Accounting Cycle Meaning
The accounting cycle refers to the entire process of following the accounting procedures in recording, classifying, and summarizing the business transactions. The accounting cycle starts right from the identification of business transactions and ends with the preparation of monetary statements and the closing of books.
Steps in the Accounting Cycle
Whether you’re a business owner or aspiring accountant, it’s important to understand and understand the method involved within the accounting cycle. The accounting cycle consists of 8 steps listed below:
Step 1 – Identification of Business Transactions
The first step of the accounting cycle begins with the identification of monetary transactions that have occurred within the business. During this accounting cycle, the accountant or the bookkeeper collects the info of all the transactions like purchases, sales, payments, receipts, etc. and maintains the info to be able to complete the next step of the accounting cycle. Here, the accountant or bookkeeper analyzes the character of transactions, accounts impacted etc.
Step 2 – Recording of Transactions Within the Books of Accounts
The next step of the accounting cycle is the most vital and important. During this accounting cycle, the bookkeeper or accountant records the financial transaction within the book of accounts. This step of the accounting cycle may be additionally referred to as a journal entry and therefore the book during which it’s recorded is a journal book.
Here, all the transactions are recorded in chronological order alongside the ledger accounts involved, amounts in Dr/Cr, and narration (a brief note on the transactions)
Step 3 – Ledger Posting
Ledger posting simply refers to posting the financial transactions recorded in journal books to individual ledger statements. for instance, in preparing a cash ledger account, you want to post all Debit (receipts) and Credit (payments) into a statement, and the difference between these two including the opening balance of money is going to be the closing balance.
This part of the accounting cycle includes posting all the Debit and Credit transactions into a press release belonging to a ledger account as shown within the below image.
Step 4 – Organize an Unadjusted Balance
In this step, you want to list all ledger accounts with closing balances posted from individual ledger accounts statements (discussed above). The format of balance consists of the Debit column and Credit column during which the closing balance of every ledger account is going to be posted. After posting the closing balance of all the ledger accounts, the debit balance should match with the credit balance.
This is the first source for preparing the ultimate accounts and everyone’s other financial statements.
Step 5 – Post the Adjustment Entries
Here, adjustment entries like accrued incomes, depreciation, etc. are posted considering the unadjusted balance prepared earlier.
Step 6 – Organize the Adjusted Balance
Adjusted balance may be a statement listing all the closing balance of the ledger accounts in any case the adjustment entries associated with the accounting period are posted into the books of accounts.
Step 7 – Organize Financial Statements
This is the foremost important step in the accounting cycle. Once you’ve followed all the above steps of the accounting cycle, it’s time for you to start out preparing financial statements. Profit & Loss account and record are the 2 key financial statements.
- Profit and Loss Account: Profit and loss accounts may be a budget prepared to understand the profitability of the business. This is often also referred to as an earnings report.
- Balance Sheet: Record is one among the topmost budgets prepared by the companies. The financial details of the record assist you and therefore the external stakeholders are able to to gauge the financial performance of the business on a given date.
Step 8 – Closing the Books of Accounts
Closing books of accounts means freezing books from recording the business transaction. This is often done after the closure of the accounting period and posting all the adjustment entries. At this stage of the accounting cycle, all the financial statements are prepared and new books for the next fiscal year are prepared to be started.
Modern-Day Accounting Cycle
With the expansion of trade and commerce and therefore the diversity of the business operations, businesses are using accounting software to obviate the complex procedure involved within the accounting cycle. Accounting software automates the whole accounting cycle by just recording the transactions. For business owners, it saves time and effort involved within the manual accounting cycle. Not just automating the accounting cycle but the capabilities to auto-generate various financial statements like income, accounts receivables reports, projections, etc. makes accounting software invaluable to the business.