The Accounting Cycle Explained: The Full 8-Step Process

First, an income statement can be prepared using information from the revenue and expense account sections of the trial balance. This new trial balance is called an adjusted trial balance, and one of its purposes is to prove that all of your ledger’s credits and debits balance after all adjustments. Journal entries are usually posted to the ledger as soon as business transactions occur to ensure that the company’s books are always up to date. Following the accounting cycle is a standard practice that helps to ensure that all financial transactions are accounted for.

Preparing the adjusted trial balance

As previously mentioned, there are typically general guidelines regarding what information you’ll need to use and how it should be managed. However, the individual business has a lot of nuance regarding the actual execution of the reporting efforts. As such, we recommend that you draft an internal plan outlining specific actions and then repeat those steps every month without variance. Training is an important part of growing your accounting firm successfully. When new team members join staff, training them efficiently requires thorough documentation of critical processes.

#3 Posting to the General Ledger (GL)

Once you identify your business’s financial accounting transactions, it’s important to create a record of them. You can do this in a journal, or you can use accounting software to streamline the process. At the start of the next accounting period, occasionally reversing journal entries are made to cancel out the accrual entries made in the previous period.

He has built multiple online businesses and helps startups and enterprises scale their content marketing operations. He worked with TIME, Observer, HuffPost, Adobe, Webflow, Envato, InVision, and BigCommerce. Moreover, if you have inaccurate information, you might inadvertently mislead your lenders, creditors and investors, which can have serious legal consequences. Finally, if your books are disorganized, payroll accounting setting up and calculating staff payrolls you might provide inaccurate information when filing taxes.

The statement of retained earnings begins with the opening balance of retained earnings from the previous accounting period. This opening balance represents the cumulative earnings that have not been distributed to shareholders as dividends. A business transaction refers to any activity that involves the exchange of goods, services, or resources, resulting in a measurable financial impact on a company’s financial position.

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If you can offload a repetitive or time-consuming task onto technology, do it. With automation, you’ll be able to cut down on errors in your data and complete calculations and reconciliations in seconds. Further, you can eliminate unnecessary process delays caused by waiting for staff to begin the next step in the chain. You’ll need to research the cause for any variance you discover thoroughly and then amend relevant records to explain the discrepancy. For example, an invoicing error might force you to amend that file with credit notes or create a whole new, this time accurate, payment request.

Step 4: Prepare the Unadjusted Trial Balance

This step mandates that once performance obligations have been fulfilled, revenue must be recognized. The contract will decide whether this will happen all at once, or must be stretched over a period of time. If, for instance, a product takes time to assemble and ship, revenue needs to be recognized after delivery and fulfilment has happened and not at the time of placing the order. For SaaS style continuous obligation of performance, payment of each month must be recognized as revenue for the respective accounting period. Continues intermediate accounting series designed to give students an in-depth understanding of the theory and current practice of financial accounting. Focuses on the accounting for investments, liabilities, stockholders’ equity, revenues, and cash flows.

A business can conduct the accounting cycle monthly, quarterly or annually, depending on how often the company needs financial reports. The first step in the accounting cycle is identifying business transactions. Companies use internal controls to ensure all transactions are identified and recorded accurately. After adjustments, there is a need to prepare a trial balance again that ensures that all credits and debits are equal. After determining the accounts involved, the next step is to journalize the transaction in a journal book.

Poor cash flow management

Give yourself sufficient time to complete your month-end close without rushing. While streamlining and accelerating processes can be helpful, don’t employ any strategies or shortcuts that put the accuracy of your data or final records at risk. A simple mistake or overlooked file early in the process will complicate your reconciliation efforts and can potentially cause even greater headaches for subsequent audits or year-end closings. The ledger, on the other hand, is a summarized collection of all accounts where transactions are posted from the journal. It provides a consolidated view of account balances and is organized by account type.

And without a formalized routine guiding your closing efforts, irregularities or unknown variables can creep into your reports and mislead key sales returns and allowances decision makers. Within your accounting practice, there are many processes you can use to practice your flowcharting skills. You could start by choosing any step within an accounting cycle chart, for example, from analyzing transactions to closing entries. The trial balance is a list of all account balances from the general ledger.

Accounts receivable conversion

• The adjusted trial balance includes all accounts from the general ledger with their updated balances after considering the adjusting entries.
• It represents the period starting from the purchase of raw materials or inventory to the collection of cash from the sale of finished goods.
• It’s probably the biggest reason we go through all the trouble of the first five accounting cycle steps.
• Companies use internal controls to ensure all transactions are identified and recorded accurately.
• A general journal, also known as a book of original entries, is a chronological record of business transactions.

Following the accounting cycle ensures that financial reporting is compliant with generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). Reversing entries enhance the comparability of financial vintage yellow accounting practice forms statements across periods. By eliminating the effects of certain adjustments, the financial statements for the current period are more comparable to those of previous periods. Once the business transactions are identified and analyzed, they need to be properly documented and organized. Accountants use source documents, such as invoices, receipts, and bank statements, to record each transaction’s essential details accurately.

Properly using these symbols ensures a broad audience can read and understand your flowchart. Accounting flowcharts present cumbersome activities in a series of simple, finite steps. The steps follow an exact progression, with all decision points, data required, and action items marked. This presentation, done correctly, clarifies your firm’s processes for internal and external stakeholders. Flowcharts can add efficiency to nearly any repeatable process, potentially boosting KPI metrics, increasing client satisfaction scores, and improving profitability. Specific outcomes can include clearer accounting processes, easier staff training, reduced inefficiencies, and improved transparency in compliance and risk mitigation efforts.

• Delegating and distributing tasks will also improve the overall accuracy and efficiency of your finance and accounting team.
• Debits and credits are the foundational principles of double-entry accounting.
• Once a transaction is recorded as a journal entry, it should be posted to an account in the general ledger, which is an old-fashioned term for a record-keeping system for a company’s financial data.
• This step mandates that once performance obligations have been fulfilled, revenue must be recognized.
• Analysts can quickly assess a company’s financial health, profitability, liquidity, and other performance metrics using the standardized information presented in the financial statements.
• By comparing the adjusted trial balance to the unadjusted trial balance, accountants can identify any discrepancies or errors that need to be addressed.

Post Journal Entries to the General Ledger

The accounting cycle provides a framework for recording transactions and checking them for accuracy before they make it to the financial statements. On the other hand, the budget cycle uses the financial information compiled by the accounting cycle process to forecast revenue, expenses, cash position, and more over the next accounting period. Performing all eight steps in the accounting cycle can be time-consuming. There’s also a higher chance of human error—when you’re recording and transferring thousands of transactions in your books, it’s possible you’ll mistype a transaction amount or skip a transaction. But if you use accounting software, you won’t need to prepare the trial balance manually.

Transactions include expenses, asset acquisition, borrowing, debt payments, debts acquired and sales revenues. This final trial balance is generally referred to as the post-closing trial balance. Its format is similar to that of an unadjusted and adjusted trial balance. However, it lists only permanent accounts because all temporary accounts get closed in step 8 above. The post-closing trial balance serves as the base or opening trial balance for the next period’s accounting cycle. The next step of the accounting cycle is to organize the various accounts by preparing two important financial statements, namely, the income statement and the balance sheet.

The total credit and debit balance should be equal—if they don’t match, there’s an error somewhere. The unadjusted trial balance is the initial version of the trial balance that hasn’t been analyzed for accuracy and adjusted as needed. The general ledger is a central database that stores the complete record of your accounts and all transactions recorded in those accounts. You need to identify all transactions that occur throughout the fiscal year.

The main content and items of the Profit and loss account include the revenues, cost of goods sold, gross profit, all expenses, and the year-end income. If the amount is negative, it means that the company had incurred a loss and if the amount is positive, it means that the company had earned a significant profit within the specific time period. The Accounting Cycle is the complete accounting process that starts with the identification of financial transactions and ends with the preparation of financial statements and the closing process.

A typical accounting cycle is a 9-step process, starting with transaction analysis and ending with the preparation of the post-closing trial balance. The accounting cycle is a set of steps that are repeated in the same order every period. The culmination of these steps is the preparation of financial statements.