Any business that wants to survive and grow must perform the accounting function. It entails logging, categorizing, and summarizing financial transactions in order to shed light on a company’s financial situation. To ensure accurate and comprehensive financial accounts, accountants follow a set of procedures known as the accounting cycle. The seven phases of the accounting cycle will be covered in this article, along with some pertinent questions.
Let’s define a few terms before moving on to the accounting cycle. Although accounting and accountancy are frequently used synonymously, there is a little distinction between the two. Accountancy is the profession or area of study that includes accounting, whereas accounting is the practice of documenting and summarizing financial transactions. Accounting is therefore a part of accountancy. What are the four categories of accounting?
Financial accounting, managerial accounting, tax accounting, and auditing are the four primary subtypes of accounting. Creating financial statements for creditors and other external stakeholders is part of financial accounting. Managerial accounting is giving internal stakeholders, including managers and executives, financial information so that they can make wise business decisions. Tax accounting entails the creation of tax returns and monitoring legal compliance. Examining financial records for correctness and completeness is part of the auditing process.
Analyze transactions in Step 1
The analysis of financial transactions is the first phase in the accounting cycle. Identification of the type of transaction, the accounts impacted, and the dollar amount are required. For instance, if a business buys inventory on credit, the deal would be categorized as a purchase on account, affecting the accounts payable and inventory, and the transaction’s monetary value would be the cost of the goods.
Transactions must be entered into the accounting system after they have been examined. In order to do this, journal entries must be made that accurately indicate the debits and credits for each transaction. In our example of an inventory, the journal entry would credit accounts payable and debit inventory.
Post to Ledger in Step 3
Transactions must be uploaded to the general ledger after they have been journalized. The general ledger is a list of all the accounts that the business uses. A distinct ledger for every account keeps track of its balance and activity. In our example of inventory, the ledgers for inventory and accounts payable would both get the journal entry.
Prepare the Unadjusted Trial Balance in Step 4
A trial balance that has not been changed is created after all transactions have been recorded in the ledger. All of the accounts are listed here, along with their current balances. The unadjusted trial balance is used to make sure that all transactions have been appropriately recorded and that debits and credits are equal.
Adjusting entries are done for things such as accumulated expenses, prepaid expenses, and depreciation after the unadjusted trial balance has been created to ensure that the accounts are current and accurate. At the conclusion of an accounting period, these entries are made before financial statements are created.
Step 6: Create the Balance Sheet, Income Statement, and Adjusted Trial Balance. An adjusted trial balance is created once adjusting entries have been made. All of the accounts are listed here along with their updated balances. Financial statements are created using the adjusted trial balance. The balance sheet displays assets, liabilities, and equity at a certain point in time, whereas the income statement displays revenue and expenses for the accounting period.
The closing of the books is the last phase of the accounting cycle. Creating closing entries is required to move the balances of the revenue and expense accounts to the retained earnings account. To be ready for the following accounting period, the books are closed.
Selling, general, and administrative costs, sometimes known as SGA costs, are expenses a firm incurs while conducting business. Rent, payroll, advertising, and office supplies are a few examples of SGA costs. To calculate a company’s net income, revenue is reduced from these costs.
The amount of money a corporation makes from its main business operations is known as revenue from operations. Investment income and other non-operating activity income are not included. Investors and analysts use revenue from operations as a key performance indicator when assessing a company’s financial health.
The accounting cycle, then, is a set of procedures that accountants adhere to in order to produce accurate and comprehensive financial statements. The seven phases are transaction analysis, recording, posting to ledger, unadjusted trial balance preparation, entry correction, preparation of adjusted trial balance, preparation of income statement, preparation of balance sheet, and bookkeeping. There are four basic categories of accounting: financial, managerial, tax, and auditing. Accounting is a subset of accountancy. Revenue from operations is the amount of money a company makes from its main business activities, and SGA expense is a form of expense made by a corporation in the course of doing business.