What Is The Accounting Cycle?

 

In maintaining our books of account we need to go through a series of sequential steps. These steps are important and the sequence cannot be altered. What I am going to do here is explain each of the steps in detail.

 

Whether you have an accountant, bookkeeper or insist on preparing the books yourself, you need to understand what's going on. Failure to do so will cause management gaps, gaps in your understanding of what's going on in your own business.

 

1. Analysis of Business Transactions-the first crucial step is to analysze a business transaction or economic event. The purpose of your books is to record economic events, financial transactions. If it's not a financial transaction, it is not recorded in the books. For example-your business purchases a computer. There are two things going on here-first an asset was acquired and an asset was paid for. There are many ways of paying for a purchase and that would need to be reflected in your books. So now we have a financial event that we need to record.

2. Make Journal Entires-we now need to record a transaction in a journal which is referred to as a book of original entry. This is where debits and credits come in. There is no need to explain exactly how debits and credits work, that's your bookkeepers job. Just be aware that it's simple an accounting convention that helps us do our work. Just be aware that in all cases the sum of debits and credits need to equal zero. When they equal zero, they are balanced. The journal entries that we prepare are journalized-that simply means that they are recorded in a book that we call a journal. Recording journal entries in the journal provides us a convenient place to summarize all the information that we need to record.

3. Post to Ledger Accounts-posting the journal entires from the General Journal (this is the book that has all of journal entries within it) to the Ledger Accounts is the next step. Looking back at the book analogy, our general ledger has a number of "chapters" in it. The chapters in our accounting book are referred to as ledger accounts. The way we create the table of contents for our accounting "book" or general ledger is by developing a chart of accounts. I'll discuss that elsewhere, but it's extremely important to have a well thought out and practical chart of accounts. Otherwise the table of contents becomes too length and useless to any reader. You can see below what your general journal looks like.

4. Prepare the Trial Balance-this is a pretty easy step. Your bookkeeper will simply make a list of all the accounts in the General Ledger. Beside each account they will include the accounts balance-debit of credit. When we prepare the trial balance the sum total of debits and credits should equal zero otherwise the books don't balance. problem. As the owener manager, you should be regularly reviewing the trial balance for any unusual items. There is where we come! We will train you in the art of trial balance reviews. You'll see pretty quickly that it's an easy task and that you can gain a lot of information from the exercise. Again, this responsibility is included in your role as owner/manager. Ultimately, it's your business and you are responsible for it. Your bookkeeper should be helping you. But it's your "dime"!

5. Make Adjusting Entries-after completing the routine entries, we need to look at and preapre adjusting journal entries. Adjusting journal entries are entries that we make every year, monthly, etc. Their purpose is to pick up the non-cash, non-routine items that need to be recorded in our books. Som examples of these are depreciation, interest, preapid expenses, and other adjustments that we need to make to bring us to the accrual basis of accounting.

6. Adjusted Trial Balance-we then post these adjusting journal entries to the General Legder and prepare another trial balance that we call the adjusted trial balance. The adjusted trial balance is simply the books adjusted to capture items that need to be accrued, items that would not show up in the normal course of our bookkeeping.

7. Prepare Financial Statements-we use the adjusted trial balance to prepare our financial statements. Normally, this is the job of your accountant where the financial statements are used for external purposes such as income tax reporting, the bank and other interested third parties. We don't go here although we can prepare financial statements for internal reporting purposes.

8. Close The Accounts-we then close the accounts to bring your revenue and expense accounts to zero. If we don't close the accounts, all your revenue and expenses would accumulate from day one. Not terribly useful information and it certainly doesn't prepare you for the Canada Revenue Agency! We need to know our revenue and expenses for each fiscal period. not from day one.

9. Post-closing Trail Balance-this is done to ensure that the books are balanced.