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Accounting Cycle 101 The 8 Steps Explained

September 29, 2020

This can provide businesses with a clear understanding of their financial health and ensure compliance with federal regulations. The accounting cycle is started and completed within an accounting period, the time in which financial statements are prepared. However, the most common type of accounting period is the annual period. Following the accounting cycle is a standard practice that helps to ensure that all financial transactions are accounted for. Not following the accounting cycle would likely lead to an accumulation of bookkeeping errors, which could cause severe problems for your business.

  • Next, you’ll break down (or analyze) the purpose of each transaction.
  • Also known as a “book of original entry,” this is the book – or spreadsheet – where all transactions are initially recorded.
  • However, businesses with internal accounting cycles also follow the external accounting cycle of the fiscal year.
  • The budget cycle is an estimation of revenue and expenses over a specified period of time in the future and has not yet occurred.
  • However, the general consensus is that there are 8 steps in the accounting cycle, 9 if you count the beginning of the cycle.

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. The accounting cycle focuses on historical events and ensures that incurred financial transactions are reported correctly. As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle.

Importance of the Accounting Cycle

Most companies seek to analyze their performance on a monthly basis, though some may focus more heavily on quarterly or annual results. If the total credit and debit balances don’t match, you need to figure out what’s missing, record those transactions and post these adjusting entries to the general ledger. The total credit and debit balance should be equal—if they don’t match, there’s an error somewhere.

8 steps of the accounting cycle

Each entry should list details about every transaction in chronological order. If your company uses double-entry accounting, the details include a debit and credit for each transaction. First, an income statement can be prepared using information from the revenue and expense account sections of the trial balance.

Step 4: Preparing an unadjusted trial balance

The trial balance provides the company with insight into the balances in the account and discovers any discrepancies. Since no accounting method is seamless, you might find discrepancies when balancing your books. The general ledger is the master list of any transaction information in journals divided into accounts.

The eight-step accounting cycle starts with recording every company transaction individually and ends with a comprehensive report of the company’s activities for the designated cycle timeframe. Many companies use accounting software to automate the accounting cycle. This allows accountants to program cycle dates and receive automated 8 steps of the accounting cycle reports. The accounting cycle is critical because it helps to ensure accurate bookkeeping. Skipping steps in this eight-step process will likely lead to an accumulation of errors. If these errors aren’t caught and corrected, they can give you and your employees an inaccurate view of your company’s financial situation.

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They will also want to note important information to make categorizing and following steps easier. Depending on each company’s system, more or less technical automation may be utilized. Typically, bookkeeping will involve some technical support, but a bookkeeper may be required to intervene in the accounting cycle at various points.

Once this initial review has been completed, and your transactions have been coded properly, you can move on to the next step in the accounting cycle. The closing entry process involves transferring your net income into retained earnings. When earnings are transferred, all temporary accounts should be closed. Simply put, the credit is where your money is coming from, and the debit is what it’s going towards. If you buy some new business cards, for example, your marketing expense account is debited, and your bank account is credited.

A trial balance is an accounting document that shows the closing balances of all general ledger accounts. You need to calculate the trial balance at the end of the fiscal year. The objective of the trial balance is to help you catch mistakes in your accounting. When thinking about the order to prepare financial statements, the statement of changes in equity is prepared last. This statement shows a company’s changes in equity during a specific period of time.

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