Accounting cycle

The accounting cycle is a basic eight-step process for completing a company's accounting activities. It provides clear guidance for recording, analyzing and final reporting of a company's financial activities. The accounting cycle is used comprehensively through an entire reporting period. Therefore, staying organized throughout the process time frame can be a key element that helps maintain overall efficiency. Accounting cycle periods vary according to your reporting needs. Most companies try to analyze their performance on a monthly basis, although some may focus more on quarterly or yearly results. Regardless, most accountants will have an awareness of the company's financial position on a day-to-day basis. Overall, determining the amount of time for each accounting cycle is important because it establishes specific dates for opening and closing. Once an accounting cycle closes, a new cycle begins, restarting the eight-step accounting process all over again.

Understanding of the eight-step accounting cycle

The eight-step cycle of accounting begins with recording each business transaction individually and ends with a comprehensive report of the business's activities for the designated cycle time period. Many companies use accounting software to automate the accounting cycle. This allows accountants to schedule cycle dates and receive automatic reports. Depending on the system of each company, more or less technical automation can be used. Typically, accounting will require technical support, but an accountant may be required to intervene in the accounting cycle at various points. Each individual company will usually need to modify the eight-step accounting cycle in certain ways to fit their company's business model and accounting procedures. Changes to accrual versus cash accounting are usually a major concern. Businesses can also choose between single-entry accounting and double-entry accounting. Double-entry bookkeeping is required for businesses to prepare all three major financial statements: income statement, balance sheet, and cash flow statement.The eight phases of the accounting cycle:

1. Identify transactions. The first step in the accounting cycle is the identification of transactions. Businesses will have many transactions during the accounting cycle. Each must be properly recorded in the company's books. Record keeping is essential for recording all types of transactions. Many companies will use point-of-sale technology connected to their books to record sales transactions. Besides sales, there are also expenses that can come in many varieties.
2. Record transactions in a journal. The second stage of the cycle is the creation of journal entries for each transaction. Point-of-sale technology can help combine steps one and two, but businesses also need to keep track of their spending. The choice between accrual accounting and cash accounting will determine when transactions are officially posted. Keep in mind that accrual accounting requires matching income with expenses, so both must be recorded at the time of sale. Cash accounting requires transactions to be recorded when money is received or paid. Double-entry accounting requires posting two entries with each transaction in order to maintain a fully developed balance sheet along with an income statement and cash flow statement. Generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS) both require public companies to use accrual accounting for their financial statements. With double-entry accounting, each transaction has an equal debit and credit. Single-entry accounting is comparable to managing a checkbook. Provides a balance report but does not require multiple entries.
3. Publication. Once a transaction has been posted as a journal entry, it should be posted to an account in the general ledger. The general ledger provides a breakdown of all accounting activities by account. This allows an accountant to track financial positions and statuses on behalf. One of the most commonly referenced accounts in the general ledger is the cash account which details the amount of cash on hand.
4. Unadjusted trial balance. At the end of the accounting period, a trial balance is calculated as the fourth stage of the accounting cycle. A trial balance communicates the unadjusted balances in each account to the company. The unadjusted trial balance is then carried over to stage five for testing and analysis.
5. Worksheet. Analyzing a worksheet and identifying adjustment items is the fifth stage of the cycle. A worksheet is created and used to ensure that debits and credits are equal. If there are any discrepancies, adjustments will need to be made. In addition to identifying any errors, you may need to adjust entries for income and expense matching when using accrual accounting.
6. Adjustment of diary entries. In the sixth stage, an accountant makes the changes. Where necessary, adjustments are posted as journal entries.
7. Financial statements. After the company has made all the adjustment postings, it generates its financial statements in step seven. For most businesses, these statements will include an income statement, balance sheet, and cash flow statement.
8. Closing the books. Finally, a business ends the accounting cycle in the eighth stage by closing its books at the end of the day on the specified closing date. Final statements provide a report for analyzing performance over the period. After closing, the accounting cycle starts all over again with a new reporting period. Closing is usually a good time to file paperwork, plan for the next reporting period, and review a calendar of future events and activities.

The bottom line

The eight-step accounting cycle process simplifies bookkeeping for busy accountants and business owners. It can help take the guesswork out of how to handle accounting tasks. It also helps ensure consistency, accuracy and efficient analysis of financial performance.

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Author: Chiara Di Miscio