The accounting cycle is about steps used by an accounting department of a business in another word, we can understand that the accounting cycle is a process which includes some steps for recording, classification and summarization of economic transaction of a business. It includes the income statement, balance sheet, cash flow statement and statement of changes in equity.
Major steps in the accounting cycle
Following are the major steps involved in the accounting cycle:
Analysing and recording transactions via journal entries: Analysing transactions and recording them as journal entries is the first step in the accounting cycle. It begins at the start of an accounting period and continues throughout the period.
Posting journal entries to ledger accounts: The second step of accounting cycle is to post the journal entries to the ledger accounts. The journal entries recorded during the first step provide information about which accounts are to be debited and which to be credited and also the magnitude of the debit or credit (see debit-credit-rules). The debit and credit values of journal entries are transferred to ledger accounts one by one in such a way that debit amount of a journal entry is transferred to the debit side of the relevant ledger account and the credit amount is transferred to the credit side of the relevant ledger account.
Preparing unadjusted trial balance: An unadjusted trial balance is a trial balance which is created before any adjusting entries are made in the ledger accounts. A trial balance is a list of the balances of ledger accounts of a business at a specific point of time usually at the end of a period such as month, quarter or year.
Preparing adjusting entries at the end of the period: Adjusting entries are journal entries recorded at the end of an accounting period to adjust income and expense accounts so that they comply with the accrual concept of accounting. Their main purpose is to match incomes and expenses to appropriate accounting periods.
Preparing adjusted trial balance: An adjusted trial balance is a trial balance which is prepared after the preparation of adjusting entries. Adjusted trial balance contains balances of revenues and expenses along with those of assets, liabilities and equities. Adjusted trial balance can be used directly in the preparation of the statement of changes in stockholders' equity, income statement and the balance sheet. However, it does not provide enough information for the preparation of the statement of cash flows.
Preparing financial statements: Financial statements are reports that provide information about a company's financial performance and financial position and how it has changed over a period. When we talk about financial statements, we often mean the general-purpose financial statements, the financial statements which a company prepares under some applicable financial reporting framework (such as IFRS or US GAAP). These are intended primarily for the company's investors and creditors but may address information needs of other stakeholders.
Closing temporary accounts via closing entries: Closing entries journal entries made at the end of accounting the period which transfers the balances of temporary accounts to permanent accounts. Closing entries are based on the account balances in an adjusted trial balance.
Preparing post-closing trial balance: A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have been passed and posted to the ledger accounts. Since the closing entries transfer the balances of temporary accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the retained earnings account, the new balances of temporary accounts are zero and therefore they are not listed on a post-closing trial balance. However, all the other accounts having non-negative balances are listed including the retained earnings account.