What Is The Accounting Cycle? Explained Step by Step

Introduction 

Within the ever-evolving landscape of financial management, the accounting cycle assumes a crucial role as a foundational process that establishes the basis for precise and insightful decision-making. Essentially, the accounting cycle represents a carefully orchestrated series of steps that converts raw financial data into meaningful and comprehensible reports. 

Each phase in the accounting cycle holds significant importance, ensuring that a company’s financial records not only comply with regulatory standards but also provide a comprehensive reflection of its economic activities. From the meticulous input of financial data to the generation of reports, the accounting cycle ensures a systematic approach to maintaining financial records. 

This article delves into the nuances of these steps and highlights its significance in promoting transparency, accountability, and well-informed decision-making in the business sphere. Additionally, we explore the impact of technology as a catalyst in optimizing the efficiency and effectiveness of the accounting cycle, streamlining routine tasks and augmenting accuracy.

What is the Accounting Cycle? 

The accounting cycle is an 8-step process that captures, analyzes, and records a company’s financial transactions. Starting with transaction occurrence, it progresses through journal entries and general ledger updates, and concludes with financial statements generation and book closure.

The 8 steps of the Accounting Cycle 

From identifying transactions to preparing financial statements, the 8 steps in the accounting cycle ensure accurate record-keeping. Let us understand these steps in depth.

1. Transaction identification and analysis

   The initial step in the accounting cycle involves the identification and analysis of all transactions occurring throughout the accounting period. These transactions encompass a wide range of financial activities, such as expenses, debt payments, sales revenue, and cash receipts from customers. 

   To systematically capture and document these transactions, companies employ subsidiary ledgers or journals, recording the occurrences in their books and subsequently integrating them into the financial statements. Utilizing the principles of double-entry bookkeeping, where each transaction is accompanied by balancing debits and credits, the organization ensures accuracy and completeness in its accounting system. This methodical approach is fundamental to the accounting system’s integrity. 

2. Transaction recording in journal 

   Following the identification and analysis of transactions, the subsequent step in the accounting cycle involves the meticulous recording of these entries in the company’s journal, maintaining a chronological order. Whether documented in a physical book or through accounting software, the process adheres to the principles of double-entry accounting. Each transaction is methodically entered as a debit in one or more accounts and a corresponding credit in two or more subledger accounts, ensuring a balance between debits and credits.

    The timing of these recordings depends on the chosen accounting method—accrual or cash accounting. Accrual accounting recognizes transactions when incurred, providing a comprehensive overview of financial activities. Conversely, cash accounting revolves around the actual exchange of cash, capturing transactions as and when the funds change hands. This systematic recording of financial transactions not only establishes a transparent chronological record but also forms a crucial foundation for the subsequent stages of the accounting cycle.

3. Posting to general ledger 

   After recording and approving journal entries, the subsequent step in the accounting cycle involves posting these entries to the general ledger. The general ledger serves as the master record, offering a comprehensive summary of all financial transactions categorized by individual accounts. 

   As each transaction is documented in the journal, it is systematically posted to the corresponding account in the general ledger. This critical process provides a detailed breakdown of all accounting activities, allowing for tracking of various company account finances. The general ledger plays a pivotal role in offering a consolidated view of financial data, ensuring accuracy and transparency in the representation of the organization’s financial standing. 

4. Preparation of unadjusted trial balance 

   Following the posting of journal entries to individual general ledger accounts, the trial balance is prepared to verify that the total debits match the total credits in the financial records. This step is crucial for maintaining the accuracy of financial data. The unadjusted trial balance reflects the closing balances of these accounts without incorporating any adjustments, hence the term “unadjusted.” Trial balance ensures the accurate recording of all transactions in the general ledger, serving as a preliminary check for errors. 

   An unadjusted trial balance not only provides insight into each account’s unadjusted balance but also plays a vital role in identifying anomalies, such as missing or misaligned transactions. The balances from this trial are then carried forward for further testing and analysis in the subsequent steps of the accounting cycle.

5. Worksheet analysis to identify anomalies 

   The fifth step in the accounting cycle involves using worksheets to analyze and reconcile debits and credits, aiming to identify and rectify errors and discrepancies. When the trial balance reveals mismatches between debits and credits, bookkeepers turn to a worksheet to track corrective adjustments. This process includes aligning debits and credits from various accounts in a single spreadsheet, allowing for a comprehensive review of transaction data. 

   The analysis serves to identify necessary adjusting entries, ensuring that the total credit and debit balances align. This step is crucial not only for error detection but also for reconciling revenue and expenses, particularly in the context of accrual accounting. Any identified discrepancies prompt adjustments, paving the way for the subsequent steps in the accounting cycle.

6. Make adjusting entries

   As the sixth step in the accounting cycle, adjusting entries is crucial at the end of the company’s accounting period to ensure accurate financial reporting. This step is a seamless continuation of prior processes, addressing any errors identified in the trial balance and worksheet analysis. Manual adjustments, including accruals for expenses incurred and reconciling items uncovered during account reconciliation, are incorporated. 

   After entering and posting adjusting entries to the general ledger, the total debit balances are meticulously matched with total credit balances as part of the accounting control process. The effectiveness of this adjustment is confirmed by generating and reviewing an adjusted trial balance report. This step, occurring just before the creation of financial statements, signifies the culmination of meticulous error correction and reconciliation, ensuring the integrity of the financial data. 

7. Generation of financial statements 

   Following the posting of adjusted entries and the preparation of an adjusted trial balance, the subsequent step in the accounting cycle involves the generation of formal financial statements. Once adjustments are applied, corrected account balances provide the basis for creating essential reports that encapsulate a company’s financial activities and performance for a specified period, whether monthly or quarterly. The key financial statements typically produced include the income statement, balance sheet, and cash flow statement. Additionally, companies may generate statements such as the statement of owner’s equity. 

   The balance sheet and income statement offer insights into business events throughout the accounting cycle, while the cash flow statement aids in projecting and monitoring a business’s cash flow. These financial statements serve as the culmination of the accounting cycle, providing a comprehensive overview of a company’s financial health. Interpreting these statements is vital for financial management, facilitating informed decision-making and the formulation of growth strategies.

8. Closing the book 

   In the final stage of the accounting process, called “closing the books,” the main goal is to reset certain accounts on the income statement to zero. These accounts, like revenue and expenses, show the company’s financial performance for a specific time, like a month or a year. Unlike accounts on the balance sheet, which reflect the company’s overall financial status at a certain point, income statement accounts need to be reset to start fresh for the next period.

   To do this, we make closing entries, which involve moving the net income or loss from the income statement to the retained earnings account on the balance sheet. This retained earnings account carries over to the next period. It’s important to note that this process doesn’t apply to something called a soft close.

   Closing entries ensure that all revenue, expenses, and related entries for the accounting period are accounted for properly. After these entries are made, we prepare a post-closing trial balance to double-check that debits and credits are balanced before starting a new accounting cycle. This whole process marks the end of one accounting cycle and the beginning of the next reporting period.

Importance of the Accounting Cycle

The accounting cycle serves as the backbone of financial management, providing a systematic approach to track, analyze, and communicate a company’s financial health and performance. Some of the major benefits of the accounting cycle are. 

1. Ensures transaction accuracy and documentation

   Within the accounting cycle, every financial transaction undergoes meticulous analysis and documentation. This structured and systematic approach minimizes errors and guarantees consistency in recording and organizing transactions. The cycle ensures accuracy, which proves beneficial in creating annual budgets and reports. Furthermore, the detailed documentation provides a comprehensive understanding of the exact amounts, purposes, and timelines of transactions, contributing to overall financial transparency.

2. Ensures financial statement accuracy and compliance

   The accounting cycle is a crucial tool for businesses in preparing accurate and reliable financial statements, ensuring compliance with federal regulations. At the end of each fiscal period, the standardized process aids in generating annual reports for investors and shareholders. This organized approach guarantees that financial transactions are precisely recorded, providing businesses with a clear understanding of their financial health. Stakeholders, from management to creditors, can make informed decisions based on the timely and relevant financial statements produced at the close of each accounting cycle.

3. Aids in internal financial analysis and decision-making

   The accounting cycle’s significance extends to internal financial analysis within a business. Ongoing steps, such as analyzing, journalizing, and posting transactions, contribute to continuous monitoring of financial performance. End-of-cycle activities, like preparing and adjusting trial balances, provide crucial data for leaders to make informed decisions about future spending and financial strategies. The standardized process facilitates better financial analysis and enables meaningful comparisons of financial data across different periods, supporting strategic planning and sustainable business growth.

4. Ensures compliance with legal regulations 

   The accounting cycle plays a vital role in ensuring businesses comply with federal regulations and tax requirements. Adhering to the accounting cycle guarantees that financial statements align with accounting principles and standards, meeting legal and regulatory requirements. This ensures information availability to interested parties, contributing to the overall transparency of business operations.

5. Ensures efficient accounting procedures and accountability

   For businesses, especially smaller ones with limited resources, the accounting cycle serves as a model for efficient accounting procedures and ongoing processes. The cycle’s step-by-step nature functions as a checklist, guiding accountants through each phase. This structured approach enhances accountability and process management. Using a customized accounting close checklist with assigned responsibilities and deadlines improves overall efficiency and ensures that each task is documented, approved, and completed within the accounting cycle.

Recommended Reading: Why does Month End Close Take Time?

Timing of the Accounting Cycle 

A business’s accounting period is determined by various factors, including reporting obligations and deadlines. The accounting period refers to the timeframe for preparing financial documents, varying from monthly to annually. Companies may opt for monthly, quarterly, or annual financial analyses based on their specific needs. 

Companies might employ multiple accounting periods, but it’s crucial to note that each period solely reports transactions within that time frame. If the accounting period extends to a year, it is also termed a fiscal year. Publicly traded firms, mandated by the SEC, submit quarterly financial statements, while annual tax filings with the IRS necessitate yearly accounting periods. 

How HighRadius Can Help in Optimizing the Accounting Cycle

HighRadius leverages the latest technology to enable organizations to fundamentally transform their accounting processes with a comprehensive Record to Report (R2R) solutions, offering end-to-end capabilities to streamline and automate various accounting processes and workflows. Powered by cutting-edge accounting technologies, the R2R solution empowers organizations to achieve a remarkable 30% reduction in days to close by seamlessly integrating Financial Close Management, Account Reconciliation, and Anomaly Management.

For organizations seeking to optimize their financial closing processes, HighRadius’s Financial Close Management is an indispensable tool. It transforms the accounting cycle by amalgamating automation, anomaly detection, and structured project planning. Utilizing the Month End Close Checklist, organizations gain access to a detailed project plan guiding accounting teams through all necessary tasks for a seamless month-end close. This checklist comprises templates and support documents, offering a structured framework for efficient and error-free closing processes.

At the core of HighRadius’s R2R solution lies an AI-powered platform catering to diverse accounting roles. An outstanding feature is its ability to automate nearly 50% of manual repetitive tasks, achieved through a No Code platform, LiveCube. This innovative tool replaces Excel, automating data fetching, modeling, analysis, and journal entry proposals.

HighRadius’s solutions not only optimize the accounting cycle but also ensure a faster, error-free close. With emphasis on automation, user-friendly interfaces, and AI powered account reconciliation, HighRadius solutions demonstrate commitment to making the accounting cycle more efficient and responsive to modern business needs.

FAQs

1. What are the 8 steps of the accounting cycle?

   The accounting cycle involves analyzing transactions, journalizing entries, posting to the ledger, preparing an unadjusted trial balance, anomaly identification, making adjusting entries, preparing financial statements, and concluding with closing entries.

2. What is the simple example of the accounting period concept?

   In the accounting period concept, a simple example is a company adopting a quarterly period. All financial transactions and reports, like income statements and balance sheets, are prepared, reviewed, and reported on a quarterly basis, providing regular intervals for analysis and decision-making.

3. What is full cycle accounting?

   Full cycle accounting encompasses all accounting processes from transaction initiation to financial statement preparation. It includes recording transactions, adjusting entries, financial statement creation, and closing entries. This ensures a comprehensive and accurate representation of a company’s financial activities.

4. How long is an accounting cycle?

   The accounting cycle typically spans a fiscal period, commonly a month, quarter, or year. It involves recording, classifying, summarizing transactions, adjusting entries, and financial statement preparation. The cycle’s duration depends on the reporting requirements and business needs.

5. How does the accounting cycle work?

   The accounting cycle involves recording transactions, posting to the ledger, preparing trial balances, adjusting entries, creating financial statements, and closing entries. It ensures accurate and systematic financial record-keeping for businesses, facilitating informed decision-making.

6. What is an accounting cycle process example?

   An example of an accounting cycle process is the monthly financial close, which includes recording all transactions that happened in the month, preparing unadjusted trial balance, adjusting entries, preparing financial statements, and closing entries to ensure accurate and complete financial reporting.

7. What is a bookkeeping cycle?

   Bookkeeping cycle involves recording financial transactions, classifying them into appropriate accounts, summarizing in ledgers, preparing trial balances, identifying anomalies, adjusting entries, creating financial statements, and closing the books. It ensures accurate and organized financial records.