Accounting cycle is a sequence of accounting procedures which are used to record, classify and summarize accounting information. The accounting cycle begins with the initial recording of business transactions and concludes with the preparation of formal financial statements summarizing the effect of these transactions upon the assets, liabilities and owner’s equity of the business.
The term “cycle” indicates that these procedures must be repeated continuously to enable the business to prepare new and up-to-date financial statements at reasonable intervals.
Accounting cycle relates to the preparation of balance sheet or income statement for a service type business with the manual accounting system. The accounting procedures discussed in above paragraph may be summarized as follows:
1.Identify the transaction
Identify the transaction which occurred or the set of events. This step is not mandatory but it will help you out in the next step of accounting cycle.
2.Prepare the Source Document
Prepare the source document such as P.O (Purchase order) or Invoice of the collection of transaction identified in the first step.
3.Recording transactions in the journal
The first step of accounting cycle is recording transactions in the ledger. As any type of business transaction occurred; they are entered in the journal, thus creating sequential record of events. This procedure completes the recording step in the accounting cycle.
4. Post to ledgers account
The debit and credit entries in account balances are posted from journal to the ledger. This procedure classifies the effects of the business transactions on terms of specific asset, liability, owner’s equity, revenue and expense accounts.
5. Preparing a trial balance
A trial balance proves and authenticates the equality of debit and credit entries in the ledger. The purpose of this procedure is to verify the accuracy of posting process and the computation of the ledger account balances. In the nut shell debit and credits sides are balanced at the end in the trial balance.
Prepare the adjusting entries to record inventory,deferred, accrued and estimated accounts.
7.Post adjusting entries
Post adjusting entries to ledger to develop adjusted trial balance.
8.Preparation of financial statements
The final step of accounting cycle is to extract figures from trial balance which are then summarized up to prepare the financial statements. These financial statements demonstrate the position of the business at the specific date i.e. Balance sheet or the position of business for specific period
Income statement. The preparation of financial statements concludes the effects of business transactions occurring through the date of the statements and completes the accounting cycle.
Balance Sheet. This statement include assets (current assets and fixed assets), liabilities (short term liabilities and long term liabilities) and equity accounts. These accounts are used to develop the balance sheet of the company.
Statement of retained earning. This statement is developed from income statement and dividend information.
Cash flow Statement. Cash flow statement developed from other financial statement using direct or indirect method.
9.Prepare closing journal entries
Prepare the closing journal entries to close the temporary account include gain, revenues, expense and losses.