The eight-step accounting cycle is important to know for all types of bookkeepers. It breaks down the entire process of an accountant’s responsibilities into eight basic steps. Many of these steps are often automated using accounting software and technology programs. However, knowing and using the steps manually can be essential for small business accountants working on books with minimal technical support.
Key points to remember
- The accounting cycle is a process designed to facilitate financial accounting of business activities for business owners.
- There are generally eight steps to follow in an accounting cycle.
- Closing the accounting cycle provides business owners with comprehensive financial performance reports that are used to analyze the business.
- The eight stages of the accounting cycle are: Identify Transactions, Record Transactions in a Journal, Post, Unadjusted Trial Balance, Spreadsheet, Adjust Journal Entries, Financial Statements, and Close Books.
What is the accounting cycle?
The accounting cycle is a basic eight-step process for accomplishing a company’s accounting tasks. It provides a clear guide for recording, analyzing and final reporting of a company’s financial activities.
The accounting cycle is used exhaustively throughout a full reporting period. Thus, staying organized throughout the period of the process can be a key part of helping to maintain overall efficiency. The periods of the accounting cycle will vary depending on reporting needs. Most companies seek to analyze their performance on a monthly basis, although some may focus more on quarterly or annual results.
Either way, most accountants will have knowledge of the day-to-day financial situation of the business. Overall, determining the length of each accounting cycle is important because it sets specific opening and closing dates. Once an accounting cycle ends, a new cycle begins, restarting the eight-step accounting process.
Understanding the accounting cycle in 8 steps
The eight-step accounting cycle begins with recording each business transaction individually and ends with a comprehensive report of business activities for the designated cycle period. Many companies use accounting software to automate the accounting cycle. This allows accountants to schedule cycle dates and receive automated reports.
Depending on the system of each company, more or less technical automation can be used. Typically, bookkeeping involves some technical support, but a bookkeeper may be involved in the accounting cycle at various times.
Each individual business will typically need to modify the eight-step accounting cycle in certain ways to suit their business model and accounting procedures. Changes in accrual accounting versus cash accounting are usually a major concern.
Businesses can also choose between single-entry and double-entry bookkeeping. Double-entry bookkeeping is required for businesses to prepare the three main financial statements: income statement, balance sheet, and cash flow statement.
The 8 stages of the accounting cycle
The eight stages of the accounting cycle are:
Step 1: Identify Transactions
The first step in the accounting cycle is to identify the transactions. There are many transactions that businesses will make throughout the accounting cycle. Each must be properly recorded in the company’s books.
Record keeping is essential for recording all types of transactions. Many businesses will use point-of-sale technology linked to their books to record sales transactions. Beyond sales, there are also expenses that can come in many forms.
Step 2: Record transactions in a journal
The second step in the cycle is creating journal entries for each transaction. Point-of-sale technology can help combine steps one and two, but businesses also need to track their spending. The choice between accrual accounting and cash accounting will dictate when transactions are officially recorded. Keep in mind that accrual accounting requires the matching of income with expenses, so both must be accounted for at the time of sale.
Cash accounting requires that transactions be recorded when money is received or paid. Double-entry accounting requires the recording of two entries for each transaction in order to manage a well-developed balance sheet as well as an income statement and a cash flow statement.
With double-entry bookkeeping, each transaction has equal debit and credit to each other. Single-entry accounting is like managing a checkbook. It gives a balance report but does not require multiple entries.
Step 3: Publication
Once a transaction is posted as a journal entry, it should be posted to a general ledger account. The general ledger provides a breakdown of all accounting activities by account. This allows an accountant to monitor financial positions and statuses by account. One of the most common accounts referenced in the general ledger is the cash account which details the amount of money available.
Step 4: Unadjusted trial balance
At the end of the posting period, a trial balance is calculated as the fourth step of the posting cycle. A trial balance tells the business about its unadjusted balances in each account. The unadjusted trial balance is then carried over to step five for testing and analysis.
Step 5: Worksheet
Analyzing a spreadsheet and identifying the accrual entries is the fifth step in the cycle. A spreadsheet is created and used to ensure debits and credits are equal. If there are any discrepancies, adjustments will need to be made.
In addition to identifying errors, adjusting postings may be required for the reconciliation of income and expense when using accrual accounting.
Step 6: Adjust the journal entries
In step six, an accountant makes adjustments. Adjustments are saved as journal entries if necessary.
Step 7: Financial statements
After the business has made all of the adjusting postings, it then generates its financial statements in step seven. For most businesses, these statements will include an income statement, a balance sheet, and a cash flow statement.
Step 8: Close the books
Finally, a business completes the accounting cycle at step eight by closing its books at the end of the day on the specified closing date. Closing statements provide an analysis report of performance over the period.
After closing, the accounting cycle starts again from the beginning with a new reporting period. At close, it’s usually a good time to file documents, plan for the next reporting period, and review a schedule of future events and tasks.
The bottom line
The eight-step accounting cycle process makes accounting easier for busy bookkeepers and entrepreneurs. This can help take the guesswork out of how to handle accounting activities. It also helps to ensure consistency, accuracy and efficiency in the analysis of financial performance.