The accounting process or cycle starts with identifying and measuring financial transactions. It is followed by recording the transactions and subsequent steps in the accounting cycle. It ultimately culminates in preparing the final accounts as financial statements, viz. “Profit & Loss Account” and “Balance Sheet”. Various steps are involved in an accounting cycle, and we will discuss all steps of accounting cycle in the next part.
Steps of Accounting Cycle
These steps of accounting cycle as follows:
Step 1: Business Transactions Take Place
Source documents, viz. Receipts, bills, vouchers, invoices, bank deposit slips, etc., are created.
Step 2: Analysis and Recording of the Transaction
Information from the source documents is entered in the primary books of account (i.e., journal or subsidiary books). This is a very crucial steps of accounting cycle.
Step 3: Posting the Information (Journal to the Ledger)
Entries made in the journal/subsidiary books are posted/recorded into the general ledger (A general ledger is a complete record of financial transactions over the life of a company). It contains accounting information which is required to prepare financial statements and includes accounts for assets, liabilities, owner’s equity, revenues, and expenses.
Step 4: Preparation of a Trial Balance
A trial Balance is a bookkeeping statement in which the balances of all the accounts of General Ledger (assets, liabilities, owner’s equity, revenue, and expense accounts) are compiled into debit and credit columns: A company prepares a trial balance periodically, usually at the end of every reporting period. Without this step of accounting cycle, you cannot ahead in this process.
Step 5: Journalize the Adjusting Entries
For recording the “Adjusting Entries” in the ‘Journal,’ there are no source documents. Adjusting entries are usually made on the last day of an accounting period (year, quarter, or month) so that the financial statements truly reflect the revenues earned and the expenses incurred during the accounting period.
Step 6: Posting of Adjusting Entries from the Journal to the Ledger
The adjusting entries recorded in the journal are posted in the ‘General Ledger. When we complete this step of accounting cycle then we will move on to the next step.
Step 7: Prepare preparation of an Adjusted Trial Balance
The “Adjusted Trial Balance” is the trial balance prepared after the Adjusting Entries have been posted in the ‘General Ledger.’ This is the second trial balance prepared in the accounting cycle. The value of some items in the ‘Unadjusted Trial Balance may change the “Adjusted Trial Balance”.
Step 8: Journalize Closing Entries
This step involves closing all the temporary (nominal) accounts, transferring the amount to the respective permanent accounts, and bringing the balance in such temporary accounts to “Nil”. Such accounts would start with zero balance in the next accounting period.
Step 9: Posting of Closing Entries (Journal to the Ledger)
In this step, closing entries of the journal are posted into the ‘General Ledger’. After complete this step of accounting cycle, we will enterend into last stage of this process.
Step 10: Preparation of a Post-Closing Trial Balance
“Post Closing Trial Balance” is prepared based on the general ledger prepared after posting closing entries. It shows only the items of “Permanent Accounts, which are permanent (they carry current balances as long as the business continues) and is not closed at the end of the period. These are balance sheet accounts (except for withdrawals).
Step 11: Preparation of the Financial Statements
The last step of the “Accounting Cycle” is the preparation of the financial statements, viz. “Profit & Loss Account” and “Balance Sheet” with the help of post-closing trial balance.
The accounting system refers back to the systematic and established method used to document, examine, and record economic transactions and facts of a commercial enterprise or company. It involves a series of step of accounting cycle which might be followed to ensure accurate and reliable economic facts.