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The 7 Steps of the Accounting Cycle
The accounting cycle is a structured, seven-step process that businesses use to record, classify, and summarize all financial transactions within a specific accounting period (like a month, quarter, or year). Bookkeeping Services in Cleveland. This systematic approach ensures that financial statements are accurate and reliable.
1. Identify and Analyze Transactions
This is the starting point. Every economic event that affects the financial position of the company and can be measured in monetary terms is a transaction.
Activity: Gather source documents (like invoices, receipts, bank statements, and payment vouchers) and analyze them to determine which accounts are affected and by how much.
Goal: To confirm that a recordable event occurred and to prepare it for entry.
2. Record Transactions in the Journal
Once a transaction is verified, it is formally recorded in the company’s journal, also known as the book of original entry.
Activity: Use the double-entry bookkeeping system to record the transaction, ensuring that for every entry, total debits equal total credits. This maintains the fundamental accounting equation ($Assets = Liabilities + Equity$).
Goal: To create a chronological record of all financial activity.
3. Post Journal Entries to the Ledger
The journal entries are then transferred, or posted, to the general ledger. The ledger organizes all financial data by individual account.
Activity: Transfer the debit and credit amounts from the journal to their respective individual accounts in the ledger (e.g., Cash, Accounts Receivable, Rent Expense).
Goal: To summarize the total activity in each specific account for easy reference.
4. Prepare an Unadjusted Trial Balance
At the end of the accounting period, a trial balance is prepared to verify the mechanical accuracy of the recording and posting process.
Activity: List all account balances from the general ledger. The total of all debit balances must equal the total of all credit balances.
Goal: To confirm that the double-entry system is in balance before proceeding to the crucial adjustment phase.
5. Journalize and Post Adjusting Entries
The unadjusted balances rarely reflect the true financial picture. Adjusting entries are made to adhere to the accrual basis of accounting.
Activity: Record transactions that have occurred but haven't been formally documented (like depreciation, accrued salaries, or earned but unbilled revenue).
Goal: To ensure revenues and expenses are recognized in the period they were earned or incurred, providing an accurate balance for all accounts.
6. Prepare Financial Statements
Once the accounts are adjusted, the main goal of the entire process is realized: the creation of formal reports.
Activity: Compile the adjusted account balances into the three primary financial statements: Income Statement: Shows profitability (Revenues - Expenses).
Statement of Retained Earnings/Equity: Shows changes in equity.
Balance Sheet: Shows assets, liabilities, and equity at a specific date.
Goal: To communicate the company's financial health and performance to internal and external users.
7. Journalize and Post Closing Entries
This final step prepares the books for the next accounting period.
Activity: Closing entries are made to zero out all temporary accounts (revenues, expenses, and dividends) and transfer their net balances to a permanent account (Retained Earnings).
Goal: To start the new period with a zero balance in the temporary accounts, ready to track the new period's activity accurately. Permanent accounts (Assets, Liabilities, and Equity) retain their final balance, which becomes the opening balance for the new period.
1. Identify and Analyze Transactions
This is the starting point. Every economic event that affects the financial position of the company and can be measured in monetary terms is a transaction.
Activity: Gather source documents (like invoices, receipts, bank statements, and payment vouchers) and analyze them to determine which accounts are affected and by how much.
Goal: To confirm that a recordable event occurred and to prepare it for entry.
2. Record Transactions in the Journal
Once a transaction is verified, it is formally recorded in the company’s journal, also known as the book of original entry.
Activity: Use the double-entry bookkeeping system to record the transaction, ensuring that for every entry, total debits equal total credits. This maintains the fundamental accounting equation ($Assets = Liabilities + Equity$).
Goal: To create a chronological record of all financial activity.
3. Post Journal Entries to the Ledger
The journal entries are then transferred, or posted, to the general ledger. The ledger organizes all financial data by individual account.
Activity: Transfer the debit and credit amounts from the journal to their respective individual accounts in the ledger (e.g., Cash, Accounts Receivable, Rent Expense).
Goal: To summarize the total activity in each specific account for easy reference.
4. Prepare an Unadjusted Trial Balance
At the end of the accounting period, a trial balance is prepared to verify the mechanical accuracy of the recording and posting process.
Activity: List all account balances from the general ledger. The total of all debit balances must equal the total of all credit balances.
Goal: To confirm that the double-entry system is in balance before proceeding to the crucial adjustment phase.
5. Journalize and Post Adjusting Entries
The unadjusted balances rarely reflect the true financial picture. Adjusting entries are made to adhere to the accrual basis of accounting.
Activity: Record transactions that have occurred but haven't been formally documented (like depreciation, accrued salaries, or earned but unbilled revenue).
Goal: To ensure revenues and expenses are recognized in the period they were earned or incurred, providing an accurate balance for all accounts.
6. Prepare Financial Statements
Once the accounts are adjusted, the main goal of the entire process is realized: the creation of formal reports.
Activity: Compile the adjusted account balances into the three primary financial statements: Income Statement: Shows profitability (Revenues - Expenses).
Statement of Retained Earnings/Equity: Shows changes in equity.
Balance Sheet: Shows assets, liabilities, and equity at a specific date.
Goal: To communicate the company's financial health and performance to internal and external users.
7. Journalize and Post Closing Entries
This final step prepares the books for the next accounting period.
Activity: Closing entries are made to zero out all temporary accounts (revenues, expenses, and dividends) and transfer their net balances to a permanent account (Retained Earnings).
Goal: To start the new period with a zero balance in the temporary accounts, ready to track the new period's activity accurately. Permanent accounts (Assets, Liabilities, and Equity) retain their final balance, which becomes the opening balance for the new period.
