The Accounting Cycle
This short introduction explains the complete accounting cycle in theory, from journal entries to financial statements. Some of this is a repeat, but this short refresher can help you understand a bit better now that you've had a little hands-on work.
The accounting cycle includes analysis of transactions, transferring journal entries into a general ledger, revenue, and expense closed.
Outline the accounting cycle from point of transaction to financial statements
- When a transaction occurs, a document is produced. Most of the time these documents are external to the business, however, they can also be internal documents, such as inter-office sales. These documents are referred to as a source document.
- The Journal entries are then transferred to a Ledger. The group of accounts is called ledger, or a book of accounts. The purpose of a Ledger is to bring together all of the transactions for similar activity.
- Financial statements are drawn from the trial balance which may include: the Income statement, the Balance sheet, and the Cash flow statement.
- Journal entries
A journal entry, in accounting, is logging of transactions into accounting journal items. The journal entry can consist of several items, each of which is either a debit or a credit.
There are eight steps in the accounting cycle and they are as follows:
- Analyze transactions by examining source documents.
- Journalize transactions in the journal.
- Post journal entries to the accounts in the ledger.
- Prepare a trial balance of the accounts and complete the worksheet (includes adjusting entries ).
- Prepare financial statements.
- Journalize and post adjusting entries.
- Journalize and post closing entries.
- Prepare a post-closing trial balance.
When a transaction occurs, a document is produced. Most of the time these documents are external to the business, however, they can also be internal documents, such as inter-office sales.
These documents are referred to as a source document. Some examples are the receipt you get when you purchase something at the store, the interest you earned on your savings account which is documented in your monthly bank statement, and the monthly electric utility bill that comes in the mail. These source documents are then recorded in a Journal. This is also known as a book of first entry. It records both sides of the transaction recorded by the source document. These write-ups are known as Journal entries.
These Journal entries are then transferred to a Ledger, which is the group of accounts, also known as a book of accounts. The purpose of a Ledger is to bring together all of the transactions for similar activity. For example, if a company has one bank account, then all transactions that include cash would then be maintained in the Cash Ledger. This process of transferring the values is known as posting. Once the entries have all been posted, the Ledger accounts are added up in a process called Balancing.
A particular working document called an unadjusted Trial balance is created. This lists all the balances from all the accounts in the Ledger. Notice that the values are not posted to the trial balance, they are merely copied. At this point accounting happens. The accountant produces a number of adjustments which make sure that the values comply with accounting principles. These values are then passed through the accounting system resulting in an adjusted Trial balance. This process continues until the accountant is satisfied.
Financial statements are drawn from the trial balance which may include: the Income statement, the Balance sheet, and the Cash flow statement.
Finally, all the revenue and expense accounts are closed.
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