The accounting cycle is a multi-step process that involves accepting, recording, sorting, and crediting payments made within a business during a period of time. It creates an accurate record of the business's financials that are summarized on its financial statements.
During these various steps, companies will record their financial transactions in a journal, transfer the entries into the general ledger (GL), and analyze the entries to ensure the books are balanced and accurate before moving to financial statements.
The amount of time required to work through the accounting cycle depends on a few factors: volume of transactions, automated systems in place (if any), and the type of financial close.
The 8 Steps of the Accounting Cycle
- Identify & Analyze Transactions. The first step in the accounting cycle is to identify and analyze all of the transactions that were made for the business during the period. This includes expenses, debt payments, revenue from sales, and cash received from customers. During this stage, it is important to identify any transaction that affects the business's financials, although this should also be a regularly occurring task for a business's bookkeeping team.
- Record Transactions. Once the transactions are identified, record all of the transactions as journal entries. Ideally, this should be done in an accounting software, rather than manually. The timing in which the transaction is recorded will depend on if the business operates on an accrual basis or a cash basis accounting method.
- Post Transactions to the GL. Once the journal entries are recorded and approved, they are posted in the general ledger. The GL is the master record and is home to all financial transactions. It is broken down by account to give a more detailed view.
- Determine the Unadjusted Trial Balance. A trial balance is the closing balance of all of the GL accounts at the end of the accounting period. It is considered an unadjusted trial balance because, at this point, no adjustments have been made for any unbalanced debits and credits that may occur.
- Analyze the Worksheet. This step in the accounting cycle is where errors and any abnormalities are identified. This is done by lining up the debits and credits from the various accounts in a single spot. If there is an imbalance in the numbers, the bookkeeping team will need to go back and revisit the transaction that was entered into the journal and adjust the entries accordingly.
- Adjust Journal Entries for Errors. This step piggybacks off of the last step if there are adjustments that need to be made in the journal entries. If an error was made it must be corrected by entering an adjusting journal entry to reflect a change to an already existing journal entry. This will be the time for any items that did not make it into the initial record.
- Create Financial Statements. Once the adjustments are situated, it is time to move on to the financial statements. Financial statements summarize the financial activity of a business and will provide a look into the overall health of the business. It's important that this step is started with accurate data compiled in the previous steps. The three key financial statements that a company should generate at the time, at a minimum, are an income statement, a balance sheet, and a cash flow statement.
- Finalize Closing the Books. The closing is the final step of the accounting cycle. It locks in the accounting period and finalizes the books. Once the close occurs, the temporary accounts on the income statement (revenue & expenses) are reset to zero. These do not carry over from period to period. The Net income (or loss) is transferred to the retained earnings account and carries over to the next period.
The accounting cycle is a rather standard procedure for all businesses. It provides a few areas to catch any transactional errors and can also be done quicker with the help of a cloud-based accounting system like NetSuite. To learn more about the NetSuite platform or for assistance with your business bookkeeping needs, turn to the pros at AccountingDepartment.com.