The Beginner’s Guide to Accounting Cycle and Process

accounting cycle

Accounting is a repetitive process of recording and interpreting financial data. But, for most businesses, it is a misunderstood term that is mostly restricted to a department which engages in crunching numbers and generating complex reports. The role of accounting is as important to a business just as capital, finance or any other element would play in the achievement of long-term business objectives. It is necessary to have a comprehensive view of accounting processes and better analysis of financial transactions to shed light on wastage and productive areas. For this, it is important to get back to basics of accounting and understand what goes on in the entire accounting cycle.

What is an Accounting cycle?

In today’s fast-paced world, accounting cycle is commonly mistaken as the year-end drama that goes on in the accounting and finance departments, executives pressing for relevant documents and preparation of detailed financial reports to read out annual meetings and conferences.
But, the actual definition of accounting cycle refers to the process of collecting and recording business transactions carried on throughout the year in the form of journals and ledgers, creation of trial balance, corrections and adjustments to the trial balance, preparation of financial statements such as profit and loss accounts as well as cash flow, income and equity statements and finally balance sheet to ascertain the overall financial standing.

Important Steps in an Accounting Cycle

Journal Entries: The accounting cycle begins with simple, manual recording of every transaction such as purchases, sales, payments, incomes and expenses where there is a debit and credit of cash and finances. The journal entries are referred to create individual ledger accounts that are prepared as per the rules of accounting to interpret effects on individual transactions.

Ledger Accounts: Entries from the journal is posted into the ledger accounts throughout the accounting period to close accounts, adjust balances and distribute profits and incomes. There are three types of accounts ̶ real, personal and nominal accounts.

Preparation of Trial Balance: Trial balance is a statement of all debit and credit transactions carried out during the financial year shown in the respective debit and credit columns. The purpose of this statement is to catch accounting errors and oversights in ledger accounts to ensure the sum total of all debit transaction tallies with that of credit balance. The debit entries are recorded on the left side and the credit entries are placed on the right side of the trial balance.

Preparation of Financial Statements: Financial statements such as income statement, statement of cash, equity and debentures are prepared on a monthly, quarterly or yearly basis, depending upon the need of the business. This statement helps in the calculation of profit and loss as well as to note the liquidity or cash-readiness of the company over a specified period of time.

Balance Sheet: Balance sheet is an annual financial statement prepared at the end of the financial year that summarizes all assets, liabilities and capital owned by the company. The balance sheet has two columns, assets and liabilities. All asset balances such as cash flows, bank balance, prepaid expenses, inventory, goodwill and fixed assets like land, property and machinery appear on the right side of the balance sheet. Whereas liabilities, including bank interests, outstanding credit balance, dividends, rents, taxes payable as well as pension funds and capital are recorded on the left side. The balance sheet helps to provide an overview of the capital or shareholders’ equity with the help of simple formula ̶ Capital= Assets – Liabilities.

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