Lecture Note 2: The Accounting Cycle
What is the Accounting Cycle?
The accounting cycle is a step-by-step process that businesses use to track, record, and analyze
their financial transactions during a specific accounting period. It ensures the accuracy and
completeness of financial reporting and ends with the preparation of financial statements.
Steps in the Accounting Cycle
1. Identifying and Analyzing Transactions
Every accounting cycle begins when a financial transaction occurs. This could include sales,
purchases, payroll, or payments. Each transaction must be identified, analyzed, and supported by a
source document like a receipt or invoice.
2. Recording Transactions in the Journal (Journalizing)
Once a transaction is identified, it is recorded chronologically in the general journal. Each journal
entry must include:
- The date
- The accounts involved
- The amount debited and credited
- A brief description
Example:
Date: Jan 1
Accounts: Debit - Equipment $5,000; Credit - Cash $5,000
Description: Purchased equipment for cash
3. Posting to the Ledger (Posting)
After journalizing, entries are transferred to individual accounts in the general ledger. The ledger
organizes transactions by account, helping businesses track balances and analyze financial data.
4. Preparing a Trial Balance
The trial balance is a list of all ledger account balances at a particular date. It checks the
mathematical accuracy of the books.
Rule: Total Debits = Total Credits
5. Adjusting Entries
At the end of the period, adjusting entries are made for accruals and deferrals. This step ensures
revenues and expenses are recognized in the period they occur.
Types of Adjustments:
- Accrued revenues
- Accrued expenses
- Deferred revenues
- Deferred expenses
- Depreciation
6. Adjusted Trial Balance
After adjustments, another trial balance is prepared to confirm the accounts are still in balance. This
is the basis for preparing financial statements.
7. Preparation of Financial Statements
Using the adjusted trial balance, the main financial statements are prepared:
- Income Statement
- Balance Sheet
- Cash Flow Statement
- Statement of Changes in Equity
8. Closing the Books
Temporary accounts (like revenue and expenses) are closed at the end of the period to update
retained earnings and prepare the business for the next cycle.
Visual Summary of the Cycle:
Transaction -> Journal -> Ledger -> Trial Balance
-> Adjustments -> Adjusted Trial Balance -> Financial Statements -> Closing Entries
Why the Accounting Cycle Matters:
- Ensures compliance with accounting standards
- Provides accurate financial data for decision-making
- Helps detect errors and discrepancies
- Prepares companies for audits
Tips for Mastering the Cycle:
- Understand debit/credit rules thoroughly
- Always cross-check trial balances
- Keep accurate and timely source documents
- Use accounting software for automation and accuracy
Conclusion:
The accounting cycle is the backbone of financial reporting. By following its steps methodically,
businesses can maintain transparent records, ensure accuracy, and comply with financial
regulations. Mastery of this cycle is crucial for accountants, managers, and entrepreneurs alike.
