At the core of the accounting cycle lies the recording of financial transactions. This initial step involves capturing all business activities that result in a financial impact. In this step, accountants examine and interpret the financial effects of each transaction on the organization. They determine which accounts are involved and classify the transactions based on their nature (e.g., revenue, expense, asset, liability). They are prepared at the beginning of the new accounting period to facilitate a smoother and more consistent recording process, especially if the company uses a cash-basis accounting system. Accountants first need to gather information about business transactions, then record and collate them to come up with values to be reported (steps 1-6 in the accounting cycle).
Post-closing trial balance
We’re going to go over all of the steps and provide examples of what each step would look like. The accounting cycle is important because it gives companies a set of well-planned steps to organize the bookkeeping process to avoid falling into the pitfalls of poor accounting practices. Whether your accounting period is monthly, quarterly, or annually, timing is crucial to implementing the accounting cycle properly. Mapping out plans and dates that coincide with your accounting deadlines will increase productivity and results. Before you create your financial statements, you need to make adjustments to account for any corrections for accruals or deferrals.
- Electronic document management reduces reliance on paper-based processes, minimizes physical storage space, and improves document traceability (making it audit-ready).
- If you need a bookkeeper to take care of all of this for you, check out Bench.
- Accounting procedures can be customized to reflect the particular regulations, cost structures, revenue recognition practices, and performance indicators of each industry.
- Should you seek further accounting tips or need accounting services, consult your local CPA firm.
Accounting Cycle Steps
The purpose of this stage is to create a permanent record of all financial activities, establishing a foundation for further analysis and reporting. A business’s accounting period is determined by various factors, including reporting obligations and deadlines. The accounting period refers to the timeframe for preparing financial documents, varying from monthly to annually. Companies may opt for monthly, quarterly, or annual financial analyses based on their specific needs. The balance sheet is a depiction of the financial position of the business entity. It displays the assets owned by the entity, liabilities owed to creditors, and owner’s capital/equity at the date of its preparation.
Utilize automated reporting tools
Producing financial statements is a primary objective of the accounting cycle, offering stakeholders a holistic perspective of the company’s financial health and standing. Navigating the financial workings of a business requires a methodical approach. At the core of this method is the accounting cycle, a systematic procedure crucial for monitoring, analyzing, and disclosing financial activities. A balance sheet can then be prepared, made up of assets, liabilities, and owner’s equity.
Adjustments also account for items like prepaid expenses, accrued revenues, and accrued expenses that have not been recorded properly in the regular course of transactions. Adjustments are necessary to recognize revenues and expenses in the period they are earned or incurred, even if cash transactions haven’t occurred yet. Summarization helps in condensing vast amounts of transactional data into manageable formats, providing a concise overview of the company’s financial position and performance at a given point in time. After organizing the data, the accounting cycle entails summarizing transactions into meaningful aggregates. This is typically done through the use of journals and ledgers, where individual transactions are grouped and totaled according to their respective accounts. Adjusting entries are prepared to update the accounts before they are summarized in the financial statements.
Step 1: Identify Transactions
The closing step impacts only temporary accounts, which include revenue, expense, and dividend accounts. The permanent or real accounts are not closed; rather, their balances are carried forward to the next financial period. These journal entries are known as adjusting entries, which ensure that the entity has recognized its revenues and expenses in accordance with the accrual concept of accounting.
Also, this step would involve the preparation or collection of business documents, or as auditors would call them – source documents. A business document (such as sales invoice, official receipt, etc.) provides evidence that a particular transaction happened, and serves as basis in recording the transaction. For example, a personal loan made by a business owner that does not have anything to do with the business shall not be recorded in the books of the business. When the owner buy a personal car, it should also not be recorded as an asset of the business. What’s left at the end of the process is called a post-closing trial balance.
Financial accounting software can execute many of the steps in the accounting cycle automatically. However, understanding how the process works is critical so you can intervene when needed. So, we can conclude that the accounting cycle encompasses everything from recognizing a transaction to closing entries to resetting for the next period. The accounting intangible asset cycle plays a crucial role in maintaining consistency and ensuring that companies comply with regulatory standards like Generally Accepted Accounting Principles (GAAP). Closing the books takes place at the end of business operations on the last day of the accounting period. Then, the next day, a new accounting period begins, and new books are opened.
Essentially, you are looking to record your sales (cash and credit), purchases (at any price point), and any other financial matters that are measurable or relevant. Accuracy is critical because you’ll use the financial information generated by the accounting cycle to analyze transactions and financial performance. It’s even more important for companies that need to report financial information to the SEC (Securities and Exchange Commission). After a stint in equity research, he switched to writing for B2B brands full-time. Arjun has since written for investment firms, consultants, and SaaS brands in the Accounting and Finance space.