Accounting
process is a continuous and systematic working process that begins with the
analysis of business transactions and ends with the preparation of post-closing
trial balance. According to going concern concept, it is presume that a
business organization will run for an indefinite period. But, this indefinite
period is divided into small periods to know operating result and financial
position of a business organization. Accounting process is a constitutional
working process in determining these financial results. These constitutional
rules of accounting process require systematic and successive recording of
business transactions. The successive working process of accounting method is
called accounting cycle. This cycle begins with the analysis of business
transactions and ends with the preparation of a post-closing trial balance. The
accounting working process starts with identification of transactions and its
journalisation. After recording the transactions in journal these are to be
classified and posted to ledger accounts. The trial balance is prepared with
balances of ledger accounts to prove arithmetical accuracy of accounts. After
preparation of trial balance adjusting entries are passed for preparing
adjusted trial balance, and there after a worksheet is prepared for convenient
preparation of true and fair financial statements. For taking various financial
decisions the statements of accounts are interpreted and analysed for providing
necessary information. After preparation of financial statements closing
entries are passed for closing periodic expenses and income in order to close
these and after that a post closing trial balance is prepared finally with
which the next year activities start.
The steps in the cycle are performed in
sequence and are repeated in each accounting period. Therefore, accounting
cycle is a complete accounting process, which starts with identification of
transaction and its journalization and reaching final stage of accounting
activities step by step and starts next year activities with opening journal
entries and again reaches final stage of accounting activities in the same
process. This accounting process repeats so long a business exists.
Various steps of accounting
cycle
The
various steps or phases of accounting cycle are shown in the following
flowchart along with explanation:
The
steps of accounting cycle are shortly described below:
Identification of Transaction
and Other Events
The
first step of the accounting cycle is identification of transaction and
selected other events. In an organization, many events occur every day. But all
of them are not transactions, because every transaction will not involve cash.
Only the events measurable in terms of money and make change in financial
position/accounting equation are identified as transaction- it should be
recorded and in the next stage accounts are maintained for these.
Journalizing
In
the second stage of accounting cycle transactions are recorded initially in
chronological order of dates debiting one account and crediting the other with
brief explanation before transferred to the accounts. Thus, the journal is
referred to as the ‘book of original entry.’ If transactions are not recorded
earlier in journal, in later stage ledger accounts becomes almost complex.
Posting to ledger accounts
Step
three of accounting cycle is to classify business transaction. The statement
that is prepared classifying and summarizing the transactions in groups like
income expense, assets and liabilities is called ledger. The procedure of
transferring journal entries to the ledger accounts is called posting. As all
transactions are finally recorded in this book permanently, it is called
‘permanent book of account.’
Preparation of Trial Balance
In
forth step of accounting cycle a trial balance is prepared with the help of
ledger accounts list and their balances at a given time. As a matter of course,
at a particular date of period end the accounts are listed in the order in
which they appear in the ledger, with debit balances listed in the left column
and credit balances in the right column. Primarily a trial balance is prepared
to prove the arithmetical accuracy of debits and credits after posting and
facilitate preparing financial statement. A trial balance also uncovers errors
in journalizing and posting.
Adjustment
Adjustments
are needed to ensure that the revenue recognition and matching principles are
followed. To determine operating result of a particular period and exact
financial position at a particular date of a business concern various
information regarding accruals and advances is essential to be accounted.
Adjustments are done in the following ways:
a) According to accrual concept, payable expense lime payable salary, rent and accrued income like accrued interest on investment etc. are to be adjusted in the books of accounts for determining actual income or loss of a particular period.
a) According to accrual concept, payable expense lime payable salary, rent and accrued income like accrued interest on investment etc. are to be adjusted in the books of accounts for determining actual income or loss of a particular period.
b)
According to income-expense matching concept for determining actual profit
expense incurred for earning income like advance, expense, depreciation
expense, uncollectible allowance etc. are to be adjusted in the book of
account.
Adjusted Trial Balance
In
this step of accounting cycle adjusting entries have been journalized and
posted in the ledger accounts again for finding out relevant ledger balances at
the end of the period. The trial balance that is prepared again with these
ledger balances is called adjusted trial balance. The purpose of an adjusted
trial balance is to show the effects of all financial events that have occurred
during the accounting period.
Financial Statement
Preparation
Financial
statements are prepared from adjusted trial balance directly. At first to
determine net income or net loss, the income statement is prepared from the
revenue and expense accounts. After that, the owner’s equity statement is
derived from the owner’s capital and drawing account and the net income or net
loss from the income statement. Finally, the balance sheet is completed by
listing all the assets, liabilities and owner’s equity. Assets will always
equal the liabilities and equity that is why this statement is called balance
sheet and it shows the financial condition of the enterprise at a given time.
Closing Entries
Journalizing
and posting closing entries is a required step in the accounting cycle.
Generally, after preparation of financial statements the temporary accounts
such as revenue or expense and gain or loss including balance of income
statement are closed by passing closing journal entries These accounts are
closed to a temporary income summary account, from which the balance is transferred
to the retained earnings account (capital). Any dividend or withdrawal accounts
also are closed to capital. The necessity of closing expenses and incomes
arises as their utilities ended during the particular accounting period and
these are not carried forward to the nest year like assets, liability and
owner’s equity.
Post Closing Trial Balance
(optional)
A
third trial balance may be taken after journalizing and posting the closing
entries, called the post closing trial balance, shows that equal debits and
credits have been posted to the income summary accounts. The purpose of this
trial balance is to prove the equality of the permanent account balances that
carried forward into the nest accounting period as opening balances. At this
point, only the permanent accounts (total assets, liabilities and owner’s
equity) appear since the temporary accounts have been closed.
Reversing Entries (optional)
Reversing Entries (optional)
The preparation of reversing entries is the last step of accounting cycle and it is an optional bookkeeping procedure that is not a required step in the accounting cycle. A reversing journal entry is recorded on the first day of the new period. Reversing entries are adverse to adjustment entries which are passed at the beginning of next financial year. In fact, reversing entries are passed for outstanding and advances of previous year in the beginning of an accounting year which are opposite to adjusting entries. By reversing the adjusting entry, one avoids double counting the transaction occurs in the next period. Reversing entries are made only for adjusting entries of outstanding and advances. And for the other adjusting entries no reversing entries are required.
Work Sheet (optional)
The
accounting process is completed when all accounts are closed and
"reset" for the new financial cycle. This involves working with a
work sheet that condenses all the financial statements onto one table. Use of
work sheet helps the accountant prepare the financial statements on a timelier
basis. To facilitate the end of period (monthly quarterly or annually)
accounting and reporting process, a work sheet is often used. Big business
organizations where number of accounts and adjustments are comparatively huge,
work sheet is prepared to facilitate preparation of financial statements
conveniently and accurately. The 10-column work sheet provides columns for the
first trial balance, adjustments, adjusted trial balance, income statement and
balance sheet. Completing the work sheet provides considerable assurance that
all of the details related to the end of period accounting and statement
preparation have been properly brought together.