7 The Accounting Cycle

The Accounting Cycle: 9-Step Accounting Process
The accounting cycle, also commonly referred to as accounting process, is a series of procedures in the
collection, processing, and communication of financial information.
As defined in earlier lessons, accounting involves recording, classifying, summarizing, and interpreting
financial information.
Financial information is presented in reports called financial statements. But before they can be prepared,
accountants need to gather information about business transactions, record and collate them to come up
with the values to be presented in the reports.
The cycle does not end with the presentation of financial statements. Several steps are needed to be
done to prepare the accounting system for the next cycle.
Accounting Cycle Steps

1. Identifying and Analyzing Business Transactions
The accounting process starts with identifying and analyzing business transactions and events. Not all
transactions and events are entered into the accounting system. Only those that pertain to the business
entity are included in the process.
For example, a personal loan made by the owner that does not have anything to do with the business
entity is not accounted for.
The transactions identified are then analyzed to determine the accounts affected and the amounts to be
recorded.
The first step includes the preparation of business documents, or source documents. A business
document serves as basis for recording a transaction.
2. Recording in the Journals

A journal is a book paper or electronic in which transactions are recorded. Business transactions are
recorded using the double-entry bookkeeping system. They are recorded in journal entries containing at
least two accounts (one debited and one credited).
To simplify the recording process, special journals are often used for transactions that recur frequently
such as sales, purchases, cash receipts, and cash disbursements. A general journal is used to record
those that cannot be entered in the special books.
Transactions are recorded in chronological order and as they occur.
Journals are also known as Books of Original Entry.
3. Posting to the Ledger

Also known as Books of Final Entry, the ledger is a collection of accounts that shows the changes made
to each account as a result of past transactions, and their current balances.
After the posting all transactions to the ledger, the balances of each account can now be determined.
For example, all journal entry debits and credits made to Cash would be transferred into the Cash
account in the ledger. We will be able to calculate the increases and decreases in cash; thus, the ending
balance of Cash can be determined.
4. Unadjusted Trial Balance

A trial balance is prepared to test the equality of the debits and credits. All account balances are extracted
from the ledger and arranged in one report. Afterwards, all debit balances are added. All credit balances
are also added. Total debits should be equal to total credits.
When errors are discovered, correcting entries are made to rectify them or reverse their effect. Take note
however that the purpose of a trial balance is only test the equality of total debits and total credits and not
to determine the correctness of accounting records.
Some errors could exist even if debits are equal to credits, such as double posting or failure to record a
transaction.
5. Adjusting Entries
Adjusting entries are prepared as an application of the accrual basis of accounting. At the end of the
accounting period, some expenses may have been incurred but not yet recorded in the journals. Some
income may have been earned but not entered in the books.
Adjusting entries are prepared to update the accounts before they are summarized in the financial
statements.
Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or
liability method), prepayments (asset method or expense method), depreciation, and allowances.
6. Adjusted Trial Balance

An adjusted trial balance may be prepared after adjusting entries are made and before the financial
statements are prepared. This is to test if the debits are equal to credits after adjusting entries are made.
7. Financial Statements
When the accounts are already up-to-date and equality between the debits and credits have been tested,
the financial statements can now be prepared. The financial statements are the end-products of an
accounting system.
A complete set of financial statements is made up of: (1) Statement of Comprehensive Income (Income
Statement and Other Comprehensive Income), (2) Statement of Changes in Equity, (3) Statement of
Financial Position or Balance Sheet, (4) Statement of Cash Flows, and (5) Notes to Financial Statements.
8. Closing Entries
Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the system for the
next accounting period. Temporary accounts include income, expense, and withdrawal accounts. These
items are measured periodically.
The accounts are closed to a summary account (usually, Income Summary) and then closed further to the
appropriate capital account. Take note that closing entries are made only for temporary accounts. Real or
permanent accounts, i.e. balance sheet accounts, are not closed.
9. Post-Closing Trial Balance

In the accounting cycle, the last step is to prepare a post-closing trial balance. It is prepared to test the
equality of debits and credits after closing entries are made. Since temporary accounts are already closed
at this point, the post-closing trial balance contains real accounts only.
*10. Reversing Entries: Optional step at the beginning of the new accounting period
Reversing entries are optional. They are prepared at the beginning of the new accounting period to
facilitate a smoother and more consistent recording process.
In this step, the adjusting entries made for accrual of income, accrual of expenses, deferrals under the
income method, and prepayments under the expense method are simply reversed.

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7 The Accounting Cycle

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The Accounting Cycle: 9-Step Accounting Process

Accounting Cycle Steps

2. Recording in the Journals

3. Posting to the Ledger

4. Unadjusted Trial Balance

6. Adjusted Trial Balance

9. Post-Closing Trial Balance

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