What is the Accounting Cycle?
The accounting cycle is the process of calculating, recording, and classifying financial transactions over an accounting period, which can be quarterly, annually, or any other time frame. Public companies often synchronize their accounting cycles with the due dates of their financial statements.
How Does the Accounting Cycle Work?
The specific steps in the accounting cycle vary depending on the reporting needs of the company, as some businesses follow seven steps while others follow nine steps. Here are some common key steps:
1. Identification and Analysis: Reviewing receipts, invoices, and other documents to analyze transactions and their impact on accounts.
2. Recording: Entering transactions into the sales and purchase journals, using a double-entry or single-entry system.
3. Posting Journal Entries: Posting journal entries to the appropriate general accounts.
4. Preparing an Unadjusted Trial Balance: Verifying the balance of accounts at this stage and ensuring that there are no errors that require adjustments.
5. Making Necessary Adjustments: Making any necessary adjustments and recording them as journal entries, such as recognizing prepaid expenses or incurred but unpaid expenses.
6. Preparing the Adjusted Trial Balance: Ensuring that the company’s records are in balance after adjustments are made.
7. Preparing Financial Statements: Once adjustments are complete, the company can prepare financial statements, including the income statement, balance sheet, cash flow statement, and statement of equity.
8. Closing the Records: The accounting cycle ends with closing the records on the last day of the accounting period, which includes closing expenses and revenues in the income summary account, closing the income summary account to the owner’s capital account, and closing the draw account to the owner’s capital account.
The resulting financial reports allow you to understand how your money is moving and how much money is available to you at any given time, along with many other financial metrics. Once the accounting cycle is closed, a new cycle begins.
Why is the Accounting Cycle Important?
The accounting cycle is a crucial part of business management as it provides a comprehensive understanding of business performance. When accountants break down complex financial information into categories, accounts, and step-by-step calculations, they can ensure greater accuracy.
Even small businesses may have multiple employees to handle payroll, purchase equipment, process customer receipts, and pay operating costs. Businesses may be funded by a mix of bank loans and investments from family or personal funds from the owner.
Every aspect of your business must be accounted for accurately so you can:
– Carefully track financial trends.
– Analyze financial trends such as revenue growth and profitability.
– Prepare necessary financial reports for tax authorities, regulators, investors, and others.
– Make financial decisions about the business, including managing expenses and improving profits.
Key Takeaways
– The accounting cycle is a process that produces a comprehensive report on the financial performance of a company.
– Companies complete the accounting cycle once for each accounting period, which can be quarterly, annually, or other time frames, depending on regulatory requirements.
– The accounting cycle helps businesses, analysts, and investors analyze key financial metrics using financial data such as income statements and balance sheets.
– The duration of the accounting cycle may vary from one company to another.
Source: https://www.thebalancemoney.com/what-is-the-accounting-cycle-5218035
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