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Accounting Cycle: De nition, Steps & Process

Lesson Transcript

Accounting isn't just about working with numbers. It is about following guidelines to get the job done. In this
lesson, you will learn what the accounting cycle is and the steps to complete it.

Accounting Cycle De ned

There is ebb and a ow to every industry. In accounting, the ebb and ow is the accounting
cycle. The term accounting cycle refers to the speci c steps that are involved in completing the
accounting process. The cycle is like a circle. It begins at one point and revolves through speci c
steps, before starting again at the same point and then repeating those same steps.

The length of the accounting cycle varies from company to company. It may be monthly,
quarterly, semiannually, or annually, depending on when the nancial statements of the
company are published. Regardless of the timing of the accounting cycle, the processes involved
remain the same.

Steps in the Accounting Cycle

There are ten basic steps to the accounting cycle.

1. Collect source documents

The very rst step in the accounting cycle is to gather all the documents that are related to
nancial transactions of the organization. These documents, called source documents, are
things like receipts, bank statements, checks, and purchase orders. They are the items that
describe what a transaction was for.

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2. Analyze transactions

The second step in the accounting cycle is to analyze the source documents. The purpose of this
is to look them over and then decide what e ect they have had on company accounts.

3. Journalize transactions

The third step in the accounting cycle is to post entries into the journal for the analyzed
transactions. A journal is the book or electronic record that documents all the nancial
transactions for a company and the accounts that are a ected by each transaction. When a
journal entry is made, the 'double-entry' rule is used. This means that for every one transaction,
at least two accounts are a ected. There must be a debit and a credit for each transaction, and
the total of debits and credits must equal the amount of the transaction. Journal entries are
entered in chronological order, and debits are entered before credits.

4. Post transactions

The fourth step in the accounting cycle is to transfer information from the journal to the ledger.
A ledger is a book or an electronic record of all the accounts that a company has. These
accounts are broken down by account number and class. When the information from the
journal is transferred to the ledger, it is transferred to each account that was a ected by a
transaction.

5. Prepare an unadjusted trial balance

A trial balance is a list of all the company's accounts and their balance at the time the trial
balance is prepared. An unadjusted trial balance is a trial balance that is prepared before
adjusting entries are made into accounts. This information comes directly from the ledger. The
total debit balance and total credit balance must be equal.

6. Prepare adjusting entries

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Adjusting entries are entries that are made in the journal and posted in the ledger. The purpose
of these entries is to bring account balances to the proper amounts. Not all accounts will have
an adjusting entry. Adjusting entries are made at the end of the accounting period but not the
end of the accounting cycle.

7. Prepare trial balance

Remember, the trial balance is a list of all accounts and their balances after adjustments have
been made. This trial balance is prepared to check and make sure that debits and credits equal
after adjusting entries are made. It is used to prepare the nancial statements.

8. Prepare nancial statements

These are prepared in a speci c order because information from one nancial statement is
often used in preparing another nancial statement. The order that the nancial statements
need to be prepared is:

Income statement - This statement measures how well a company is performing nancially during a
speci c time period. If the company made money, then it had a net pro t. If it lost money, then it had a
net loss.

Statement of retained earnings - This statement shows the e ect of any pro t or loss on the retained
earnings of a company for a speci c time period.

Balance sheet - This statement summarizes the assets, liabilities, and stockholder's equity of an
organization at a given time. Asset accounts are always listed on the left side of the balance sheet, with
liabilities and stockholder's equity on the right side. The balance sheet must follow the basic accounting
equation formula of Assets = Liabilities + Stockholder's Equity, meaning that the total balance from all
accounts on the left side of the balance sheet must equal the total balance from all the accounts on the
right side of the balance sheet.

Statement of cash ow - This statement shows how much money is made and spent by a company
during a given time period.

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9. Prepare closing entries

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Closing entries are the entries that are completed after the nancial statements have been
prepared. The purpose of these entries is to close out temporary items by transferring income
and expense items to the balance sheet.

10. Post-closing trial balance

The last step in the accounting cycle is to prepare a post-closing trial balance. The post-closing
trial balance should only contain the permanent accounts that are used in the company and
their balances. All temporary accounts should have been taken care of with the closing entries.
Again, the total balance of all debit accounts must equal the total balance of all credit accounts.

Once all ten steps of the accounting cycle are complete, it is time to begin a new accounting
period.

Lesson Summary
The accounting cycle is a multi-step, complex process. Each step must be completed
successfully in order to complete the step that follows it. By having the multiple steps that it
does, there is a greater chance of catching errors long before the accounting period is closed.
Since the nancial statements paint the picture of the nancial health for a company, it is very
important that all information contained in those statements be accurate. For that reason, it is
imperative that anyone working in the accounting eld pay close attention to the work that they
are doing. Even transposing one number can cause hours of headache for the person trying to
balance the books!

Learning Outcomes
Using this lesson, you can prepare to:

Note the characteristics of the accounting cycle

Remember the ten steps of the accounting cycle

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