The accounting cycle involves a number of steps that are repeated in each reporting period as they correspond to the business processes. They verify the transactions and are implemented to prepare financial statements for internet and external business use. All organizations use some variation of these steps
The accounting cycle involves a number of steps that are repeated in each reporting period as they correspond to the business processes. They verify the transactions and are implemented to prepare financial statements for internet and external business use. All organizations use some variation of these steps to record, analyze and summarize transactions and events of the business. It helps businesses ensure that their financial reporting is accurate and reflects Generally Accepted Accounting Principles, or GAAP.
Analyzing, Journalizing and Posting
Accounting is necessary in everyday business operations to make projections, assess opportunities and secure financing for the business. The first part of the accounting transaction cycle involves analyzing transactions and its source documents that relate to the business processes. For example, a business process may have involved purchasing $10,000 in supplies on account. A double-entry transaction is recorded to recognize the effect on the account balances before recording them in the General Journal. Journalizing the transactions creates a record of all transactions in one document, which prevents mistakes and links debit and credit entries for every transaction.
Preparing the Unadjusted Trial Balance
Once the transactions relating to all business processes for the period are journalized and posted, preparing the unadjusted trial balance helps to ensure that no errors were made by showing that the total debit amounts are equal to the total credit amounts. The unadjusted trial balance also brings together everything from the ledger to use to prepare the financial statements. The account balances are recorded in the same order as the Chart of Accounts and debit and credit balances are totalled and compared to ensure that they are equal.
Adjusting and Preparing the Adjusted Trial Balance
Business processes involving external transactions like supply purchases or utility payments are recorded previously, however internal transactions required adjusting to the trial balance. For example, business processes during the period may involve the use of prepaid rent or unearned revenue, making it necessary to record and adjust the account balances. Preparing the adjusted trial balance involves recording all internal and external transactions and again verifying that all credit and debit balances are equal.
Preparing the Financial Statements
The adjusted trial balance lays out all the information needed to create the financial statements for the business, including the income statement, the statement of owner’s equity and the balance sheet. Businesses may choose to use this information to create other financial statements, summaries or spreadsheets, such as the cash flow statement. They may also use the account balances and information to calculate any necessary liquidity ratios as required.
Closing and Post-Closing the Trial Balance
To prepare for the business processes of the next period, the current period’s accounts must be closed. Any temporary accounts are closed and permanent accounts have their balanced carried forward to the next period. Closed entries are recorded and posted to the capital account once recorded on the income summary account. All revenue expense, withdrawal and income summary balances are then brought to a zero balance. The post-closing balance records the balances of all accounts that were not closed, which generally includes assets, liabilities and owner’s equity. Total debits and total credits should equal one another to ensure that all temporary accounts were closed properly and all permanent accounts balance.
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