The sequence of steps in the accounting process provides a foundation for consistency and accuracy, both of which are vital for calculating and presenting effective reports on the financial health of a company. Typically referred to as the accounting cycle, this series of accounting activities follows generally accepted accounting practices, and while details change from business to business, the overall process is familiar and recognizable to anyone with bookkeeping or accounting experience.
Accounting activities break down into periods. During each period, an accounting cycle occurs and progresses from start to finish before starting again the next period. The transactions recorded within an accounting cycle provide the data for reporting on that period.
Period length could be as little as a day or as long as a year, and a company can track multiple periods. For example, a manufacturing business may track production operations using a weekly period to provide useful feedback for adjusting production efficiency. This company may also undertake wider reporting for a quarterly period to reflect all financial activity including activity that may be outside the core of the company’s business.
Three types of transactions comprise the basic record of business transactions. These are:
- Reversing entries, made to adjust or correct account balances from the previous period
- Current transactions, the revenues and expenses that occur in the day-to-day business of the current period
- Closing entries, transactions needed to balance accounts at the end of the accounting cycle for the current period
Assuming that the previous cycle is successfully closed and accounts are reset to zero, the new accounting cycle begins with identifying and analyzing transactions for the current period. These transactions include everything that relates to the company’s financial health, from sales and revenues to expenses small and large.
The journals are the day-to-day working records of transactions. Formerly, the journals were physical books in which transactions were written down. Today, most journals exist in computer accounting software packages.
The ledger was once the ink-and-paper master record, generated from the journals once these were filled and verified. Again, this is typically a software function now, but the traditional accounting terminology persists.
A report called the unadjusted trial balance follows to test the balance of all accounts. In the double-entry accounting system, every transaction is both debited and credited to an account. Without errors, master debit and credit accounts should balance. The trial balance confirms this or identifies the need for adjusting entries.
Corrections and late transactions require adjusting entries to eliminate errors. After these corrections are made, the adjusted trial balance report can be generated.
At this point, financial statements that accurately reflect the financial activity for the period are prepared. These include reports such as cash flow statements, balance sheets and income statements.
Prepare the financial statements when all accounts are up to date and balanced. The financial statements are the end product of the accounting cycle.
Closing entries adjust the transactions of temporary accounts to prepare for a new accounting cycle. Temporary accounts are those that are returned to zero for the next accounting period.
The post-closing trial balance includes only permanent accounts, such as a balance sheet account, to confirm accurate data after the temporary accounts are reset.
If the temporary accounts don’t reflect a zero balance, reversing entries are made to accomplish this. These entries are either the last step in the current accounting cycle or the first step of the next cycle.