The 8 Important Steps in the Accounting Cycle - Investopedia

The eight steps of the accounting cycle are as follows: identifying transactions, recording transactions in a journal, posting, the unadjusted trial balance, ... Business CorporateFinance&Accounting CorporateFinance&Accounting GuidetoAccounting FinancialAnalysis CorporateFinance FinancialStatements FinancialRatios Accounting Debt Mergers&Acquisitions CorporateInsurance SeeAll Theeight-stepaccountingcycleisimportanttoknowforalltypesofbookkeepers.Itbreaksdowntheentireprocessofabookkeeper’sresponsibilitiesintoeightbasicsteps.Manyofthesestepsareoftenautomatedthroughaccountingsoftwareandtechnologyprograms.However,knowingandusingthestepsmanuallycanbeessentialforsmallbusinessaccountantsworkingonthebookswithminimaltechnicalsupport. KeyTakeaways Theaccountingcycleisaprocessdesignedtomakefinancialaccountingofbusinessactivitieseasierforbusinessowners.Thereareusuallyeightstepstofollowinanaccountingcycle.Theclosingoftheaccountingcycleprovidesbusinessownerswithcomprehensivefinancialperformancereportingthatisusedtoanalyzethebusiness.Theeightstepsoftheaccountingcycleareasfollows:identifyingtransactions,recordingtransactionsinajournal,posting,theunadjustedtrialbalance,theworksheet,adjustingjournalentries,financialstatements,andclosingthebooks. WhatIstheAccountingCycle? The accountingcycle isabasic,eight-stepprocessforcompletingacompany’sbookkeepingtasks.Itprovidesaclearguidefortherecording,analysis,andfinalreportingofabusiness’sfinancialactivities. Theaccountingcycleisusedcomprehensivelythroughonefullreportingperiod.Thus,stayingorganizedthroughouttheprocess’stimeframecanbeakeyelementthathelpstomaintainoverallefficiency.Accountingcycleperiodswillvarybyreportingneeds.Mostcompaniesseektoanalyzetheirperformanceonamonthlybasis,thoughsomemayfocusmoreheavilyonquarterlyorannualresults. Regardless,mostbookkeeperswillhaveanawarenessofthecompany’sfinancialpositionfromday-to-day.Overall,determiningtheamountoftimeforeachaccountingcycleisimportantbecauseitsetsspecificdatesforopeningandclosing.Onceanaccountingcyclecloses,anewcyclebegins,restartingtheeight-stepaccountingprocessalloveragain. Understandingthe8-StepAccountingCycle Theeight-stepaccountingcyclestartswithrecordingeverycompanytransactionindividuallyandendswithacomprehensivereportofthecompany’sactivitiesforthedesignatedcycletimeframe.Manycompaniesuseaccountingsoftwaretoautomatetheaccountingcycle.Thisallowsaccountantstoprogramcycledatesandreceiveautomatedreports. Dependingoneachcompany’ssystem,moreorlesstechnicalautomationmaybeutilized.Typically,bookkeepingwillinvolvesometechnicalsupport,butabookkeepermayberequiredtointerveneintheaccountingcycleatvariouspoints. Everyindividualcompanywillusuallyneedtomodifytheeight-stepaccountingcycleincertainwaysinordertofitwiththeircompany’sbusinessmodelandaccountingprocedures.Modificationsforaccrualaccountingversuscashaccountingareusuallyonemajorconcern. Companiesmayalsochoosebetweensingle-entryaccountingversusdouble-entryaccounting.Double-entryaccountingisrequiredforcompaniestobuildoutallthreemajorfinancialstatements:theincomestatement,balancesheet,andcashflowstatement. The8StepsoftheAccountingCycle Theeightstepsoftheaccountingcycleincludethefollowing: Step1:IdentifyTransactions Thefirststepintheaccountingcycleisidentifyingtransactions.Companieswillhavemanytransactionsthroughouttheaccountingcycle.Eachoneneedstobeproperlyrecordedonthecompany’sbooks. Recordkeepingisessentialforrecordingalltypesoftransactions.Manycompanieswillusepointofsaletechnologylinkedwiththeirbookstorecordsalestransactions.Beyondsales,therearealsoexpensesthatcancomeinmanyvarieties. Step2:RecordTransactionsinaJournal Thesecondstepinthecycleisthecreationofjournalentriesforeachtransaction.Pointofsaletechnologycanhelptocombinestepsoneandtwo,butcompaniesmustalsotracktheirexpenses.Thechoicebetweenaccrualandcashaccountingwilldictatewhentransactionsareofficiallyrecorded.Keepinmind,accrualaccountingrequiresthematchingofrevenueswithexpensessobothmustbebookedatthetimeofsale. Cashaccountingrequirestransactionstoberecordedwhencashiseitherreceivedorpaid.Double-entrybookkeepingcallsforrecordingtwoentrieswitheachtransactioninordertomanageathoroughlydevelopedbalancesheetalongwithanincomestatementandcashflowstatement. Generallyacceptedaccountingprinciples(GAAP)andInternationalFinancialReportingStandards(IFRS)bothrequirepubliccompaniestoutilizeaccrualaccountingfortheirfinancialstatements. Withdouble-entryaccounting,eachtransactionhasadebitandacreditequaltoeachother.Single-entryaccountingiscomparabletomanagingacheckbook.Itgivesareportofbalancesbutdoesnotrequiremultipleentries. Step3:Posting Onceatransactionisrecordedasajournalentry,itshouldposttoanaccountinthegeneralledger.Thegeneralledgerprovidesabreakdownofallaccountingactivitiesbyaccount.Thisallowsabookkeepertomonitorfinancialpositionsandstatusesbyaccount.Oneofthemostcommonlyreferencedaccountsinthegeneralledgeristhecashaccountthatdetailshowmuchcashisavailable. Step4:UnadjustedTrialBalance Attheendoftheaccountingperiod,a trialbalance iscalculatedasthefourthstepintheaccountingcycle.Atrialbalancetellsthecompanyitsunadjustedbalancesineachaccount.Theunadjusted trialbalanceisthencarriedforwardtothefifthstepfortestingandanalysis. Step5:Worksheet Analyzingaworksheetandidentifyingadjustingentriesmakeupthefifthstepinthecycle.Aworksheetiscreatedandusedtoensurethatdebitsandcreditsareequal.Iftherearediscrepanciesthenadjustmentswillneedtobemade. Inadditiontoidentifyinganyerrors,adjustingentriesmaybeneededforrevenueandexpensematchingwhenusingaccrualaccounting. Step6:AdjustingJournalEntries Inthesixthstep,abookkeepermakesadjustments.Adjustmentsarerecordedasjournalentrieswherenecessary. Step7:FinancialStatements Afterthecompanymakesalladjustingentries,itthengeneratesitsfinancialstatementsintheseventhstep.Formostcompanies,thesestatementswillincludeanincomestatement,balancesheet,andcashflowstatement. Step8:ClosingtheBooks Finally,acompanyendstheaccountingcycleintheeighthstepbyclosingitsbooksattheendofthedayonthespecifiedclosingdate.Theclosingstatementsprovideareportforanalysisofperformanceovertheperiod. Afterclosing,theaccountingcyclestartsoveragainfromthebeginningwithanewreportingperiod.Atclosingisusuallyagoodtimetofilepaperwork,planforthenextreportingperiod,andreviewacalendaroffutureeventsandtasks. TheBottomLine Theeight-stepaccountingcycleprocessmakesaccountingeasierforbookkeepersandbusyentrepreneurs.Itcanhelptotaketheguessworkoutofhowtohandleaccountingactivities.Italsohelpstoensureconsistency,accuracy,andefficientfinancialperformanceanalysis. CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. Provider Name Description RelatedArticles Accounting TheDifferenceBetweenaGeneralLedgerandaGeneralJournal CareerAdvice Bookkeepingvs.Accounting:What'stheDifference? Accounting HowtoUseExcelasaGeneralAccountingLedger FinancialAnalysis HowDoesDepreciationAffectCashFlow? Accounting HowDidtheFieldofAccountingEvolve? Accounting Accrualvs.AccountsPayable:What'stheDifference? PartnerLinks RelatedTerms AccountingCycle Theaccountingcyclerecordsandanalyzesaccountingeventsrelatedtoacompany'sactivities. more WhatisanAdjustingJournalEntry? Anadjustingjournalentryoccursattheendofareportingperiodtorecordanyunrecognizedincomeorexpensesfortheperiod. more WhatIsReconciliationinAccounting? Reconciliationisanaccountingprocessthatcomparestwosetsofrecordstocheckthatfiguresarecorrect,andcanbeusedforpersonalorbusinessreconciliations. more HowGeneralLedgersWork Ageneralledgeristherecord-keepingsystemforacompany’sfinancialdata,withdebitandcreditaccountrecordsvalidatedbyatrialbalance. more AccruedRevenueDefinition Accruedrevenue—anassetonthebalancesheet—isrevenuethathasbeenearnedbutforwhichnocashhasbeenreceived. more WhatIsanAccruedExpense? Anaccruedexpenseisrecognizedonthebooksbeforeithasbeenbilledorpaid. more