The Accounting Cycle

         When accounting for a business, four financial statements, a general ledger, a general journal complete with journal entries, and a trial balance are needed in order to finalize the accounting process for a period. The four financial statements are the balance sheet, the income statement, the statement of retained earnings, and the statement of cash flows. The general ledger is a journal that accountants post entries to as needed. When the business has obtained the financial statements and the fulfilled general ledger and journal, they can analyze their strengths, weaknesses, opportunities, and threats. Accountants show a business all of their assets, the extent of their liabilities, how much revenue they accrue and where it comes from etc. From a legal view point, accountants can discover whether or not there is any fraudulent activity occurring in a business. Accountants use a 9-step model called the accounting cycle to refer to when analyzing a business.

1.  Analyze business transactions. During the first step of the accounting cycle, accountants must decide which transactions to include in their journal entries and financial statements. Naturally, everything that goes on in a business is not recorded. They must choose economic events relevant to the business. Examples of events that would be considered relevant are the payment of dividends to shareholders of Coca-Cola, the sale of coffee by Starbucks, and the telephone service provided to a customer by T-Mobile. It is the responsibility of the accountant to accurately select the transactions. Not all transactions need to be recorded, although they must keep in mind that even if a transaction does not include cash, it still may need to be recorded.

2.  Journalize the transactions. At step 2 of the accounting cycle, accountants write in journal entries to the general journal. The selected transactions each have a specific account. For example, when Coca-Cola declares a $60,000 dividend for its shareholders, the Dividends Payable account is credited. This means that the account is increasing. Dividends Payable is a liability account, and liability accounts are increased by crediting. Likewise, asset accounts are increased by debiting. An example of an asset account is cash. So the journal entry for Coca-Cola paying a $60,000 dividend would be:           

DR. Dividends Payable 60,000

    CR. Cash 60,000

 Coca-Cola had paid the dividend so their cash had decreased, but their liability of paying that dividend has also decreased. The process of recording entries to the general journal is called journalizing. The steps in journalizing are: (1.) record the date the transaction occurred, (2.) what accounts are debited and credited and by what amount, and (3.) give a brief explanation of each transaction. Keep in mind; this is just the preliminary process of posting to the general ledger. Although the information journalized is important, it is not final.

3.  Post to ledger accounts. Immediately following the journalizing process is the procedure of posting the journal entries to the general ledger. The transferring of journal entries to the general ledger is called posting. Posting consists of the subsequent steps:

(1.)      Enter to the debit accounts the amount debited, the date, and the reference to the journal page.

(2.)      Write the number to refer to in the general journal concerning debits.

(3.)       Enter to the credit accounts the amount credited, the date, and the reference to the journal page.

(4.)      Write the number to refer to in the general journal concerning credits.

 Accountants must make sure that posting is done on a regular basis to guarantee that the ledger is up to date. Along with consistent posting they must make sure that previous posts are accurate at a later date. 

4.  Prepare a trial balance. A trial balance is a record of accounts and their amounts at a certain point in time. The essential purpose of a trial balance is to ensure that debits equal credits after posting. Debits and credits must always be equal, otherwise a mistake has occurred. Mistakes in accounting usually occur from mathematical errors, incorrect postings, or writing down data incorrectly. If debits and credits are not equal, the trial balance will show this. The steps to preparing a trial balance are as follows:

(1.) Tabulate the names and amounts of the accounts being used

(2.) Add up the debit and credit amounts.

(3.) Show the equality of debits and credits.

A trial balance is a needed as a sort of checkpoint in accounting. Accountants must recall that the trial balance is not proof that the company has recorded all transactions or that the general ledger is accurate.

5. Journalize and post adjusting entries: Prepayments/Accruals.  A company makes adjusting journal entries every time it prepares the financial statements. Adjusting entries ensure that certain accounting principles are followed and allow the correct reporting of amounts on the balance sheet and the income statement. Adjusting entries are categorized as either deferrals or accruals. Both deferrals and accruals have subcategories and they are as follows:

Deferrals

1.     Prepaid Expenses (or Prepayments): Expenses recorded as assets and paid in cash before consumption.

2.     Unearned Revenues: Revenue has not yet been earned but cashed has been received, therefore they are recorded as liabilities.

Accruals

1.     Accrued Revenues: Revenues that have been earned but aren’t recorded yet because they have not been received.

2.     Accrued Expenses: Expenses that aren’t recorded because they have not yet been paid.

6. Prepare an adjusted trial balance. In this step of the accounting cycle, the accountant simply adds in the adjusting entries to the trial balance. Deferral and accrual accounts supplement the trial balance and ensure equality. Accountants must strive for accuracy because the financial statements can be prepared straight from the trial balance.
7. Prepare financial statements: Income statement, balance sheet, Statement of retained earnings, Statement of cash flows: Subsequently to completing the trial balance, accountants transfer the accounts to the appropriate financial statement. For example, revenues go on the Income statement, retained earnings and dividends go on the statement of retained earnings, asset, liability, and stockholder’s equity accounts go on the balance sheet and so forth. Accountants should use extreme precision when preparing the financial statement, for they are what a company heavily depends on for data. Mistakes are expected, but must be quickly corrected.

8. Journalize and post closing entries. Next in the accounting cycle, closing entries are journalized in the general journal, and posted to the general ledger. This is called the process of closing the books (the “books” are the general journal and ledger). This process is necessary at the end of the accounting period to prepare the accounts for the next period. Closing the books distinguishes which accounts are temporary and which are permanent. Temporary accounts relate only to a certain period and are closed at the end of that period. Permanent accounts relate to one or more future periods therefore must be appropriately prepared at the end of the period. Permanent accounts are not closed at the end of an accounting period; their balances are brought into the next period. Accountants must be very careful at this stage for the journal entries are being closed and should be accurate at this point.

9. Prepare a post-closing trial balance. Lastly, the accountants prepare a post-closing trial balance for the company. The post-closing trial balance consists of permanent accounts, and its purpose is to guarantee the equality of those permanent accounts. Permanent accounts are used in subsequent accounting periods, so the accuracy of them is imperative.

 These 9 steps are very important to a corporation for they depend extensively on the information provided by accountants. So meticulously follow these 9 steps, and you will have completed the accounting cycle!