REVIEW OF THE ACCOUNTING CYCLE
The Accounting Process (or accounting cycle) consists of 2 interrelated parts, namely:
- Recording Phase - concerned w/ collecting information about economic transactions and events and distilling that information into a form useful to accounting process.
- Reporting Phase - the recorded information is organized and summarized using various formats for a variety of decision-making purposes.
STEPS IN THE ACCOUNTING PROCESS
RECORDING PHASE (during the accounting period) Step 1 - Step 3
Step 1 - Business documents analyzed
Analysis of documentation provides basis for making an initial record of each transaction or other economic events.
Economic events that have consequences to the business entity:
- Transactions - are transfers or exchanges of something w/ value between the firm and 1 or more independent outside parties.
- Other Economic Events:
- Internal Events - events that occur within and have economic consequences for the firm. Example: use of the inventory for production
- External Events - events that occur outside and have economic consequences for the firm. Example: casualty loss, changes in market values of assets
Step 2 - Transactions are recorded in journals
Based on supporting documents from Step 1, transactions are recorded using journal entries in chronological order in books of original entry (journals).
Step 3 - Transactions are posted to ledgers
Transactions, as classified and recorded in the journal are posted in the appropriate accounts in the general ledger, and when applicable, subsidiary ledgers.
It is a copying process; it involves no new analysis.
REPORTING PHASE (At the end of the accounting period) Step 4 - Step 9
Worksheet (Optional) Step 4 - Step 6
Step 4 - Unadjusted Trial Balance
After all transactions for the period has been posted to the ledger accounts, the balance of each account is determined and a list of every account in the ledger along with the current debit or credit balance is prepared.
Step 5 - Adjustments
All relevant information that has not been recorded must be determined and appropriate adjustments made to make the accounts current.
Typical areas that requiring adjustments at the end of the reporting period:
- Asset depreciation - charges to operation for the use of buildings, furniture and equipment. The carrying value of the asset is reduced by the amount of depreciation. A reduction in an asset account for depreciation is recorded by a credit to a contra account.
- Bad debts - under the accrual concept, an adjustment should be made to estimated bad debt expense for in the current period rather than when specific accounts will become uncollectible in later periods.
- Accrued expenses - At the end of the accounting period, determine and record any expenses incurred for which payment is not to be made until a subsequent period.
- Accrued revenues - At the end of the accounting period, determine and record revenues earned, although the collection of cash is not to be made until a subsequent period.
- Prepaid expenses - At the end of the accounting period, determine the portions of recorded expenditures for goods and services that are not to be received or used up currently.
- Deferred revenues - Payments could be received from customers prior to delivery of goods and services. At the end of the accounting period, determine the amount of revenue earned in the current period and the unearned amount to be deferred to future periods.
- Inventory - When a periodic system is used, physical inventories must be taken at the end of the accounting period to determine the inventory to be reported on the balance sheet and the cost of goods sold to be reported on the income statement. - When a perpetual inventory system is in use, an adjustment is made only to correct record balances for any spoilage, theft, or bookkeeping errors that may have occurred, as determined by the physical count.
- Income taxes - when an entity reports earnings, adjustments must be made for income taxes.
Step 6 - Adjusted Trial balance
Account balances, as adjusted, are carried forward to appropriate financial statement columns.
A worksheet includes a pair of columns for the income statement accounts and a pair for balance sheet accounts.
There are no columns for the statement of cash flows because this statement requires additional analysis of changes in account balances for the period.
Step 7 - Financial Statements
Statements summarizing operations and showing financial position and cash flows are prepared from the adjusted accounts.
Step 8 - Closing entries
Balances in the nominal accounts are closed into relevant equity accounts.
Step 9 - Post-closing Trial balance (optional)
A post-closing trial balance is prepared to determine the equality of debits and credits after posting the adjusting and closing entries.
(At the start of next accounting period)
Step 10 - Journalize and Post Reversing Entries (optional)
Certain adjusting entries for deferred and accrued items are reversed at the first day of the new accounting period.
In most cases, only accrued adjusting entries are reversed.
The accounting cycle is a vital process that ensures accurate financial reporting and compliance with accounting principles. By following these sequential steps, businesses can maintain reliable financial records, produce meaningful financial statements, and provide stakeholders with valuable insights into the company's financial performance and position. Best Cash Flow Forecasting Software | Financial Forecasting Strategy
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