The accounting cycle

The accounting cycle is a step-by-step process bookkeepers use to record, organize, and classify a company’s financial transactions. It helps to keep all accounting uniform and eliminate mistakes.

How it works

The cycle works as an aid to organize workflow into a cyclical chain of steps that are designed to reflect the way assets, money, and debts have moved in and out of a business. It progresses through eight different steps, in the same order each time, and restarts as soon as it has finished. The cycle can be based on any length of time—this is known as an accounting period—and usually lasts a month, a quarter, or a year. Accounts which deal with revenues and expenses return to zero at the end of each financial year, while accounts showing assets, liabilities, and capital carry over from year to year.

The eight-step cycle

The processes shown here are repeated in the same way for every accounting period. All businesses go through different phases, and the accounting cycle works by reflecting that. The financial statement, which is prepared toward the end of each cycle, is helpful in showing how strongly the business has performed during each period of time.

Transactions
Any type of financial transaction, from buying or selling an asset to paying off a debt, can start the accounting cycle.

Journal entries Accountants then analyze the transaction and note it in the relevant journal—a book or an electronic record.

Posting Journal entries are then transferred to the general ledger—a large book or electronic record logging all the company’s accounts.

Trial balance A list of all the company’s accounts
is prepared at the end of the accounting period, usually a year, quarter, or month.

Worksheet Often, trial balance calculations don’t accurately balance the books . In such cases, changes are made on a worksheet.

Adjusting journal entries Once the accounts are balanced, any adjustments are noted in journals at the end of the accounting period.

Financial statements The corrected balances are then
used to prepare the company’s financial statements.

Closing the books A closing entry based on adjusted journal entries is taken, the books are closed, and the cycle restarts.

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BOOKKEEPING AND ACCOUNTING

• ❯ Internal controls A method of deploying, measuring, and monitoring a business’s resources. This helps prevent fraud and keep track of the value of assets.
• ❯ Double-entry bookkeeping The process of recording all transactions twice—as a debit and as a credit. If a company buys a chair for $100, its debit account increases by $100 and its credit account decreases by $100.
• ❯ Bad debts Debts that cannot be or are unlikely to be recovered, so are useless to the creditor (lender), who writes them off as an expense.

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NEED TO KNOW

• ❯ Debits Expenses—dividends, assets, and losses. In double-entry accounting, debits appear on the left-hand side of the account
• ❯ Credits Gains—income, revenue, owners’ equity, and liabilities. In double-entry accounting, credits appear on the right-hand side
• ❯ Chart of accounts List giving the names of all of a company’s accounts, used to organize records
• ❯ Audit trail Full history of a transaction, allowing auditors to trace it from its source, through the general ledger, and note any adjustments made