The accounting cycle refers to the complete process of identifying, recording, and processing the financial transactions or accounting events of a company. The accounting cycle starts when a transaction occurs and ends with the processing of the transaction in the financial Statement. The systematic recording of accounting events is one of the primary responsibilities of bookkeepers.
The accounting cycle has been standardized into eight steps and computerized to simplify the process of preparing up-to-date financial statements at regular intervals, such as every quarter of the fiscal year. This leads to financial transparency in businesses. Accounting cycles start and finish concurrently with an accounting period.
Let us look at the steps of the accounting cycle.
The globally accepted accounting cycle consists of eight steps, which begin with analyzing and entering transactions and culminate in the preparation of final accounts.
Step1: Identification of Financial Transactions – Not all business transactions are recorded in the books of accounts. Financial transactions begin the accounting cycle. Transactions can be anything — paying off debt, selling inventory, buying raw materials, purchasing or acquiring assets, making lease payments, or any expenses incurred.
Step2: Recording Transaction in Journal entry — These transactions recorded and tallied in the company journal as debits and credits. Debits occur when the money spent or expenses incurred, and credits happened when payment received or sale or income received. In this ‘dual entry’ bookkeeping process requires simultaneously debiting one or more accounts and crediting one or more accounts.
Step3: Posting — Once transactions recorded in Step 2, it is posted in the general ledger, which contains a summary and breakdown of all the transactions.
Step 4: Draft Trial Balance — At the end of the accounting period, which can be a month, a quarter, or a year, a trial balance is calculated. Ideally, at this stage, Trial balance will have unadjusted accounts, unequal debits and credit balances, etc.
Step 5: Final Trial Balance — In this step, the accountant removes all the discrepancies in the Trail balance, including locate and fix errors, pass adjusting entries, etc. After these adjustments, Trail Balance is finalized
Step 7: Financial statements — With the corrections done, the three financial statements — Income Statement, Balance Sheet, and Cash flows Statement are prepared and finalized.
Step 8: Closing the Books — Finally, a company closes all ledgers and ends the accounting cycle by closing its books on the last day of the accounting period. Closing books means all the balances are closed while assets and liabilities are carried forward to the next accounting period. Accounting cycle starts over again in the next year, and the company follows all the above eight steps.