The accounting cycle is used to analyze and summarize business transactions and events, and it helps businesses of all sizes ensure that their financial records are accurate, up-to-date, and in accordance with accepted accounting principles.
So, what does the accounting cycle involve? Lets break it down on a step by step basis...
1) Analysis
The first step is to analyze all transactions from the past year and to locate and file relevant documents for them.
2) General Journal
Next, it is necessary to create a central record of all of the transactions. This record is referred to as a General Journal.
3) Posting
Following the journalizing of transactions, they are then transferred and posted to the ledger. This paper / electronic trail is important to verify accuracy and to refer to if accounts are found not to be balancing up later on.
4) The Unadjusted Trial Balance
The next step is to total up debit and credit balances to ensure that they are equal. Information from the ledger should also be compiled so that financial statements can be prepared.
5) Adjustment
Having recorded and verified external transactions (like utility payments and supply purchases), internal transactions (like unearned revenue and prepaid rent) must now be factored in.
6) The Adjusted Trial Balance
The preparation of the adjusted trial balance is the next task, which encompasses all internal and external transactions for the reporting period. Again, there accuracy is verified, by ensuring the credit and debit sums are equal.
7) Financial Statements
The Income Statement, Statement of Owner's Equity and Balance Sheet are now created.
Closing Of The Trial Balance
Permanent accounts now have their balances carried into the next period, while temporary accounts are closed. The last entries made in those accounts are posted to the capital account of the business, after which all balances (expense, revenue, withdrawal, etc.) should be zero.
9) Post-Closing Trial Balance
The final step is to list the balances of non-closed accounts, such as assets and liabilities. This verifies that all permanent accounts balance i.e. that they have equal credit and debit sums.
It is important that business owners understand the steps involved in this accounting cycle. They are ultimately responsible for any mistakes in their finances, so knowing what is legally expected of them makes sense. However, it would be a mistake for them to try and cut costs by doing their own accounting, as any mistakes made may not only be costly, but could also land them in trouble with the tax office.
Hiring a reputable accounting firm is therefore highly advisable. They will offer peace of mind that the accounting cycle is being appropriately followed through with, and will also be able to offer advice on how to better organize the finances of the business in the future.
This article was written by an experienced accountant. You can learn more about them, and also find further accounting advice, by visiting: Five Dock Accounting
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