).
The purpose of this step is to ensure that the total credit balance and total debit balance are equal. This stage can catch a lot of mistakes if those numbers do not match up.
Step 5: Worksheet
Analyzing a worksheet and identifying adjusting entries make up the fifth step in the cycle. A worksheet is created and used to ensure that debits and credits are equal. If there are discrepancies then adjustments will need to be made.
In addition to identifying any errors, adjusting entries may be needed for revenue and expense matching when using accrual accounting.
Step 6: Adjusting Journal Entries
In the sixth step, a bookkeeper makes adjustments. Adjustments are recorded as journal entries where necessary.
Step 7: Financial Statements
After the company makes all adjusting entries, it then generates its financial statements in the seventh step. For most companies, these statements will include an income statement, balance sheet, and cash flow statement.
Step 8: Closing the Books
Finally, a company ends the accounting cycle in the eighth step by closing its books at the end of the day on the specified closing date. The closing statements provide a report for analysis of performance over the period.
After closing, the accounting cycle starts over again from the beginning with a new reporting period. Closing is usually a good time to file paperwork, plan for the next reporting period, and review a calendar of future events and tasks.
What Is the Difference Between the Accounting Cycle and the Budget Cycle?
The main difference between the accounting cycle and the budget cycle is the accounting cycle compiles and evaluates transactions after they have occurred. The budget cycle is an estimation of revenue and expenses over a specified period of time in the future and has not yet occurred. A budget cycle can use past accounting statements to help forecast revenues and expenses.
What Are the Steps of the Accounting Cycle in Order?
The steps in the accounting cycle are identifying transactions, recording transactions in a journal, posting the transactions, preparing the unadjusted trial balance, analyzing the worksheet, adjusting journal entry discrepancies, preparing a financial statement, and closing the books.
What Is the Main Purpose of the Accounting Cycle?
The main purpose of the accounting cycle is to ensure the accuracy and conformity of financial statements. Although most accounting is done electronically, it is still important to ensure everything is correct since errors can compound over time.
What Are Some of the Advantages and Disadvantages of Accounting?
Some advantages of accounting are that it provides help in taxation, decision making, business valuation, and provides information to important parties like investors and law enforcement. Some disadvantages are that the information may be biased, can be estimated to a degree, can be manipulated, and that the units used to measure business performance, namely cash, change in value.
The Bottom Line
The eight-step accounting cycle process makes accounting easier for bookkeepers and busy entrepreneurs. It can help to take the guesswork out of how to handle accounting activities. It also helps to ensure consistency, accuracy, and efficient financial performance analysis.
Original Source: Investopedia