Deliverable 2 - The Accounting Cycle

What is the Accounting Cycle?

The accounting cycle represents the process of recording a company’s financial transactions from the when the transaction occurs until the preparation of the financial statements and the accounts are closed at the end of the period. Typically, a company has a monthly accounting cycle culminating with a yearly financial close at the end of the fiscal year.

Steps in the Accounting Cycle

TRANSACTIONS

Business transactions need to be identified and analyzed for their impact on the financial position of the company. Only those that have a financial impact are entered into the accounting system. Examples are revenues that have been earned and expenses that have been incurred.

RECORDING

Business transactions are recorded in chronological order in the journals of the company's double entry accounting system. They are recorded using journal entries that are comprised of at least two accounts. The debits and credits for each journal must balance (equal).

POSTING TO THE GENERAL LEDGER

Journal entries are then posted to the company's general ledger which is a collection of all of the company's accounts and where we keep track of the balance in each account. For example a company's Cash account would show all the increases (receipts) in cash on the debit side and decreases (payments of cash) on the credit side. The balance in any account can be determined by subtracting the smaller side from the larger

PREPARE THE UNADJUSTED TRIAL BALANCE

A trial balance is a numerical listing of all accounts in the ledger and there ending balance. It also serves to test the equality of all the debits and credits entered into the system.

ADJUSTING ENTRIES

Adjusting entries are sometimes called internal transaction and their purpose is to bring our accounting records into compliance with accrual accounting. Their purpose is to record any revenue that has been earned but not yet recorded and any expenses that have been incurred but not yet recorded. These entries are called accruals and deferrals.

ADJUSTED TRIAL BALANCE

Another trial balance is prepared, called the adjusted trial balance. This is prepared by taking the unadjusted trial balance in step 4 and adjusting the balances for the adjusting entries in step 5. The adjusted trial balance also serves as another test of the equality of debits and credits.

FINANCIAL STATEMENTS

A complete set of financials statements is now prepared:

· Income Statement

· Statement of Changes in Equity

· Balance Sheet

· Statement of Cash Flows

CLOSING ENTRIES

Once the financial statement are complete we need to begin the process of getting the accounting system

ready for the next accounting period. This is accomplished by preparing the 4 closing journal entries.

These entries bring the balance in all of the temporary accounts to zero. The four closing entries are:

· Bring all revenue accounts to a zero balance and transfer the balances to the income summary account

· Bring all expense accounts to zero and transfer the balances to the income summary account.

· The income summary account now represents the amount of net income or loss. Since the net income or loss belongs to the owners, we need to bring the income summary account to zero and transfer the balance to the Owner's Capital account

· The owner's withdrawal account (or dividend account) also needs to be brought to zero and also transferred to the Owner's capital account.

POST-CLOSING TRIAL BALANCE

The post-closing trial balance is our final check to be sure our accounting records are ready for the next

period. Since we have closed all of the revenue and expense accounts have all been brought to zero, the

only accounts that should remain are the balance sheet accounts, called permanent accounts.

The accounting cycle represents the process that companies follow each accounting period. The financial statements represent the culmination of the accounting cycle. Larger companies may break the responsibilities in the accounting cycle into separate departments while a small company may just have one bookkeeper performing the tasks associated with the cycle.