Accounting Cycle Steps
1. Identifying and Analyzing Business Transactions
The accounting process starts with identifying and analyzing business transactions and
events. Not all transactions and events are entered into the accounting system. Only those that
pertain to the business entity are included in the process.
For example, a personal loan made by the owner that does not have anything to do with the
business entity is not accounted for.
The transactions identified are then analyzed to determine the accounts affected and the
amounts to be recorded.
The first step includes the preparation of business documents, or source documents. A
business document serves as basis for recording a transaction.
2. Recording in the Journals
A journal is a book – paper or electronic – in which transactions are recorded. Business
transactions are recorded using the double-entry bookkeeping system. They are recorded in
journal entries containing at least two accounts (one debited and one credited).
To simplify the recording process, special journals are often used for transactions that recur
frequently such as sales, purchases, cash receipts, and cash disbursements. A general journal
is used to record those that cannot be entered in the special books.
Transactions are recorded in chronological order and as they occur.
Journals are also known as Books of Original Entry.
3. Posting to the Ledger
Also known as Books of Final Entry, the ledger is a collection of accounts that shows the
changes made to each account as a result of past transactions, and their current balances.
After the posting all transactions to the ledger, the balances of each account can now be
determined.
For example, all journal entry debits and credits made to Cash would be transferred into the
Cash account in the ledger. We will be able to calculate the increases and decreases in cash;
thus, the ending balance of Cash can be determined.
4. Unadjusted Trial Balance
A trial balance is prepared to test the equality of the debits and credits. All account balances
are extracted from the ledger and arranged in one report. Afterwards, all debit balances are
added. All credit balances are also added. Total debits should be equal to total credits.
When errors are discovered, correcting entries are made to rectify them or reverse their
effect. Take note however that the purpose of a trial balance is only test the equality of total
debits and total credits and not to determine the correctness of accounting records.
Some errors could exist even if debits are equal to credits, such as double posting or failure to
record a transaction.
5. Adjusting Entries
Adjusting entries are prepared as an application of the accrual basis of accounting. At the end
of the accounting period, some expenses may have been incurred but not yet recorded in the
journals. Some income may have been earned but not entered in the books.
Adjusting entries are prepared to update the accounts before they are summarized in the
financial statements.
Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income
method or liability method), prepayments (asset method or expense method), depreciation,
and allowances.
6. Adjusted Trial Balance
An adjusted trial balance may be prepared after adjusting entries are made and before the
financial statements are prepared. This is to test if the debits are equal to credits after
adjusting entries are made.
7. Financial Statements
When the accounts are already up-to-date and equality between the debits and credits have
been tested, the financial statements can now be prepared. The financial statements are the
end-products of an accounting system.
A complete set of financial statements is made up of: (1) Statement of Comprehensive
Income (Income Statement and Other Comprehensive Income), (2) Statement of Changes in
Equity, (3) Statement of Financial Position or Balance Sheet, (4) Statement of Cash Flows,
and (5) Notes to Financial Statements.
8. Closing Entries
Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the
system for the next accounting period. Temporary accounts include income, expense, and
withdrawal accounts. These items are measured periodically.
The accounts are closed to a summary account (usually, Income Summary) and then closed
further to the appropriate capital account. Take note that closing entries are made only for
temporary accounts. Real or permanent accounts, i.e. balance sheet accounts, are not closed.
9. Post-Closing Trial Balance
In the accounting cycle, the last step is to prepare a post-closing trial balance. It is prepared to
test the equality of debits and credits after closing entries are made. Since temporary accounts
are already closed at this point, the post-closing trial balance contains real accounts only.
*10. Reversing Entries: Optional step at the beginning of the new accounting
period
Reversing entries are optional. They are prepared at the beginning of the new accounting
period to facilitate a smoother and more consistent recording process.
In this step, the adjusting entries made for accrual of income, accrual of expenses, deferrals
under the income method, and prepayments under the expense method are simply reversed.
What is Accounting Cycle?
By Carol Wiley, Accountingedu contributing writer
Updated April 2013
During each accounting period, businesses must perform a number of steps to account for
business activities. These steps are called the accounting cycle. Although different sources
identify the steps in the cycle slightly differently, the following ten-step accounting cycle
covers the entire process comprehensively.
The first three steps take place throughout the accounting period, while the last seven steps
happen only at the end of each accounting period.
Step One: Identify and Analyze Transactions
Identifying and analyzing transactions involves looking at the source documents, such as
bank statements, checks, and purchase orders, that describe the transactions and their
purpose, including the transaction amount. It is then decided which accounts are affected by
the transaction, and how exactly those accounts were affected.
Step Two: Journalize
Journalizing refers to using double-entry accounting to record the appropriate debits and
credits for a transaction into a journal.
Step Three: Post
Posting is the transfer of the debits and credits from the journal to the ledger. While a journal
is simply a list of transactions, a ledger is a collection of all of the company’s accounts (Cash,
Accounts Receivable, Accumulated Depreciation, Accounts Payable, etc.).
Step Four: Make an Unadjusted Trial Balance
A list of all accounts and their balances at a point in time is called a trial balance. The
purpose of a trial balance is to make sure that the debits equal the credits.
Step Five: Make Adjusting Entries
Accrued and deferred items require the use of adjusting entries, which assign income and
expenses to a different accounting period. Adjusting entries are recorded in the general
journal and then posted to the ledger.
Step Six: Make an Adjusted Trial Balance
Another trial balance is prepared to verify that debits still equal credits. This information is
also used to prepare the financial statements.
Step Seven: Prepare Financial Statements
The financial statements must be prepared in a specific order:
1. Income statement
2. Retained earnings statement
3. Balance sheet
4. Cash flow statement
This order must be followed simply because the retained earnings statement uses information
from the income statement and the balance sheet uses information from the retained earnings
statement.
Step Eight: Close
Closing entries move the balances of temporary accounts to owner’s equity and get the
accounts ready for recording transactions in the next period.
Step Nine: Make a Post-Closing Trial Balance
A post-closing trial balance contains only the balance of debits and credits for permanent
accounts. Again, the purpose is to make sure that debits equal credits and that all temporary
accounts have a zero balance.
Step Ten: Make Reversing Entries
This step is optional. A reversing entry reverses previous adjusting entries. Companies may
use reversing entries to make it easier to record later transactions by getting rid of the need
for compound entries.
