Introduction to Accounting Cycle
The accounting cycle is initiated when a transaction takes place in any company, the process consists of analyzing, identifying, and recording the actions of the company from an accounting perspective; post that depending on the nature of transaction they are included in the financial statements of the company.
- The accounting cycle forms an integral base for the financial statements of the company, the accounting method has prescribed rules to follow and record transactions in the financial statements to sustain the accuracy of the financial records.
- Adopting the latest computerized accounting methods, it has become easier for companies to record and maintain uniformity in the process of accounting.
- Book-keeper plays an important role to maintain the accounting process in any company, it is his responsibility to make sure the transactions and business of the company are accurately reflected in the financial statements of the company.
- The accounting cycle includes all types of entries like journal entries, T accounts, credits, and debit, it also makes sure to follow a particular method and do the adjusting entry for any financial transaction.
Purpose of Accounting Cycle
- Out of all the purposes, recording and maintaining books so that the company has a systematic approach and does not miss any important transaction details to be recorded in the books.
- So, considering all the entries are properly recorded in the statements it makes easier for the accounting team to analyze the statements and also the books act as a base for making financial statements.
- The board or the management of any company while taking a vital decision for the company, always have a look at the financial statements which depicts the clear picture regarding important components in the company like cash, assets, loans, and debts.
- Additionally, from a regulatory perspective, it is required for every business to file returns, and if the publicly listed company it even must disclose the financial statements on a public forum for the shareholders to view.
- Different accounting methods result in a different analysis like if the company follows IFRS rules of asset deduction differs from the GAAP method. This change might change the story on paper for the company and it might be a key to take any further decision.
Steps of Accounting Cycle
Steps of accounting cycle explain each step with a diagram:
- For any transaction in the company, there are multiple effects on the books and it has to follow a certain procedure which is known as Accounting Cycle, from the definitive purpose it is divided into 8 steps as shown below:
- Transaction: This is the stage which triggers the whole accounting process, any financial transaction happens in the company must be recorded in the books. Without financial transactions what will the company keep track of, transactions can vary and it might have various kinds like debt payoff, asset purchase, a loan taken, acquisition of any company, and so on. Also, a very crucial thing is to identify the type of transaction or it to be recorded accurately in the books.
- Journal Entries: While the transactions are set in motion there are journal entries to be passed to record every transaction in the right books. The entries should be passed in a systematic and chronological manner, where all debits and credits should eventually match. Commonly known as double entry bookkeeping, where every transaction has two entries which helps to manage and develop a balance sheet, income statement, and cash flow.
- Posting to General Ledger: Now is the time to record these journal entries into the ledger where a summary of all the transactions to the real, individual, or nominal account can be easily seen and analyzed. In short, the General ledger provides a breakdown on all the recorded accounting activities step by step account wise. A general ledger helps the bookkeeper to analyze the financial positions of the company account wise and keep a track of the liquidity through the cash account.
- Trial Balance: Trial balance is prepared at the end of the accounting period, which can be quarterly, monthly, or annually. It calculates the total balance of all the accounts and shows the unadjusted balances in every account.
- Worksheet: With the unadjusted entries in the trial balance, the debits and credits are bound to mismatch, so in this stage, the accountant has to make adjustments that are tracked on the worksheet.
- Adjusting Entries: Towards the end of accounting period adjusting entries must be posted in the respective accounts for accruals or deferrals and are posted as journal entries where necessary.
- Financial Statements: Now finally, with all the data and recording we have it will be easier to prepare a balance sheet, income statement, and cash flow statement using the balances from the entries.
- Closing: Eventually, the company closes the books of accounts at a specified closing date, where revenues and expenses are closed for the upcoming accounting cycle. Only income statements accounts are closed as the income statements reflect the performance during a specific period, unlike the balance sheet.
Difference between the Accounting Cycle and Budget Cycle
- The accounting cycle is used to record the business transaction in the accounting books whereas the budget cycle maintains the cost of the inventory and other related expenses, and constantly compares if the incurred costs are in line with the proposed budget.
- The focus of the accounting cycle is to maintain the books of accounts for accurate recording of transactions and the purpose of the budget cycle depends on the analysis done from the financial statements.
This is a guide to the Accounting Cycle. Here we also discuss the introduction and difference between the accounting cycle and budget cycle along with steps of the accounting cycle. You may also have a look at the following articles to learn more –