What Is the Accounting Cycle? (With Steps and Examples)

The accounting cycle is a series of steps used by an accounting department to document and report a company's financial transactions. The cycle follows ... FindjobsCompanyreviewsFindsalariesUploadyourresumeSigninSigninEmployers/PostJobStartofmaincontent CareerGuideCoronavirusJobResourcesFindingaJobMoreResumes&CoverLettersInterviewingStartingaNewJobResumeSamplesPay&SalaryCareerDevelopmentCareerPathsCoverLetterSamplesCoronavirusJobResourcesFindingaJobResumes&CoverLettersInterviewingStartingaNewJobMoreResumeSamplesPay&SalaryCareerDevelopmentCareerPathsCoverLetterSamplesCareerGuideCareerDevelopmentWhatIstheAccountingCycle?(WithStepsandExamples)WhatIstheAccountingCycle?(WithStepsandExamples)ByAnastasiaHinojosaJuly1,2021TwitterLinkedInFacebookEmailCopytoClipboardAnastasiaHinojosaisanexperiencedfinancialaccountantwithdegreesfromTexasA&M-CorpusChristiandColumbiaUniversity.Shehasworkedinthehealthcarefieldforovertenyears.Bylearningthenecessaryprocessesandterminologyofaccounting,yougainfundamentalknowledgeofacompany’sfinances.Inthisarticle,wediscusstheeightstepsoftheaccountingcycleprocesswithexamplesandexplainhowitdiffersfromabudgetcycle.LookingtoHire?PostaJobonIndeed.com.Whatistheaccountingcycle?Theaccountingcycleisaseriesofstepsusedbyanaccountingdepartmenttodocumentandreportacompany'sfinancialtransactions.Thecyclefollowsfinancialtransactionsfromwhentheyoccurtohowtheyaffectfinancialdocuments.Theaccountingcyclehappenseveryaccountingperiodorreportingperiodforwhichfinancialdocumentsareprepared.Thefinalstep—theclosingprocess—canoccurasa“softclose”throughoutthefiscalyear,buta“hardclose”onlyhappensattheendofthefiscalyear.A“softclose”closesthegeneralledgerforthataccountingperiodsothatnewjournalentriescan’tbebooked.Thisoccurssothatfinancialdocumentscanbepreparedforthatperiodwithouttheaccountbalanceschanging.Thehardcloseprocessmovestransactionsfromtemporaryaccounts—accountsontheincomestatement—topermanentaccounts,whichareaccountsonthebalancesheet.Thisprocessisimportantasitguaranteesprecisionandaccuracythroughoutacompany'sfiscalyears.Related:Accounting:DefinitionsandSpecializationsTheeightstepsoftheaccountingcycleTheaccountingcycleconsistsofeightstepsthataccountantsshouldfollowtorecordtransactionsandcheckfordataaccuracy.Stepsonethroughsevenoccureveryaccountingperiod—regardlessoflength—whilestepeightonlyoccursattheendofthefiscalyear:1.AnalyzetransactionsThefirststepintheaccountingcycleistoanalyzeeventstodetermineiftheyare“transactions”andwhattheirimpactis.Transactionsincludeanycompanypurchasesthatweremade,debtspaid,debtsacquiredorrevenueacquiredfromsales.Eventsthatarenotconsideredtransactionsincludecreatingpurchaseordersandsigningcontracts.Transactionsarethestartingpointfromwhichtherestoftheaccountingcyclewillfollow.Example:Acompanyreceives$300insalesontheirsoftwareproducts.Thisisthestartingpointoftheaccountingcycleforthistransaction.Readmore:7EffectiveMethodsforAnalyzingData2.RecordjournalentriesThenextstepintheaccountingcycleistorecordthesefinancialtransactionsasjournalentries.Thisshouldbedonebyfollowingachronologicalorder.Youneedtounderstandtheimpactofthetransaction—fromstepone—tocreatethejournalentry.Ajournalentryhasadebitandacreditwhichrelatestohowatransactionaffectsdifferentaccounts.Whetheranaccountisdebitedorcreditedisdeterminedbyhowthebalanceofthataccountistracked.Forexample,cashandreceivableaccountshavedebitbalances—increasedwithdebits,decreasedwithcredits—andrevenueaccountshavecreditbalances—increasedwithcredits,decreasedwithdebits.Thepersonenteringthetransactiondataintothejournalentriesmustmakesurethatthedebitsandcreditsarebalanced.Example:The$300transactionisenteredbasedonthedateitoccurredtoalignwiththechronologicalorderoftheothertransactionentries.A$300cashsalewillinvolveaDebitof$300toCashandaCreditof$300toSalesRevenue.Related:WhatIsDebitvs.CreditinAccounting?3.PostentriestothegeneralledgerAledgeraccountisacollectionofalljournalentriesthatdebitorcreditthataccount.Thegeneralledgeristhemastersetofallledgeraccounts.Thegeneralledgerkeepstrackofacompany'sentirefinancialactivity.Whenyouposttothegeneralledger,yourecordasummaryoftheactivityforeachledgeraccount.Example:Iftoday’stransactionsincludedacashsaleof$300,acashsaleof$200andacashrefundof$100,thenthesummarizedCashtransactionswouldbeadebitof$400.Companiesdifferinhowtheytrackrefunds,butlet’sassumethesummarizedSalesRevenuetransactionswouldbeacreditof$500withasummaryofadebitof$100recordedinSalesReturnsandAllowances—a“contraaccount,”whichmeansitoffsetsaregularrevenueaccountandhasadebitbalance.Readmore:AccountingLedgervs.Journal:What’stheDifference?4.PrepareanunadjustedtrialbalanceAttheendofeachaccountingperiod,acompany'saccountingdepartmentshouldenterthedatafromtheledgeraccountsintoatrialbalance.Thistrialbalanceisalsocalled“theunadjustedtrialbalance”becauseitispreparedbeforeadjustedentries—stepsix—beingentered.Theunadjustedtrialbalanceispreparedsothataccountantscancatchanyerrorsthatmayhaveoccurredduringtheinitialstagesoftheaccountingcycle.Atrialbalanceisconsideredsuccessfulifthedebitaccountbalancesequalthecreditaccountbalances.Eveniftheunadjustedtrialbalanceisbalanced,youmustconductstepfiveasothererrorsmayhaveoccurred.Example:Tokeepthissimple,let’sprepareatrialbalanceforonedaywhileignoringCostofGoodsSold.Topreparethetrialbalance,youneedtocompiledatafromallledgeraccounts.Let’ssaythecompanyalsohad$700increditsales—adebitof$700toAccountsReceivableandacreditof$700toSalesRevenue—andbought$200ofinventoryoncreditfromavendor—acreditof$200toAccountsPayableandadebitof$200toInventory.Takingintoaccounttheinformationfrombefore,youhavedebitbalancesof$400(Cash),$700(AccountsReceivable),$200(Inventory)and$100(SalesRefundsandAllowances).Youhavecreditbalancesof$1,200(SalesRevenue)and$200(AccountsPayable).Thisgivesyoutotaldebitsof$1,400andtotalcreditsof$1,400.Realtrialbalanceswillinvolvenumerousaccounts.Related:WhatIsaTrialBalance?HowToPrepareaTrialBalance(WithExamples)5.CheckaccuracyofworksheetsThisstepisrequiredwhenthedebitsandcreditsofatrialbalancearenotequal.Thetransactiondataenteredintopastjournalentriesmustbereviewedtofindtheerror.Anothererrormayincludepostingtothewrongaccounts.Forthiserror,debitsandcreditswillequal,butanaccountantwillnoticeunusualaccountactivityorbalances.Tofixtheseerrors,youwillneedtoenterjournalentriestoreversetheincorrectentriesandenterthecorrectones.Example:Iftheaccountantconductsatrialbalanceandfindsthatthereare$900indebitsand$1,200incredits,theymustgothroughpreviousjournalentriestoidentifythemissing$300amount.Mostaccountingsoftwarewillnotallowunbalancedjournalentriestopost;however,tomanuallyfindthesetypesoferrors,youcaneitherlookatentriesindividuallyorcomparecorrespondingaccounts—likeAccountsReceivableandSalesRevenue—totrytofindobviousmistakes.Related:7AccountingTasksandDuties6.RecordadjustingentriesThissteprequirestheusageofthematchingprincipletoorganizecompanytransactionsintotheappropriateaccountingperiods.AdjustmentsaregroupedintoDeferralsandAccruals.Usingthematchingprinciple,accountantscanexaminedeferralsandaccrualstodetermineiftheywillbefactoredintoacompany'stotalrevenueorunearnedrevenueforthefiscalperiod.Acommondeferralisaprepaidexpense—forexample,rent—andacommonaccrualisapayableexpensesuchassalaryandwages.Example:InJanuary,thecompanypays$12,000inrentforthewholeyear($1,000amonth).Theoriginaljournalentrywasa$12,000debittoRentExpenseanda$12,000credittoCash.Attheendoftheaccountingperiod(inthiscase,amonth),theadjustingentrywouldbean$11,000debittoPrepaidRentandan$11,000credittoRentExpense.Thisreflectsthatonly$1,000ofrentwasactuallyusedinJanuary.Fortheremainingelevenaccountingperiods,theadjustingentrywillbea$1,000debittoRentExpenseanda$1,000credittoPrepaidRent.TheaccountantcouldalsohavedonetwojournalentriesinJanuary:(1)a$12,000debittoPrepaidRentanda$12,000credittoRentExpense,and(2)a$1,000debittoRentExpenseanda$1,000credittoPrepaidRent.Entry#1fixestheincorrectentrywhileEntry#2recordsthecorrecttransaction.Technically,aslongastheneteffectisthat,asofJanuary31,$11,000isinPrepaidRentandonly$1,000isinRentExpense,theneithermethodisfine.Readmore:Accrualvs.Deferral:DefinitionsandDifferences7.OrganizefinancialstatementsOncealladjustingentriesarecompletedandyouensurethedebitsandcreditsstillbalance,thenyoucanpreparetheAdjustedTrialBalanceaswellasthefinancialstatements.Financialstatementsarepreparedinthisorder:IncomeStatement,StatementofRetainedEarnings,BalanceSheetandStatementofCashFlows.OncetheAdjustedTrialBalanceisfinalized,thebalanceforeachaccountisreportedontheIncomeStatement,theStatementofRetainedEarningsortheBalanceSheet.NoindividualaccountfromtheAdjustedTrialBalancewillbeonmorethanoneofthese.TheAdjustedTrialBalancedoeslistthebeginningbalanceforRetainedEarnings,butthisspecificnumberonlyappearsatthebeginningoftheStatementofRetainedEarningsandnotdirectlyontheBalanceSheet.TheorderthatyoupreparethefinancialdocumentsisimportantbecausethenetincomefromtheIncomeStatementwillbeusedtopreparetheStatementofRetainedEarnings,andtheendingbalanceontheStatementofRetainedEarningswillbeusedtopreparetheBalanceSheet.TheStatementofCashFlowsispreparedlastbecauseitusesinformationfromthefirstthreestatements.Example:Let’ssayyourincomestatementshowsTotalRevenuesof$1000andTotalExpensesof$500.YourNetIncomeisTotalRevenues-TotalExpenses=$500.This$500ismovedtoRetainedEarningsattheendofthefiscalyearduringtheclosingprocess.Let’ssayyourbeginningRetainedEarningsbalanceis$200.TheAdjustedTrialBalancewouldlistthis$200balanceforRetainedEarnings.FortheStatementofRetainedEarnings,youstartwiththe$200.Youadd$500fromnetincome.Assumingthecompanydidnotpaydividends,theendingbalanceforRetainedEarningsis$700.TheendingbalanceforRetainedEarningsisthenusedtopreparetheBalanceSheet.ItwillappearundertheEquitysection.TheStatementofCashFlowstakesinformationfromtheotherstatementstocharacterizecashflowsas“inflows”or“outflows.”TheseflowsarethencategorizedasOperating,Investing,orFinancing.8.ClosetemporaryaccountsThelaststageoftheaccountingcycleistheclosingoftemporaryaccounts.AccountsthatappearontheIncomeStatementaretemporaryaccountsthatareclosedout—alsoreferredtoas“zeroedout”—attheendofthefiscalyear.ThebalancesfromtheseaccountsaremovedtopermanentaccountsontheBalanceSheet.Themainpurposeofzeroingouttheincomestatementaccountsistoallowforrevenuesandexpensestobetrackedaneweachfiscalyear.Duringthefiscalyear,youcanalsodoa“softclose.”Ifyoupreparefinancialstatementsmonthly,thenFebruary’sbookswillbeclosedduringthebeginningofMarch,whichwillpreventnewjournalentriesfrombeingenteredwithaFebruarypostdate.Ifyoupreparefinancialstatementsquarterly,thenyoumaykeepthebooksopenforthreemonthsatatime.Softclosesdonotpermanentlyclosethebooks,soentriescanstillbeenteredafterclosewithmanagement’sapproval.Temporaryaccountsarenotzeroedoutforsoftcloses.Example:Attheendofthefiscalyear,theaccountantwilldebitthetotalofallrevenueaccountswithacorrespondingcredittoRetainedEarnings.TheaccountantwillalsocreditthetotalofallexpenseaccountswithacorrespondingdebittoRetainedEarnings.TheneteffecttoRetainedEarningsshouldequalthenetincome—anoverallincreasetoRetainedEarnings—ornetloss—anoveralldecreasetoRetainedEarnings—forthefiscalyear.Youcanchecktheaccuracyofyourjournalentriesbycomparingthenumberstothefinancialstatementsthatyoupreparedinstepseven.Readmore:UnderstandingtheStepsoftheAccountingCycleHowistheaccountingcycledifferentfromthebudgetcycle?Theaccountingcycleandbudgetcycledifferintheirtimingandfocus.Theaccountingcyclerecordsandreportspastcompanytransactions,whereasthebudgetcycleanalyzesthedirectionandaspirationsofacompanytoprojectfuturetransactions.Anotherwaytodifferentiatebetweenthesetermsistoconsidertheaccountingcycleaspartofaprocessthatallowsacompanytoshareitsfinancialdocumentswithexternalstakeholders,whereasthebudgetcycleispartofaprocessusedinternallyamongcompanyofficialstodeterminethecostsassociatedwithfuturecompanyactivities.Related:LearnAboutBeingaCPA(CertifiedPublicAccountant)TimingoftheAccountingCycleOneaccountingcyclehappenseveryaccountingperiod.Theaccountingperiodisdefinedasthetimeperiodforwhichfinancialdocumentsareprepared.Thiscouldbemonthly,quarterlyoryearlydependingonthecompany'sneeds.Afiscalyearisthecompany'staxreportingyear,whichcanbeacalendaryearorany12-monthperiod.Iftheaccountingperiodisayear,thenitcanalsobecalleda“fiscalyear.”Forexample,thegovernmentusesafiscalyearofOctober1toSeptember30.Forthegovernment,FiscalYear21(usuallydenotedasFY21)runsfromOctober1,2020toSeptember30,2021.Ifthegovernmentusesmonthlyaccountingperiods,thenPeriod1ofFY21wouldbeOctober2020.Period4ofFY21wouldbeJanuary2021.Iftheaccountingperiodisquarterly,Q1ofFY21wouldcoverOctober1,2020toDecember31,2020.Q4ofFY21wouldcoverJuly1,2021toSeptember30,2021.Companiesmayusemorethanoneaccountingperiod,butitisimportanttorememberthattheaccountingperiodisreportingtransactionsforthattimeperiodonly.Forexample,theSECrequirespubliclytradedcompaniestofilefinancialstatementsquarterly,sothesecompanieswillhavequarterlyaccountingperiodstomeetthisrequirement.CompaniesmustalsofileyearlytaxformswiththeIRS,sothesecompanieswillhaveyearlyaccountingperiodstomeetthisrequirement.Related:6EssentialAccountingSkillsRelatedArticlesTipsforSharingaWorkspaceWithHousematesWhatIsaCommunicationStrategy?(WithDefinitionandTemplate)16MajorsThatDoNotRelyonMath