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Understanding Accounting Cycle: What are the Steps

Posted by Early Growth

September 20, 2021    |     4-minute read (792 words)

Part of the duties of a bookkeeper is to track the transactions of a business consistently. Through state-of-the-art Point of Sale (POS) systems, it has never been easier to keep track of an organization’s activities. The accounting cycle is an eight-step process designed to make life simpler. While automation has replaced much of the manual processes, it’s still important to know the accounting cycle definition and how to implement it within a business. Here’s what you need to know about using and implementing an accounting cycle.

Accounting Cycle Explained

So, what is the accounting cycle? At its heart, it’s no more than the process of recording all financial transactions made within a business. Bookkeepers are required to record the type of transaction, the date and time it occurred, and the value of the transaction. These numbers are then used by an overseeing accountant to prepare financial statements for the company.

Full-cycle accounting covers an entire fiscal year and repeats itself for every year the company actively trades. The accounting cycle will cover the recording and reporting of all major business accounts, such as credits, debits, journal entries, and T accounts. Regardless of the size of the business, the accounting period cycle never changes.

What is the Purpose of the Accounting Cycle?

There are several reasons why entrepreneurs must understand and take advantage of the value of full-cycle accounting. Ensuring that every transaction is properly accounted for guarantees accuracy, consistency, and industry-specific compliance. Entrepreneurs also use the data extracted from a bookkeeping cycle summary to acquire important insights into their organizations, such as:

  • Financial Status – At a glance, business owners can understand the financial health of their organization.
  • Define Direction – Drive the future direction of the business, such as expansion, improvements in profitability, and efficiency.
  • Limit Fraud – Fraud costs businesses millions of dollars per year. An accounting cycle is an important resource to help understand where and why a business could be losing money.
  • Improved Organization – Keeping the books organized makes it easy to pinpoint specific numbers and better understand the health of an organization.
  • Industry Standards – Make it simple to compare business results with the reported figures from competitors.
What are the Accounting Cycle Steps?

So, what is the accounting cycle, steps, and processes bookkeepers must follow to meet the standards of an accounting period cycle?

Step One – Identify Transactions

Properly record all transactions and categorize them by type. Simplify this step by connecting your books with a modern Point of Sale (POS) system.


Step Two – Journal Identified Transactions

Every transaction must have its own journal entry. Again, this can be automated via a POS system. This step will vary depending on whether a company uses cash or accrual accounting. The difference is accrual accounting records the transaction at the time of sale, whereas cash accounting only creates a journal entry when cash is received or spent.


Step Three – Posting

Journaled entries will be posted to the general ledger, which is the readout of accounting activities for each distinct account, such as the cash account.


Step Four – Create an Unadjusted Trial Balance

Step four involves detailing the unadjusted balances for each account. This is the cornerstone of an accounting cycle for the end of the fiscal year.

Step Five – Balance the Books

Bookkeepers must ensure that credits and debits are equal, otherwise known as balancing the books. This step is vital to the double-entry bookkeeping process.


Step Six – Journal Entry Adjustments

If adjustments need to be made, step six is when the bookkeeper will make the necessary adjustments. All adjustments must have separate journal entries.


Step Seven – Create Financial Statements

The final step in an accounting cycle is to generate financial statements, such as the cash flow statement, balance sheet, and income statement.


Step Eight – Close the Books

Any accounting cycle ends with closing the books. Produce closing statements for a specified date and begin the accounting cycle again.


The Accounting Cycle vs. The Budget Cycle

The accounting cycle definition focuses on past events and reports those past transactions in a clear, correct, and consistent manner. External users will utilize the information produced by full-cycle accounting to make decisions. On the other hand, the budget cycle is used primarily for internal management purposes. It is a cycle used primarily to determine a business’s spending for the year ahead.


Conclusion

Understanding the cycle of accounts for the fiscal year is the basis of proper bookkeeping and accounting practices across all businesses. The information gleaned is not just to comply with regulations, but it can also be used to help make the big decisions for your business. Take the stress and hassle out of handling bookkeeping and accounting contact Early Growth to learn more about personalized CFO services now.

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