Understanding the Accounting Cycle: Step-By-Step Breakdown

Enter Transactions into the Journal.

After being identified, they are recorded in a journal.

This is called journalising. Each entry records:

• The date.
• The accounts affected.
• The amounts.
• A short description.

The accounting process and cycle is always based on the system of double-entry. That means:

In all transactions, there are two sides.

One account is debited, another account is credited. This maintains the books in balance.

Post to the Ledger

Upon recording of journal entries they get transferred into the ledger.

The ledger lumps together similar transactions into such accounts as:

• Cash
• Sales
• Expenses
• Equipment
• Wages

The journal, in case it is a diary, is the ledger, which is a filing cabinet. This accounting process would assist the businesses in viewing sums of money in each account.

Write Up the Unadjusted Trial Balance.

Then accountants make a trial balance.

This is nothing but a list of all ledger accounts and balances. It checks whether:

• Total debits = Total credits.

In case they do not coincide, there was some mistake in the process previously.

The trial balance will not ensure that no mistakes are made. It merely establishes the fact that debt and credit amounts are equal.

Make Adjusting Entries

There are transactions that are not registered on a daily basis. These require the adjustment of entries at the end of the period.

Common adjustments include:

• Unpaid wages and other accrued expenses.
• Expenses paid in advance (such as insurance in advance).
• Depreciation of equipment.
• Accrued income,

This aspect of the accounting process is important in ensuring that incomes and expenses are accrued within the right period.

It is based on the principle of accrual accounting which states:

• Record income when earned.
• Expenses to be recorded at the time they occur.
• Not when cash changes hands.

Prepare the Adjusted Trial Balance.

A new trial balance is prepared after recalculations. In this version, the figures are updated. It ensures:

• All accounts are accurate.
• Debits still equal credits.

This is a modified version required during the accounting cycle process prior to the preparation of final reports.

Consolidated Financial Statements.

Businesses prepare financial reports using adjusted trial balance. These usually include:

• Income Statement

Indicates profit or loss within a period of time.

• Financial Position (Balance Sheet).

Discloses assets, liabilities and equity.

• Cash Flow Statement

Tracks the movement of cash within and out.

These reports assist the owners, investors, and banks to know the health of the company.

This phase indicates the importance of the accounting process and cycle. These reports would be misguided without the preceding steps.

Closing the Books

Closing of temporary accounts is the last operation of the bookkeeping cycle.

Temporary accounts include:

• Revenue.
• Expenses.
• Drawings.

Their balances are moved into retained earnings. After closing:

• The revenue accounts are brought back to zero.
• Expense accounts are brought back to zero.
• The new period starts fresh
• Then the cycle of accounting starts all over again.

Accounting Cycle in Real Life.

Suppose that we consider a small cupcake store.

Step 1:

The shop sells £200 of cupcakes.

Step 2:

It registers the sale in the journal.

Step 3:

The sale is recorded on Sales and Cash accounts.

Step 4:

At the end of the month, a trial balance is made.

Step 5:

The owner understands that electricity of £50 has been used but not paid. An adjusting entry is made.

Step 6:

A modified trial balance is developed.

Step 7:

A profit is to be seen in an income statement.

Step 8:

The new month is closed in terms of revenue and expenses.

This basic illustration reveals why the bookkeeping cycle ensures everything is in order. 

To learn more about managing small businesses, check out our guide on how to start and manage a business.

Major Theories That Enable the Accounting Cycle to Operate.

There are some basics to know when it comes to the accounting steps.

Double-Entry System

Each debit is accompanied by a credit.

Accrual Accounting

Recognise revenue when it is earned and not when received.

Consistency

The same applies with businesses every period.

Accuracy

The process verifies the one before it.

These regulations render the accounting process and cycle dependable and dependable. You can learn more from our guide on accounting terms.

Common Mistakes.

Errors may occur even with a system.

Here are some common issues:

• Omission of recording transactions.
• Posting to the wrong account.
• Skipping adjusting entries.
• Mathematical errors.

Failure to close accounts in the right manner.

These errors are minimised by examining every phase of the bookkeeping cycle carefully.

The Influence of Technology on Changing the Financial Cycle.

Previously, it was all hand-operated. Software today accomplishes it at a faster pace.

The modern accounting software can:

• Recording transactions automatically.
• Post to ledgers instantly.
• Generate trial balances.
• Prepare financial reports.

Nevertheless, the accounting cycle process is the same. Nothing more than software automates the steps.

It is still necessary to have the bare minimum knowledge, though computers may do all the heavy lifting.

Who Uses the Accounting Cycle?

The accounting cycle is relied on by many people:

• Business owners.
• Accountants.
• Auditors.
• Investors.
• Banks.
• Government tax authorities.

It generates credible accounting data that is trusted by all.