Accounting cycle is a step by step process of recording business transactions which ends on the preparation of financial statements. The accounting cycle is started and completed within an accounting period.
Steps for accounting cycle are:
1. Identifying the business transactions-
Accounting cycle starts by identifying and analyzing transactions and events related to business. Only those transactions are recorded which are related to cash whether received or not. For example: Employees worked hard to achieve profit. Hence, in this case hard work of employees will not be considered as business event or transaction in the books of account. A business document serves as basis for recording a transaction.
2. Posting to journal-
Once, business transactions are identified, they are posted into journal. Through journalizing, each business transaction is recorded in two related but opposite accounts, with one account debited and the other account credited with same amount.
3. Posting to ledger-
Account information recorded in journal must be later transferred and posted to general ledger. A general ledger groups accounts based on the structure of balance sheet and income statement.
4. Preparation of trial balance-
Once, transactions are posted in general ledger, trial balance is to be prepared by the business organization. In trial balance, general ledger accounts with debit amounts will be shown in one column while general ledger accounts with credit amounts will be shown in another column. Each column is totaled and their sums are compared to each other to see if there is balance or inequality.
5. Making adjustment entries-
Companies may need to make certain adjustment entries on some business transactions that tend not to be recorded until the end of an accounting period. For example- prepaid commission or outstanding rent.
6. Compiling financial statements-
Financial statement compilation essentially is the transfer of ledger accounts balances to respective accounts in different financial statements- including balance sheets, income statement, statement of cash flows etc. it is the last step in accounting cycle.