Accounting Cycle

Accounting cycle meaning

Accounting cycle refers to the complete process of accounting procedure followed in recording, classifying and summarizing the business transactions. Accounting cycle starts right from the identification of business transactions and ends with the preparation of financial statements and closing of books.

Steps in accounting cycle

Whether you are a business owner or aspiring accountant, it is important to know and understand the process involved in the accounting cycle. Accounting cycle consists of 8 steps listed below:

Step-1 of accounting cycle is identification of business transactions

The first step of the accounting cycle beings with the identification of financial transaction that have occurred in the business. In this accounting cycle, the accountant or the bookkeeper collects the data of all the transactions such as purchases, sales, payments, receipts etc. and keeps the data ready to complete next step of the accounting cycle. Here, the accountant or bookkeeper analyze the nature of transactions, accounts impacted etc.

Step-2 of the accounting cycle is the recording of transactions in the books of accounts

The next step of the accounting cycle is the most crucial and important. In this accounting cycle, the bookkeeper or accountant records the financial transaction in the book of accounts. This step of the accounting cycle is also known as a journal entry and the book in which it is recorded is a journal book.

Here, all the transactions are recorded in chronological order along with the ledger accounts involved, amounts in Dr/Cr and narration (a brief note on the transactions)

Step-3 of accounting cycle is ledger posting

Ledger posting simply refers to posting the financial transactions recorded in journal books to individual ledger statements. For example, in preparing cash ledger account, you must post all Debit (receipts) and Credit (payments) into statement and difference between these two including the opening balance of cash will be the closing balance.

This part of the accounting cycle includes posting all the Debit and Credit transaction into a statement belonging to a ledger account as shown in the below image.

Step-4 of accounting cycle is to prepare un-adjusted trial balance

In this step, you must list all ledger accounts with closing balance posted from individual ledger accounts statement (discussed above). The format of trial balance consists of the Debit column and Credit column in which the closing balance of each ledger accounts will be posted. After posting the closing balance of all the ledger accounts, the debit balance should match with the credit balance.

This is the primary source for preparing the final accounts and all other financial statements.

Step-5 of accounting cycle is to post the adjustment entries

Here, adjustment entries such as accrued incomes, depreciation, etc. are posted considering the unadjusted trial balance prepared earlier.

Step-6 of accounting cycle is to prepare the adjusted trial balance

Adjusted trial balance is a statement listing all the closing balance of the ledger accounts after all the adjustment entries related to accounting period is posted into the books of accounts.

Step-7 of accounting cycle is to prepare financial statements

This is the most important step of the accounting cycle. Once you have followed all the above steps of the accounting cycle, it’s time for you to start preparing financial statements. Profit & Loss account and Balance sheet are the two key financial statements.

• Profit and loss account: Profit and loss accounts is a financial statement prepared to know the profitability of the business. This is also known as Income Statement.
• Balance sheet: Balance sheet is one of topmost financial statement prepared by the businesses. The financial details of the balance sheet help you and the external stakeholders to evaluate the financial performance of the business on a given date. click here to know Balance Sheet format, steps to prepare balance sheet etc.

Step-8 of accounting cycle is closing the books of accounts

Closing books of accounts refer to freezing books from recording the business transaction. This is 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 subsequent financial year will be started.

Modern-day accounting cycle

With the growth of trade and commerce and the diversity of the business operations, businesses are using accounting software to get rid of the complex procedure involved in the accounting cycle. Accounting software automates the entire accounting cycle by just recording the transactions. For business owners, it saves time and efforts involved in the manual accounting cycle. Not just automating the accounting cycle but the capabilities to auto-generate various financial statements such as cash flow, accounts receivables reports, projections etc. makes accounting software invaluable to the business.