The Accounting Cycle Laid Out: Eight-Step Method

The 8-Step Accounting Cycle is Essential to Know for All Types of bookkeepers. It breaks down the whole procedure of a bookkeeper’s obligations into eight fundamental steps. Multiple of these steps are automatic by accounting software and technology agendas. Nevertheless, understanding and using the steps manually can be important for small corporation accountants working on the books with minimal technical support. Regardless, most bookkeepers will have an awareness of the company’s financial position from day to day. Overall, deciding the amount of time for each accounting cycle is crucial because it places specific dates for opening and closing. Once an accounting cycle closes, a new cycle begins, restarting the eight-step accounting process all over again.

What Is the Accounting Cycle?

An accounting cycle is a collaborative approach to identifying, analyzing, and recording the accounting events of a company. It is an authoritative 8-step process that starts when a transaction occurs and ends with its inclusion in the financial statements. The key steps in the eight-step accounting cycle contain recording journal entries, posting to the general ledger, figuring trial balances, making adjusting entries, and creating financial statements.

How the Accounting Cycle Works?

An accounting cycle is a set of rules that ensure the accuracy and relevance of financial statements. Computerized accounting systems and streamlined accounting cycles have reduced mathematical errors. Today, most software completely automates the accounting cycle, which results in fewer human measures and errors associated with manual processing.

Why is the Accounting Cycle Important?

Accounting cycles are used by businesses and associations to register transactions and formulate financial statements. The standardized accounting cycle approach (supported by accounting systems) is essential because it enables business owners, small businesses, and designated enterprises to close their books for the accounting period. It also permits the development of financial information to perform financial statement analysis and control the business. 

Accounting departments use detailed, customized accounting completion checklists that reflect the items to be completed during each accounting cycle. Document assigned responsibilities and deadlines also completion times and approvals for each task. A checklist with deadlines in the accounting cycle enhances responsibility and operation management. Stakeholders, including administration, the Board of Directors, lenders, shareholders, and creditors, can examine the financial statement outcomes for the accounting cycle period.

What Is the Main Purpose of the Accounting Cycle?

The immediate objective of the accounting cycle is to provide the accuracy and applicability of financial statements. Even though most bookkeeping is done electronically, errors can be added over time, so it's still important to make sure everything is correct.

Understanding the 8-Step Accounting Cycle

The eight-step accounting cycle begins with recording every corporation transaction separately and ends with an exhaustive report of the company’s activities for the specified cycle timeframe. Multiple businesses employ accounting software to automate the accounting cycle. So, That permits accountants to program cycle dates and accept automated reports.

Relying on each organization’s system, more or less technological automation may be operated. Generally, bookkeeping will apply for specialized support, but a bookkeeper may be required to interfere in the accounting cycle at diverse points.

Every particular company will usually need to adjust the eight-step accounting cycle in specific ways to fit with their company’s business model and accounting practices. Modifications for accrual accounting versus cash accounting are usually one foremost situation.

Companies may also select between single-entry accounting versus double-entry accounting systems. Double-entry accounting is needed for companies to make out all three significant financial statements: the income statement, balance sheet, and cash flow statement.

We Discuss the Accounting Cycle Stages in Particular.

1. Identifying and Recording Transactions

   The first step in the accounting cycle is to recognize and document transactions via subsidiary ledgers (journals). When financial activities or business possibilities happen, transactions are recorded in the books and possessed in the financial statements. Kinds of accounting periods for recording transactions enclose monthly and annual duration. 

   When accounting subjects customer invoices, these invoices are published in numerical series for internal management. If a business even administers paper checks, they’re regulated and recorded in sequential numerical sequence. Any inaccurate statements are withdrawn and maintained to control the numerical series. 

   As an accounting period illustration, companies operate a calendar year with an accounting period beginning on January 1 and an accounting period ending on December 31. Or they may select with the IRS to utilize a further month end as a fiscal year for the end of the annual accounting period, also known as the fiscal accounting period. Financial statements may show outlined quarterly and year-to-date details.  

   Record accounting transactions in the accounting approach utilizing double-entry bookkeeping with offsetting debits and credits. Develop subsidiary journals and a general journal in the books of account.

2. Preparing Journal Entries

   To register non-routine accounting transactions, organize journal entries for crucial transactions not recorded through a subsidiary ledger like accounts receivable. You can even utilize journal entries to make modifications. Utilize automatic journal entries when feasible. 

   Corporations operate accrual accounting instead of cash accounting to observe generally accepted accounting principles (GAAP). The matching principle matches revenue with corresponding expenses by recognizing and assigning them to the proper accounting period in GAAP accounting. Journal entries register accruals and reverse them in the subsequent accounting term when that month’s accruals are committed. 

   Your accounting system will allow you to set up automated systematic transactions for subscription billing like SaaS software. You’ll be capable of automatically putting up a journal entry for a monthly transaction like prepaid insurance cost that needs to be recognized as insurance cost instead of a prepaid asset as the period elapses.

   Depreciation should automatically be induced as a journal entry when you accurately set up the fixed asset in the accounting software or ERP approach. For non-routine transactions like M and A transactions, you’ll be required to examine the transaction operating worksheets and organize and record journal entries for the contract.

3. Posting to the General Ledger

   Your accounting system will allow you to publish subsidiary journals and journal entries to the general ledger account.

4. Generating Unadjusted Trial Balance Report

   When generating an unreconciled trial balance report from the financial records,  check for errors to ensure that all transactions are recorded in the general ledger. The trial balance format is that every general ledger account balance or total is a list without the elements. In a double-entry bookkeeping system, total debits must equal total credits.

5. Preparing Worksheets

   Utilize worksheets to examine, reconcile, and determine adjusting entry and consolidation entries. When practicable, use the credentials furnished by your accounting system. Each balance sheet is reconciled at least once a month to reconcile journal entries and find and correct errors. A checklist of cash reconciling items will contain outstanding payments and outstanding deposits that haven’t yet cleared the bank and bank assistance fees.

   For other balance sheet items, reconcile the accounts receivable and accounts payable aging periodicals to the general ledger account. Reconcile additional assets and liabilities, including inventory, fixed investments, prepaid assets, accrued liabilities, retained profits, and owner’s equity for the general ledger. 

   To ensure stock balances, companies take cycle counts, which consist of sampling inventory computations during the year. Corporations take physical inventory to approximate count amounts with perpetual inventory balances in a month with lower industry activity. In the physical inventory reconciliation procedure, cost accounting causes critical and agreed on adjustments to detailed financial records and journal entries.

   Record companies can achieve some accounting procedure reconciliations like payments reconciliation automatically with AP mechanization software. In the consolidation procedure for multi-entity organizations, income statements, and balance sheets require to be integrated. But intercompany revenue ought to be eliminated as a worksheet adjustment because these transactions are not third-party dealings with outsiders parties. 

6. Preparing to Adjust Entries

   Construct the adjusting journal entries to rectify mistakes and reflect any distinctions mentioned in reconciling balance sheet accounts. Journal entries need assessment and authorization. After documenting and adjusting entries and publishing them to the general ledger, total debit balances should equal total credit balances as an accounting control procedure. You can check by executing and examining an adjusted trial balance statement.

7. Generating Financial Statements

   Pick your customized financial statements to generate the financial report for a particular organization, for the accounting period, whether monthly or year-end. Many accounting systems allow the financial report to be organized to show quarterly totals. The SEC needs quarterly financial reporting for public organizations. Financial statements contain a management assessment and authorization process before they are published. Classes of financial statements of a corporation possess: 
   • Balance sheet
   • Statement of owner’s equity
   • Income statement
   • Statement of cash flows
   The accounting equation for the balance sheet is assets minus liabilities equals owner’s equity.  

8. Closing the Books

   Execute step 8 only at fiscal or calendar year-end, but not for a standard month-end close. Close income statement temporary accounts into a permanent account. Temporary accounts include revenue and expense accounts. At year-end, net income or loss is closed into the permanent account, retained earnings. Income and payment ledger account balances are deflated to nil via a closing entry in the system.

   Schedule a post-closing trial balance statement at the end of the accounting period for the year to show a true and fair view. Again, ensure that total debits equal total credits. After successfully closing the year-end accounts, you should set the temporary general ledger accounts to zero. Make sure that the opening balance of retained earnings is used to start the next monthly accounting period and close in the following business year.

   When the post-closing trial balance is adequate, you’ve arrived at the actualization of the accounting cycle at year-end.

Timing of the Accounting Cycle

The accounting cycle begins and ends within the accounting period in which financial statements are prepared. Billing periods vary and depend on many factors. However, the most common type of accounting period is the annual accounting period. Many transactions occur and are recorded during the accounting cycle.

Annual financial statements are usually prepared at the end of the year. This is often required by law. Public institutions have deadlines for submitting annual accounts. All publicly traded companies doing business in the United States are required to file registration statements, periodic reports, and other forms with the United States Securities and Exchange Commission.

The Accounting Cycle Vs. Budget Cycle

The accounting cycle is dissimilar to the budget cycle. The accounting cycle concentrates on historical circumstances and confirms that incurred financial transactions are reported correctly. Alternatively, the budget cycle links to future operating performance and planning for coming transactions. The accounting cycle helps to produce data for external users, while the budget cycle is used for internal management objectives.

Accounting Cycle versus Operating Cycle

The accounting cycle and operating cycle are very different financially. The accounting cycle consists of the steps from entering business transactions to producing the annual financial statements for the accounting period. The operating cycle measures the time it takes to buy inventory, sell it as a product, and collect cash from the sale transaction.

The operating cycle can be expressed mathematically as the sum of the financial calculation ratios for days’ sales outstanding and the average collection duration. Comprehending the operating cycle of your business is critical to cash flow management.

The Bottom Line

The eight-step accounting cycle procedure constructs accounting easier for bookkeepers and dynamic entrepreneurs. It assists the guesswork of how to manage accounting activities. It also helps to provide consistency, accuracy, and efficient financial performance research.