What is the Accounting Cycle?
The accounting cycle is a series of steps which are always followed in good accounting practice. The steps cover the entire process from first gathering data about transactions to the point when the accounts are completed. The accounting cycle thus happens once in each reporting period, that being the interval at which accounts are produced. The length of the reporting period could be as little as a week for a major firm to a year for a self-employed person with few transactions. The accounting cycle applies most directly to manual accounting, known as bookkeeping, though the general principles are covered by computerized accounting methods.
The number of steps in the accounting cycle depends on how it is broken down. In this explanation there are nine steps. Step one is to collect the data for transactions, such as the till register in a store or the employee payroll. These are often assigned into categories determined by the company's accounting system. The categories could cover different stores or different product types, for example.
Step two is journalization, which simply involves adding the data to a running record, usually known as the general journal or book of original entry. Step three involves totaling up the figures across the entire reporting period in what is known as the general ledger. Step four is to produce what is known as an unadjusted trial balance. This is simply a check that the total of all credit balances such as revenues and assets equals the total of all debit balances such as expenses and liabilities. If the totals are not equal, it is a sign that a mistake has been made in the process and needs identifying and correcting.
Step five is to make a note of any period-end adjustments, which include revenue or expenses that have been earned or incurred, but not yet recorded. Step six is the adjusted trial balance, which repeats the process from step four but includes the period-end adjustments. Again, credit balances should equal debit balances.
Step seven is to prepare financial statements using the figures which have been confirmed by step six. Step eight is to add the overall profit or loss figure to the company's recorded assets, for example as an addition to its cash balance. This means the money from transactions during the reporting period is fully "accounted for" and does not appear in the figures for transactions in the next period. This process is known as closing the accounts. Step nine is to check that the changes made in the step eight balance are correct.
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