Accounting Cycle
The accounting cycle includes six steps in the processing of financial transactions in an accounting period. The six steps include analyzing the transactions as they occur, recording them in the journals, posting from journal entries to the general ledger, adjusting the assets with a trial balance, preparing financial statements, and closing temporary accounts. The reason these steps are taken each month is to account for financial data of a company. It is important for a company not to skip any of these steps because it could leave a business open for errors in reporting.
Identifying and recording transactions is the first step a company should complete in the accounting cycle. A company would first want to determine what to record. Even though there are GAAP guidelines, there are no simple rules that exist on what events a company should record. There are two types of events, external events and internal events. External events involve interaction between an organization and its environment. This includes a transaction with another entity, a change in price of a good or service, weather related factors (such as flood or earthquake), or an improvement in technology by a competitor. Internal events are events that occur within a company. This includes using buildings and machinery, or consuming raw materials in production processes.
Once a company identifies what needs to be recorded, journalizing is the next step in the accounting cycle. A company would need to record transactions and events that affect their assets, liabilities, and equities. One method of journalizing is the general ledger. This ledger contains a company’s assets, liabilities, and stockholders’ equity accounts. Each account shows the effect of transactions on each asset, liability, equity, revenue, and expense accounts. Another method to journalize is through the general journal. This journal has a complete record of each transaction or other event in one place. Each journal entry consists of four different parts. These parts include the accounts and amounts to be debited, the accounts and amounts to be credited, a date, and an explanation. Debit accounts are always listed first, followed by the credits. The explanation is listed under the credit and may take one or more lines.
The third step in the accounting cycle is called posting. There are four steps to follow when posting. The first step is to enter the appropriate columns of the debited accounts of the date, journal page, and debit amount from the journal into the ledger. The second step is to write the account number to which the debit amount was posted into the reference column of the journal. The third and fourth steps are the same as the first and second steps except for the credit accounts. For the reference column, a company has their own numbering system for its ledger accounts.
The fourth step in the accounting cycle is preparing the trial balance. The trial balance lists accounts