The Accounting Cycle: 9-Step Accounting Process

It is a series of procedures that enable the collection, processing, and communication of financial information.

The accounting cycle, also commonly referred to as accounting process, is a series of procedures in the collection, processing, and communication of financial information. As defined in a lesson earlier, accounting involves recording, classifying, summarizing, and interpreting phases.

Financial information is communicated through the financial statements – the end products of an accounting system. But before the financial statements can be prepared, accountants need to gather information about accountable transactions, record and collate them to come up with the values to be reported in the reports. Nonetheless, the cycle does not end with the presentation of these reports. Several steps are needed to be done to prepare the accounting system for the next cycle.

The following diagram presents the nine steps in the accounting cycle.

Accounting Cycle Steps

1. Identifying and Analyzing Business Transactions

The accounting process starts with identifying and analyzing business transactions and events. Not all transactions and events are entered into the accounting system. Only those that pertain to the business entity are included in the process. Thus, a loan made by the owner in his name that does not have anything to do with the entity is not accounted for (accounting entity assumption).

The transactions identified are then analyzed to determine the accounts affected and the amounts to be recorded.

The first step also includes the preparation of business documents, or source documents. A business document serves as basis for recording a transaction.

2. Recording in the Journals

A journal is a book – paper or electronic – in which transactions are recorded. Business transactions are recorded using the double-entry bookkeeping system. They are recorded in journal entries containing at least two accounts (one debited and one credited).

To simplify the recording process, special journals are often used for transactions that recur frequently such as sales, purchases, cash receipts, and cash disbursements. A general journal is used to record transactions that cannot be entered in the special books.

Transactions are recorded in chronological order and as they occur. Hence, journals are also known as Books of Original Entry.

3. Posting to the Ledger

Also known as Books of Final Entry, a ledger is a collection of accounts that shows the changes made to each account as a result of past transactions, and their current balances. This is the core of the classifying phase.

After the posting process, the balances of each account can then be determined. For example, all journal entries made to Cash would be transferred into the Cash account in the ledger. All increases and decreases in cash will be entered into one ledger account. Thus, the ending balance of Cash can be determined.

4. Unadjusted Trial Balance

A trial balance is prepared to test the equality of the debits and credits. All account balances are extracted from the ledger and arranged in one report. Afterwards, all debit balances are added. All credit balances are also added. The total debits should be equal to total debits.

When errors are discovered, correcting entries are made to rectify them or reverse their effect. Take note however that the purpose of a trial balance is only test the equality of total debits and total credits and not to determine the correctness of accounting records. Some errors could exist even if debits are equal to credits, such as double posting or failure to record a transaction.

5. Adjusting Entries

Adjusting entries are prepared as an application of the accrual basis of accounting. At the end of the accounting period, some expenses may have been incurred but not yet recorded in the journals. Some income may have been earned but not entered in the books. Thus, adjusting entries are prepared to have the accounts updated before they are summarized into the financial statements.

Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or liability method), prepayments (asset method or expense method), depreciation, and allowances.

There's more. Learn about the rest of the steps in the accounting cycle on the next page.

Double Entry Accounting System: A Comprehensive Lesson

Fundamental Accounting Concepts: Summary of Topics