Accounting Cycle - New Project 2

Here is a step-by-step breakdown of how the cycle works from start to finish.

1. Identify and Analyze Transactions

The cycle begins the moment a business transaction occurs. This could be selling a product, buying inventory, paying rent, or receiving a utility bill. The accountant gathers source documents (receipts, bank statements, invoices) and determines which accounts are affected.

2. Journalize Transactions

Once analyzed, the transaction is recorded in the General Journal in chronological order. This is where double-entry bookkeeping comes into play. For every transaction, at least one account is debited and another is credited, and total debits must always equal total credits./

3. Post to the General Ledger

Next, the journal entries are transferred, or "posted," to the General Ledger. The ledger organizes transactions by specific accounts (e.g., Cash, Accounts Receivable, Inventory, Wages Expense). This allows a business to see the current balance of any individual account at any given time.

4. Prepare an Unadjusted Trial Balance

At the end of the accounting period, a list of all ledger accounts and their balances is compiled. This is called the Unadjusted Trial Balance. Its primary purpose is a quick mathematical check: do total debits equal total credits? If they don't, there's an error in journalizing or posting that needs fixing.

5. Journalize and Post Adjusting Entries

Even if the trial balance matches, the books might not be entirely accurate yet due to the accrual basis of accounting. Adjusting entries are made to account for revenues earned or expenses incurred that haven't been recorded yet.

Examples: Accrued wages earned by employees but not yet paid, prepaid insurance that has expired during the month, or depreciation on equipment.

6. Prepare an Adjusted Trial Balance

After posting the adjusting entries, a new Adjusting Trial Balance is generated. This ensures that debits and credits are still in balance after the modifications and provides the finalized numbers needed for the financial reports.

7. Prepare Financial Statements

With the adjusted balances locked in, the accountant can now construct the official financial statements. They are typically prepared in this specific order because the numbers flow from one to the next:

8. Close the Books (Closing Entries)

To get ready for the next accounting period, temporary accounts (revenues, expenses, and dividends/draws) must be reset to zero. Their balances are transferred to a permanent account on the balance sheet, typically Retained Earnings. This ensures the next period's income statement starts fresh at zero. Permanent accounts (assets, liabilities, and equity) are never closed; their balances simply roll over.

9. Prepare a Post-Closing Trial Balance

The final step is to run one last trial balance. Since all temporary accounts have been zeroed out, the Post-Closing Trial Balance consists strictly of balance sheet accounts (assets, liabilities, and equity). This proves that the books are balanced, accurate, and ready for Day 1 of the next cycle.

Without this disciplined structure, financial records would quickly turn into chaos. The accounting cycle ensures:

While these steps and procedures are used by both a manual and computerized bookkeeping system, a computerized system automates them.