These types of systems have reduced most of the mathematical errors that tend to happen when calculations are done manually. Ultimately, the goal of the entire Accounting Cycle is to properly prepare accurate and honest financial statements, in which are used by both internal and external users. The financial statements provide a detailed look inside a company’s activities, profitability, and financial health in the reported period. The accounting process is also referred to as book-keeping. This process includes a series of nine steps, completed in the same order.
The steps have en simplified, or explained in simple terms, in the following paper. The first three steps in the Accounting Cycle are performed regularly, and take place during each period. The first step begins when a transaction takes place. Each transaction is analyzed by reviewing its source document (i. E. Purchase orders and receipts, deposit slips, invoices, cancelled checks, etc. ). When reviewing a transaction, determine which of the company’s accounts have been affected. The second step requires the transactions to be recorded chronologically in the general journal.
When an entry is made in the journal, the dual entry method s used. This method is used because each transaction affects at least two accounts; so there must be at least one debit and one credit to support them; and the total of these debits and credits must be equal to the transaction. 2 The third step transfers all the entries recorded in the general journal to the ledger, also referred to as the T- accounts. The ledger lists each company account separately with debits on the left and credits on the right.
All transactions that occur during an accounting period are transferred to the ledger and are posted to each account that they have affected. At the end of the period, the entries posted in each account are combined and create a single balance for each company account. The balances for each account have either a debit or a credit balance, and are posted accordingly. The remaining steps are completed at the end of each period. The fourth step in the cycle is to prepare an unadjusted trial balance, or a list of all the accounts and their balances at this point in time.
The information for this step comes straight from the ledger and its purpose is to verify that the total in debits is equal to the total in credits. If the totals are not equal, or balanced, a mistake has been made somewhere in a prior step; in mathematical calculations, or when posting the entries or transferring them from the journal to the ledger. In order to proceed to the next step, the mistake has to be found and corrected. The debits and credits must always balance. Completing the worksheet is optional, but a highly recommended. The worksheet makes the steps that follow so much easier.
More specifically, the worksheet proves to be very useful in step 7, or the preparation of financial statements. The worksheet lists the company accounts own the left side, in the first column on a spreadsheet, with the following steps listed across the top: unadjusted trial balance, adjusting entries, and adjusted trial balance. These steps are followed by income statement and balance sheet. The worksheet provides very valuable information; all of which is provided in one place and on one document. The fifth and sixth steps are very simple, especially if a worksheet is used.
The fifth step is to make necessary adjustments to some of the accounts in the unadjusted trial balance. 3 Accruals (unearned revenue) and deferrals (prepaid rent and insurance) are the counts that are typically adjusted in effort to record accurate totals for the accounts at the end of the period. Certain situations or events like accumulated depreciation, income that has not been earned (or recorded) and expenses that have been used (or expired), create a need for the balances of some accounts to be adjusted before the final reports can be prepared.
The sixth step, preparing an adjusted trial balance, is where the adjustments are computed, and the new balances are totaled and compared for accuracy and equality. This step provides the final balances of company accounts for the accounting period. The seventh step is where the company’s financial statements are prepared. This is a very important step because this is how a business communicates its financial information with others. The Income and Owner’s Equity statements are prepared first, followed by the balance sheet (which gathers its information from the Statement of Owner’s Equity) and the Statement of Cash Flows.
The combination of all four of the financial reports, along with the notes attached to them, provides all information that needs to be known about a company for the accounting period for which they are prepared. Step eight begins the closing process. This is where all of the temporary (nominal) accounts (i. E. Income and expense accounts) are closed by debiting the income accounts and crediting their balances to the Income Summary account, and by crediting the expense accounts and debiting their balances to the Income Summary account.
The balance of the Income Summary account reflects the company’s income for the period. The Owners Drawings account is closed by debiting the account and crediting it directly to the owner’s capital account. The Income Summary account must also be closed by debiting it and crediting it’s balance to the Owner’s Equity (or Retained Earnings) account. All temporary account balances should be zero 4 at the end of the period in preparation for the next accounting period to begin.
All permanent (real) account balances are carried into the next period and become the new period’s beginning balances. The final step in the Accounting Cycle is to prepare a post-closing trial balance. This step collects and posts the balances of all the remaining (real/permanent) accounts; assets, liabilities and owner’s equity. It is used to verify that the debit and credit totals for the accounts are equal, or balanced. It also helps to make sure that all the temporary accounts have been properly closed and these accounts all have a balance of zero.