The accounting cycle is used to analyze and summarize business transactions and events, and it helps businesses of all sizes ensure that their financial records are accurate, up-to-date, and in accordance with accepted accounting principles.
So, what does the accounting cycle involve? Lets break it down on a step by step basis...
1) Analyze
Analyzing all of the transactions from the past year, and locating all relevant documents and receipts, is the first step that needs to be taken.
2) General Journal
Next, transactions are recorded in a General Journal, so that there is a central record of all transactions.
3) Posting To The Ledger
Following the journalizing of transactions, they are then transferred and posted to the ledger. This paper / electronic trail is important to verify accuracy and to refer to if accounts are found not to be balancing up later on.
4) The Unadjusted Trial Balance
Next, debit and credit balances are totaled and compared to check that they are equal. This is also when information is compiled from the ledger for use in preparing financial statements.
5) Adjusting
Having recorded and verified external transactions (like utility payments and supply purchases), internal transactions (like unearned revenue and prepaid rent) must now be factored in.
6) The Adjusted Trial Balance
The trial balance, which now encompasses both external and internal transactions, is now checked for accuracy. Credit and debit sums should be equal, otherwise a mistake has been made in one of the earlier steps.
7) Financial Statements
At this stage, a number of important financial statements are created. The Income Statement and Statement of Owner's Equity first, followed by the Balance Sheet.
8) Closing Of The Trial Balance
Permanent accounts now have their balances carried into the next period, while temporary accounts are closed. The last entries made in those accounts are posted to the capital account of the business, after which all balances (expense, revenue, withdrawal, etc.) should be zero.
9) Post-Closing Trial Balance
Finally, comes the post-closing trial balance, which lists the balances of the accounts that were not closed (such as liabilities, assets, and owner's equity). This trial balance helps verify that permanent accounts balance (i.e. that they have equal debit and credit sums) and that all temporary accounts were properly closed.
It is important that business owners understand the steps involved in this accounting cycle. The reason is that they are ultimately responsible for any mistakes, whether by accident or not, in their finances. However, it would be a mistake for them to try and cut costs by doing their own accounting, as any mistakes made may not only be costly, but could also land them in trouble with the tax office.
Hiring a reputable accounting firm is therefore highly advisable. They will offer peace of mind that the accounting cycle is being appropriately followed through with, and will also be able to offer advice on how to better organize the finances of the business in the future.
Author Resource:-
This article was written by an experienced accountant. You can learn more about them, and also find further accounting advice, by visiting: Five Dock Accounting
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