The accounting cycle steps in proper order:
If you want to know about accounting process, just read the following steps in the accounting cycle.
Step 1: Analyze Transactions
The accounting process starts with finding the nature of transactions by analyzing source(s) of account with respect to their effect on financial position of company. All the transactions are not entered into the accounting system. Only those transactions that pertain to be entered are considered.
For example: The Personal Expenses of owners or loans are not considered to be recorded in book of accounts.
Step 2: Journalize Transaction
After analyzing from first step, the gathered information has to be entered in Book of Original Entry or General Journal. A Journal can be a paper book or an electronic book. The Double entry bookkeeping system is considered when recording business transactions. A General Journal is not used to record special transactions. Special Journals are used for special transactions like Sales, Purchase, invoice etc. It helps to prevent mistakes and link between debits and credits of each transaction. The transactions are recorded in chronological order.
Step 3: Posting it to General Ledger Account
Posting information to Ledger account after journalizing the transaction, all transactions are collected and summarized. It’s not frequent as entries are made either at end of the day, week of the day or end of month. It’s also known as Books of Final Entry. It shows the collection of accounts and the changes to be made in accounts due to past transactions and current balances. It’s important to verify and troubleshoot the trail later in the process if accounts are not adding up correctly. If posting were done daily then the sales account in ledger will show total and cumulative sales for the time period till date.
Step 4: Prepare Un-adjusted Trial Balance
To verify the sum of Credit and the sum of Debit equal, the entries from the ledger of a particular period is summarized. All accounts are fetched from ledger and consolidated in a single report. This doesn’t tell how correct the accounts are. If errors are there, correcting entries are made to rectify them. There could still be some errors even if Debits are equal to credits. Also, if there is inequality, then the reason is investigated and corrected before moving to the next step.
Step 5: Prepare Adjustment Entries
The Period-end-Adjustments are made to Deferred and Accruals followed by Journalized entries and posting in the ledger. Income might be earned but not recorded in the books of accounts. It is important to update accounts before financial statements are summarized.
Step 6: Prepare Adjusted Trial Balance
A new Trial balance is made after new entries are recorded, to test either credits are equal to debits or not. This will help to demonstrate the effects of events financially happened during particular time period of the company. If there are unequal debits and credits or if the account comes out to be incorrect, errors are investigated and fixed.
Step 7: Prepare Financial Statement
The corrected balances from the adjusted trial balance are used to prepare financial statements. These are the outputs for Primary Financial Accounting System. Once credits are found to be equal to debit, financial statements are prepared. Financial statements can also be termed as end-products of an accounting system.
A Financial statement consists of:
- Income statement also known as Profit and loss account.
- Balance sheet tells the financial position of the company/firm.
- Cash flow statement tells how liquid is the company and its shareholdings.
Step 8: Journalize and Post close entries
Net income or loss is transferred to the capital account for next accounting period and temporary accounts are reduced to zero to prepare accounts for next year, it will be the opening balance for next fiscal year. To prevent their not being added to or commingled with net income / revenue and expenses of other period, they need to be closed out i.e. zero balance at end of each period.
Step 9: Prepare post closing trial balance
This can be described as a 2 step way:
- To analyze either the expenses and revenue are closed properly,
- To test the equality of the credits and Debits balance of all accounts in balance sheet.
Only permanents entries remains in the book i.e. assets, liabilities and owner’s equity. The equal balance depicts that company has correctly summarized and followed the accounting cycle.