The Accounting Cycle Explained
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) Analyze
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
Next, debit and credit balances are totaled and compared to check that they are equal. This is also when information is compiled from the ledger for use in preparing financial statements.
5) Adjusting
Now that external transactions (such as supply purchases and utility payments) have been recorded and verified, it is time to adjust the accounts for internal transactions (such as prepaid rent or unearned revenue).
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
At this stage, a number of important financial statements are created. The Income Statement and Statement of Owner's Equity first, followed by the Balance Sheet.
8) Closing Of The Trial Balance
Temporary accounts are closed, while permanent carry their balances into the next period. Closing entries are recorded and posted to the business's capital account. Once that is done, all balances (revenue, expense, withdrawal, etc.) should be zero.
9) Post-Closing Trial Balance
Finally, comes the post-closing trial balance, which lists the balances of the accounts that were not closed (such as liabilities, assets, and owner's equity). This trial balance helps verify that permanent accounts balance (i.e. that they have equal debit and credit sums) and that all temporary accounts were properly closed.
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.
by: Mark Walters
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