The accounting cycle refers to a cooperative process of detecting, analyzing, and recording the enterprise activities. It’s a common eight-stage procedure that starts with transaction committing, and finishes as its incorporation in a financial statement.
The major stages for the accounting cycle include a registration of journal entries, data placement to the general ledger, a calculation of preliminary balances, a formation of accruals and deferrals, as well as a set up of financial statements.
Essence of Accounting Cycle
The accounting cycle means a sequence of actions that are aimed at registering, summarizing and reporting on economic events and enterprise transactions. Thus, the process occurs once in each reporting period, that is the interval of invoices being produced. The period can range from a week (for a large enterprise) to a year (for a self-employed entity with a limited number of financial operations).
In fact, the accounting cycle is mainly related to bookkeeping, although the general principles are covered by computerized methods. In fact, it is a set of procedures that ensure the accuracy and consistency of financial statements. Mathematical errors have been reduced thanks to the automatic systems and a consistent accounting cycle. Nowadays, this software has completely computerized the accounting cycle, facilitating less efforts and mistakes connected with manual processing.
As it was mentioned before, the accounting cycle includes eight steps:
- Identify financial operations. An enterprise starts its accounting cycle from defining the transactions that relate to a bookkeeping act. The following banking operations are taken into account: a sale, a compensation, settlement to a vendor, etc.
- Record financial operations in a journal. It implies a registration of journal entries that are premised on receiving invoices, admitting sales, or fulfilling other economic events.
- Posting. After the transaction is completed, it should be placed in the general ledger. This guarantees a breakdown of bookkeeping activities.
- Preliminary trial balance. Once the enterprise sets forth its accounts, an uncontrolled trial balance comes into play. The stage provides the total debits that are equal to the credit value in a financial report.
- Worksheet. It is made in order to find confirmation of balance between debits and credits. In the opposite case, there is a need for adjustments.
- Corrected registration entries. This is the result of supplemented data in the course of time. For instance, adjusted transactions can add unearned income that has been collected over a certain time period.
- Financial statements. As the corrected entries are published, an enterprise provides a preliminary trial balance accompanied by actual standard financial statements.
- Closing the journal. A firm extends closing entries at the end of a particular period. Such termination of accounts comprises transferring net profit into retained gains. Lastly, the enterprise makes the post-closing trial balance in order to confirm that debits and credits coincide. So that there is a possibility of a new cycle.
Timeframe of Accounting Cycle
As a rule, there exists a particular accounting period for each accounting cycle. It means time limits for creating financial statements. The terms may vary and rely upon a set of elements. The most common time constraint is an annual one.
Various financial operations take place during the accounting cycle. At the turn of the year, there is a necessity in financial statements that are usually extended to the SEC (the U.S. independent agency). Thus, the accounting cycle of the enterprise centers around reporting periods, established by the regulatory bodies.
Distinctive characteristics of the term
It is worth noting that accounting and budget cycles aren’t the same concept. The first term turns upon historical data, and guarantees an accuracy of financial operations. The second notion is connected with future operational indicators and their planning process.
Another difference is that the accounting cycle facilitates data preparation for outside users, while the budget one is often applied for internal control aims.