How to Move Through Each of the Nine Accounting Cycle Steps
Ready to get started with the accounting cycle? Here’s how to navigate each of the nine steps.
1. Analyze and measure transactions
In this phase, collect all of your company’s transactions for analysis, measurement, and recording. But here's the first common hang-up: what do you have to record?
As a general rule of thumb, a business should minimally record the following:
- All cash sales.
- All purchases (no matter how small).
- Anything that's measurable, relevant, or reliable.
- All events. This includes external and internal transactions. External transactions are things like exchanges with another company or changes in the cost of goods your business purchases. Internal transactions are exchanges that occur within your business, like moving supplies from one department to another.
In short, collect as many transactions as possible that affect your business’s financial position.
2. Record transactions in the Journal
This is also known as journalizing. A journal chronologically lists transactions and other events in terms of debits and credits to accounts. Each journal entry consists of four parts:
- The accounts and amounts to be debited
- The accounts and amounts to be credited
- The dates of the transactions
- Transaction explanations
You don’t need to keep all your transactions and events in one journal. For example, your cash transactions may exist in a journal separate from other financial events, like returned purchases or credit sales. This makes it easier to sort and find the information you need about cash transactions without wading through irrelevant raw data. It’s also easier to get a glimpse of the amount of cash on hand at any given point.
3. Post information from the Journal to the General Ledger
If you still record financial events by hand, you need to consolidate all of your raw data into one master source. The ledger contains all your transactions and events, as well as a chart of accounts that tracks the following:
- • Assets
- • Liabilities
- • Owner’s equity
- • Revenue
- • Expenses
General ledger accounting uses the double-entry method. This means that transactions are recorded twice, accounting for debits and credits and how they offset each other. All debits fall under the left-hand column, with credits in a second, right-hand column.
4. Prepare an unadjusted trial balance
By this point, you’ve posted every transaction for the month or quarter in your ledger, and you’re ready to start preparing your financial statement. Now it’s time to measure your unadjusted trial balance.
The unadjusted trial balance tells you the balances for each of your ledger accounts at the end of your reporting period. To prepare your unadjusted trial balance, go through the debits and credits in your ledger and make sure they balance out. An easy way to do this is to make sure the totals in your debit and credit columns match.
They don’t? Uh-oh. Thankfully, that’s what the next step is for.
5. Prepare adjusting entries
This is the time to identify any mistakes or overlooked items in your ledger. As you review line-by-line, ask yourself:
- • Did you provide services that won’t be paid until the next reporting period?
- • Did you receive products or services that won’t be paid until the next reporting period?
- • Are all dates and dollars recorded accurately?
- • Is there anything I haven’t accounted for in my ledger?
These are the most common reasons for mismatches. It’s easy for something to go wrong when manually tracking so many transactions and financial events. Yes, accounting software can automate much of the process and cut down on errors, but it’s not foolproof. That’s why the accounting cycle includes a dedicated stage for investigation and correction. The adjusting entries step ensures that your business transactions accurately reflect the financial position of your business.
What does this look like in your ledger?
To prepare adjusting entries, add a third column to your ledger alongside your credits and debits columns. This is where you add or subtract from your unadjusted trial balance to reflect what’s really happening with your financials.
Follow these core accounting principles when adjusting entries: the revenue recognition principle, the matching principle, and the accrual principle. The accrual principle is especially helpful for deciding whether to count revenue and expenses that won’t be billed until the next period in the current accounting period. According to the accrual principle, it doesn’t matter if the money hasn’t exchanged hands yet. If you’ve given or received products or services during that reporting period, count them.
6. Prepare an adjusted trial balance
The adjusted trial balance provides another opportunity to double-check your work and make sure everything is accurate. To prepare this, insert yet another column in your ledger that adds your unadjusted trial balance to your adjusting entries.
Make sure your new total is $0 before moving to the next stage. Having trouble here? Reach out to a reputable accounting agency like Ignite Spot for help balancing your books.
7. Prepare financial statements (Income Statement, Cash Flow, Etc.)
Congratulations, you’ve done all the recording and number crunching needed to prepare accurate financial statements. The steps above get everything in order to complete most financial statements, including the most common ones: the income statement, balance sheet, cash flow statement, and owner’s equity statement.
8. Prepare closing entries
This is where you get to actually “close your books.” In this stage, you move balances from temporary accounts, like revenues, expenses, and dividends, to permanent accounts, like an income summary.
Temporary accounts are transactions that occurred during your reporting period. They capture a snapshot of your business over the month, quarter, or year you’re reporting on, and they don’t provide the big picture that a permanent account does.
By moving balances from temporary accounts to permanent accounts, you are
- • updating the overall financial health of your business, and
- • emptying temporary accounts in preparation for the next accounting cycle.
It also gets you ready for your post-closing trial balance.
9. Prepare a post-closing trial balance
Just like the previous trial balance stages, this step ensures that the debits and credits in your post-closing trial balance match up. The only difference here is that instead of temporary accounts (all the transactions over the last reporting period), this balance consists only of permanent accounts like assets, liabilities, and owners’ equity.
Balanced totals mean your company properly journaled and posted your closing entries. If your post-closing totals don’t match, you’ll start the next reporting period with inaccurate information, making it impossible to report correctly into the future.