What Is the Accounting Cycle?
The accounting cycle is a collective process of identifying, analyzing, and recording the accounting events of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements. Additional accounting records used during the accounting cycle include the general ledger and trial balance.
How the Accounting Cycle Works
The accounting cycle is a methodical set of rules to ensure the accuracy and conformity of financial statements. Computerized accounting systems and the uniform process of the accounting cycle have helped to reduce mathematical errors. Today, most software fully automates the accounting cycle, which results in less human effort and errors associated with manual processing.
Key steps in the eight-step accounting cycle include recording journal entries, posting to the general ledger, calculating trial balances, making adjusting entries, and creating financial statements.
Steps of the Accounting Cycle
There are eight steps to the accounting cycle. An organization begins its accounting cycle with the recording of transactions using journal entries. The entries are based on the receipt of an invoice, recognition of a sale, or completion of other economic events. After the company posts journal entries to individual general ledger accounts, an unadjusted trial balance is prepared. The trial balance ensures that total debits equal the total credits in the financial records. At the end of the period, adjusting entries are made. These are the result of corrections made and the results from the passage of time. For example, an adjusting entry may accrue interest revenue that has been earned based on the passage of time.
Upon the posting of adjusting entries, a company prepares an adjusted trial balance followed by the financial statements. An entity closes temporary accounts, revenues, and expenses, at the end of the period using closing entries. These closing entries transfer net income into retained earnings. Finally, a company prepares the post-closing trial balance to ensure debits and credits match.
- The accounting cycle includes identifying and recording accounting events.
- The cycle is a set of rules and steps to ensure financial statements are prepared accurately and timely.
- The first step in the eight-step accounting cycle is to record transactions using journal entries, ending with the eighth step of closing the books after preparing financial statements.
- Accounting software today mostly automates the accounting cycle.
- The accounting cycle is generally a year, encompassing an accounting period.
Timing of the Accounting Cycle
The accounting cycle is started and completed within an accounting period, the time in which financial statements are prepared. Accounting periods vary and depend on different factors; however, the most common type of accounting period is the annual period. During the accounting cycle, many transactions occur and are recorded. At the end of the year, financial statements are generally prepared. Public entities are required to submit financial statements by certain dates. Therefore, their accounting cycle revolves around reporting requirement dates.
Accounting Cycle Vs. Budget Cycle
The accounting cycle is different than the budget cycle. The accounting cycle focuses on historical events and ensures incurred financial transactions are reported correctly. Alternatively, the budget cycle relates to future operating performance and planning for future transactions. The accounting cycle assists in producing information for external users, while the budget cycle is mainly used for internal management purposes.