Accounting cycle
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2012 by Marty J.Schmidt.Revised 9 January 2012.
The Meaning of Accounting Cycle
The accounting cycle is the sequence of accounting procedures starting with journal entries for various transactions and ending with the financial statements and the closing of temporary accounts Exhibit 1 below presents the accounting cycle as an information flow, starting with transactions that impact the organization's accounts, and ends with publication of financial statements.
Exhibit 1. The accounting cycle. Transactions are entered into the journal when they occur as the first |
During each accounting period (month, quarter year, or year), a bookkeeper normally enters transactions in a journal (or daybook) as they occur, in the order they occur. Journal entries are regularly posted to a ledger, which organizes entries by account and account category, and which contains all accounts used by the company or other entity. Note, however, that the use software-based accounting systems has brought the accounting cycle closer to being an automated, continuous process, where much of the transaction information capture and posting are processed automatically.
The accounting cycle continues when the accountant creates a trial balance from ledger entries. The trial balance is created to see whether or not debits=credits throughout the system (as they should in double entry bookkeeping). It there are places where the debits=credits equation does not hold, the accountant will typically create temporary accounts to bring about a balance, while investigating and correcting the cause of the problem.
The trail balance period also includes reconciliation, the process of checking account balances against other sources. Bank statements should agree with the ledger balances for the cash accounts, for instance, and liability accounts for bank loans should agree with the lender's account statements, and so on.
The fiinal steps in the accounting cycle are preparing and publishing the period's financial reports (including primarily the income statement, balance sheet, statement of changes in financial position, and statement of retained earnings) and closing the temporary accounts. (See Financial Metrics Pro for financial statement templates and financial statement form examples).
The basic building block of the company's accounting system, and the focus of accounting activity, is the account—a place for recording changes in value for a specific purpose; all accounts are either the so-called balance sheet accounts (asset accounts, liabilities accounts, or equity accounts), or they are so-called income statement accounts (revenue accounts or expense accounts). The complete list of accounts for use throughout the whole accounting cycle is specified in the company's chart of accounts.
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