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 company’s actions from an accounting perspective, post that depending on the nature of the transaction, they are included in the financial statements of the company.
- The accounting cycle forms an integral base for the company’s financial statements; 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 accounting process.
- The bookkeeper plays an essential role in maintaining 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 adjust entries for any financial transaction.
Purpose of Accounting Cycle
- Out of all the purposes, we are recording and maintaining books so that the company has a systematic approach and does not miss any critical transaction details to be recorded in the books.
- So, considering all the entries are recorded correctly in the statements, it makes it more accessible for the accounting team to analyze the statements. Also, books act as a base for creating financial statements.
- The board or the management of any company, while making a vital decision for the company, always looks at the financial statements, which depict the clear picture regarding essential 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 a 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 further 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 making any further decisions.
Steps of the Accounting Cycle
Steps of the 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 specific procedure which is known as Accounting Cycle; from the definitive purpose, it is divided into eight steps as shown below:
- Transaction: This is the stage that triggers the whole accounting process; any financial transaction in the company must be recorded in the books. Without financial transactions, what will the company keep track of? Transactions can vary, and they might have various kinds like debt payoff, asset purchase, a loan taken, acquisition of any company, etc. Also, the crucial thing is to identify the type of transaction to be recorded accurately in the books.
- Journal Entries: While the transactions are set in motion, there are journal entries to be passed on, recording every transaction in the right books. The entries should be given systematically and chronologically, where all debits and credits should eventually match—commonly known as double entry bookkeeping, where every transaction has two entrances that help 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 step-by-step breakdown of all the recorded accounting activities. A general ledger helps the bookkeeper analyze the company’s financial positions and keep track of the liquidity through the cash account.
- Trial Balance: A 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 the 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 recordings 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 statement 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 records the business transaction in the accounting books. In contrast, the budget cycle maintains the cost of the inventory and other related expenses and constantly compares if the incurred costs align 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, the steps of the accounting cycle, and the difference between the accounting and budget cycles. You may also have a look at the following articles to learn more –