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Accounting Cycle


The Accounting Cycle

The sequence of activities beginning with the occurrence of a transaction is known as the accounting cycle. This process is shown in the following diagram:

Steps in The Accounting Cycle
Identify the Transaction
Identify the event as a transaction
and generate the source document.
Analyze the Transaction
Determine the transaction amount,
which accounts are affected,
and in which direction.
Journal Entries
The transaction is recorded in
the journal as a debit and a credit.
Post to Ledger
The journal entries are transferred
to the appropriate T-accounts
in the ledger.
Trial Balance
A trial balance is calculated
to verify that the sum of the debits
is equal to the sum of the credits.
Adjusting Entries
Adjusting entries are made for
accrued and deferred items.
The entries are journalized and
posted to the T-accounts
in the ledger.
Adjusted
Trial Balance

A new trial balance is calculated
after making the adjusting entries.
Financial Statements
The financial statements
are prepared.
Closing Entries
Transfer the balances of the
temporary accounts
(e.g. revenues and expenses)
to owner's equity.
After-Closing
Trial Balance

A final trial balance is
calculated after the closing
entries are made.


The above diagram shows the financial statements as being prepared after the adjusting entries and adjusted trial balance. The financial statements also can be prepared before the adjusting entries with the help of a worksheet that calculates the impact of the adjusting entries before they actually are posted.

The Accounting Process
(The Accounting Cycle)


The accounting process is a series of activities that begins with a transaction and ends with the closing of the books. Because this process is repeated each reporting period, it is referred to as the accounting cycle and includes these major steps:
1.      Identify the transaction or other recognizable event.
2.      Prepare the transaction's source document such as a purchase order or invoice.
3.      Analyze and classify the transaction. This step involves quantifying the transaction in monetary terms (e.g. dollars and cents), identifying the accounts that are affected and whether those accounts are to be debited or credited.
4.      Record the transaction by making entries in the appropriate journal, such as the sales journal, purchase journal, cash receipt or disbursement journal, or the general journal. Such entries are made in chronological order.
5.      Post general journal entries to the ledger accounts.
__________________
The above steps are performed throughout the accounting period as transactions occur or in periodic batch processes. The following steps are performed at the end of the accounting period:
6.      Prepare the trial balance to make sure that debits equal credits. The trial balance is a listing of all of the ledger accounts, with debits in the left column and credits in the right column. At this point no adjusting entries have been made. The actual sum of each column is not meaningful; what is important is that the sums be equal. Note that while out-of-balance columns indicate a recording error, balanced columns do not guarantee that there are no errors. For example, not recording a transaction or recording it in the wrong account would not cause an imbalance.
7.      Correct any discrepancies in the trial balance. If the columns are not in balance, look for math errors, posting errors, and recording errors. Posting errors include:
    • posting of the wrong amount,
    • omitting a posting,
    • posting in the wrong column, or
    • posting more than once.

8.      Prepare adjusting entries to record accrued, deferred, and estimated amounts.
9.      Post adjusting entries to the ledger accounts.
10.  Prepare the adjusted trial balance. This step is similar to the preparation of the unadjusted trial balance, but this time the adjusting entries are included. Correct any errors that may be found.
11.  Prepare the financial statements.
    • Income statement: prepared from the revenue, expenses, gains, and losses.
    • Balance sheet: prepared from the assets, liabilities, and equity accounts.
    • Statement of retained earnings: prepared from net income and dividend information.
    • Cash flow statement: derived from the other financial statements using either the direct or indirect method.

12.  Prepare closing journal entries that close temporary accounts such as revenues, expenses, gains, and losses. These accounts are closed to a temporary income summary account, from which the balance is transferred to the retained earnings account (capital). Any dividend or withdrawal accounts also are closed to capital.
13.  Post closing entries to the ledger accounts.
14.  Prepare the after-closing trial balance to make sure that debits equal credits. At this point, only the permanent accounts appear since the temporary ones have been closed. Correct any errors.
15.  Prepare reversing journal entries (optional). Reversing journal entries often are used when there has been an accrual or deferral that was recorded as an adjusting entry on the last day of the accounting period. By reversing the adjusting entry, one avoids double counting the amount when the transaction occurs in the next period. A reversing journal entry is recorded on the first day of the new period.
Instead of preparing the financial statements before the closing journal entries, it is possible to prepare them afterwards, using a temporary income summary account to collect the balances of the temporary ledger accounts (revenues, expenses, gains, losses, etc.) when they are closed. The temporary income summary account then would be closed when preparing the financial statements.

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