There are eight steps in the accounting cycle. The first three steps are ongoing: these bookkeeping tasks must be performed throughout the fiscal year.
Meanwhile, the remaining five steps are the bookkeeping tasks you perform at the end of your financial year. Luckily, accounting software can help you automate these tasks these days, so doing all of these doesn't take as much time as it might seem.
1. Identify the transaction
You need to identify all transactions that occur throughout your fiscal year. The best way to do this is to create a system where all transactions are recorded automatically, which helps prevent human error. Typically, businesses integrate their accounting software with payment processing software and point of sale (POS) software to record revenue.
But you also need to record your expenses, which you can achieve by integrating your accounting software with your company bank account so that all payments are automatically invoiced.
2. Prepare the journal entry
Double-entry bookkeeping is considered standard accounting practice around the world and involves recording each transaction with two journal entries: a credit and a debit. These words represent the source of financial gain (credit) and the destination of financial gain (debit).
If you create two entries for each transaction, you can compare them later. If they don't match, you'll know there's an error somewhere. All popular accounting apps are designed for double-entry bookkeeping and create credit and debit entries automatically.
It's important to note that the way you record journal entries varies depending on whether you use the cash or accrual method of accounting.
- Cash accounting. A method of accounting that focuses on tracking a business's cash flow, by recording financial transactions as money comes in and goes out.
- Accrual accounting. An accounting method that focuses on tracking business transactions as they occur, even when no money related to the transaction in question has yet exchanged hands.
Both methods have their pros and cons, and we encourage you to read our article on the subject to help you choose the approach that best suits your business.
That being said, accrual accounting can provide a more accurate picture of a particular company's financial position, and in some cases, companies are required by law to use this method.
3. Post the journal entry to the general ledger
All journal entries must be entered into the general ledger, which is a central database that keeps a complete record of your accounts and all transactions recorded in those accounts.
Post the entries to your general ledger by adding them to the relevant accounts. Accounting software allows you to automate this.
4. Calculate the unadjusted trial balance
A trial balance is an accounting document that shows the ending balances of all general ledger accounts. You need to calculate a trial balance at the end of a financial year. The purpose of a trial balance is to help find accounting mistakes.
The total of the credit and debit balances should equal. If they don't, there is an error somewhere. An unadjusted trial balance is an initial version of a trial balance that has not been analyzed for accuracy or adjusted, if necessary.
5. Post adjusting entries to the general ledger
If your total credit and debit balances don't match, you need to figure out what's missing, record those transactions, and post these adjusting entries to your general ledger.
Also, if you've been using cash-basis accounting but are now preparing financial statements that comply with IFRS or GAAP standards, you'll need to post adjusting entries to bring your general ledger into line with accrual accounting.
6. Calculate the adjusted trial balance
The result of posting adjusting entries is an adjusted trial balance where total credit balances match total debit balances.
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7. Prepare financial statements
Once you have an adjusted trial balance, you use it to prepare financial statements. The three most common types of financial statements are:
- Ann Profit and loss statement Summarize a company's revenues and expenses during an accounting period.
- a Cash flow statement It outlines the company's cash inflows and outflows during an accounting period.
- a Balance sheet It summarises the assets and liabilities a company has at the end of an accounting period.
These financial statements can then be presented to lenders, creditors, and investors to give them an overview of the company's financial position at the end of the financial year.
8. Post the accounting journal and close the books
Finally, you need to post the closing entries that transfer the balances from the temporary accounts to the permanent accounts. This is how you close your books for the fiscal year.
Conclusion
Following the eight-step accounting cycle will help you accurately record all financial transactions, detect and correct errors, and balance your books at the end of each fiscal year before closing.
