The concept of the Accounting Cycle can be defined as the process that is a collective amalgamation of the processes such as identifying, recording, and analyzing all the accounting events of the firm over the year.
The financial statement of the firm comprises the series of accounting steps right from the start of the transactions to their end. Apart from the financial statements such as profit and loss statements and balance sheets, it also includes ledgers and trial balance.
It can also be defined as the modus operandi of recording, sorting, accepting, and making the various payments to the stakeholders, vendors, and employees of the firm during a particular time frame.
Many of the firms follow the policy of settling their books of accounts and finance at the end of every quarter and again at the year-end. It helps to avoid and iron out the financial and accounting discrepancies if any.
Some of the small scale firms prefer to check and close accounting worksheets on a weekly or monthly basis, depending on the manpower and other business resources.
- As mentioned earlier, the Accounting Cycle takes notes of the vital financial statements of the firm such as ledger accounts, profit, and loss accounts, cash flow reports, and balance sheets amongst others.
- And once all the business accounts are closed and balanced without any sort of discrepancies for a particular period of time, the company moves on the next Accounting Cycle.
- The methodology and modus operandi of the Accounting Cycle ensures the precision and accuracy of all the financial statements of the firm in order to attain the financial objectives.
- Moving away from the manual processes of the Accounting Cycle, the firms now opt for the various flexible and state of the art software’s that can be tailor-made as per the need and requirement of the firm.
- It avoids human errors and reduces the level of human efforts as well.
8 Steps of Accounting Cycle
The process starts with the financial transactions of the firms with the various internal and external parties. They include profit ratios, sales revenues, overheads, expenses, debts, purchases, and acquisition of assets amongst others.
#2 Journal Entries:
After the transactions are to record the entries in chronological order in the journal of the firm. During the process of debiting and crediting of the entries, both the sides should always balance.
#3 General Ledger:
The next step of the accounting cycle involves posting the journal entries into the general ledger. It includes the exact summary of all the transactions where individual accounts are visible as well.
#4 Trial Balance:
Post the Accounting Cycle that can be monthly, quarterly, or annually as per the financial objectives of the firm; the total balance is calculated in the trial balance.
#5 Accounting Worksheet:
The worksheet tracks and takes notes of the errors of debits and credits in the trial balance. The bookkeeper looks into the errors and takes corrective measures to rectify the same in the worksheet.
#6 Adjusting Entries:
At the end of the accounting cycle, the entries must be adjusted as per the financial standards and must be posted for accruals and deferrals.
#7 Financial Statements:
The next step involves preparing cash flow statements, balance sheets, and other income statements.
The final step involves closing and zeroing down all the expense and revenue accounts for the next Accounting Cycle. The balance sheet is not closed as it shows the financial position of the firm at a certain time period. Whereas the other statements are for a particular time frame.
- The Accounting Cycle of the firm is prepared and completed within the accounting period. However, the accounting periods of the various firms and countries vary as per the different factors and norms. The most common one is the annual or yearly period.
- In the Accounting Cycle, transactions that occur are recorded, and financial statements are prepared.
- Also, firms that are public entities are required to submit the same adhering to certain dates to the public and the financial regulatory bodies.
Accounting Cycle v/s Budget Cycle
Accounting Cycle lays its main focus and impetus on the historical events of the firm and ensures that all the financial transactions that have taken place are reported correctly and accurately.
Whereas the budget cycle focuses on the future transactions and performances of the firm.
It produces information for the external parties, and the budget cycle produces information for the management of the firm for internal works and decision-making processes.
Balancing and Accounting Cycle
The main purpose of accounting is to ensure that all the financial transactions are accounted for properly and arrive at a correct balance. Though there are various errors in accounting that are occurring the same has to be corrected to arrive at a balance of all the debits and credits.
Some of the common reasons for imbalance accounting are:
- Posting in a wrong account
- Transaction is forgotten
- Duplicate postings of the same transaction
- Posting of the incorrect amount