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What is the accounting cycle, and how does it work?

The-Accounting-Cycle

According to Finance Strategists, “the sequence of accounting procedures is referred to as the accounting cycle or the phases of accounting,” or in simpler terms, it’s the bookkeeping process that is used to produce information for business stakeholders about the company’s financial performance and position, for a specific period (monthly, quarterly, annually).

The primary reason why the accounting cycle is required in every business is that it maintains all the financial data consistently, accurately, and in an organized format. Also, It gives a robust projection of the current situation and what the future holds for the company’s success in the near five years. And it helps the owners or managers make timely and informed decisions about allocating economic resources with minimum strategic gaps.

In this blog, we will explain to you what the accounting cycle is and how it works, along with some frequently asked doubts.

What is the accounting cycle?

The accounting cycle is a repetitive process of pre-defined steps like identifying, recording, sorting, analyzing, and summarising the payments made and received in a particular accounting period by the business. It is repeated in the same order in each accounting period.

The cycle was designed to ease the financial accounting process for business owners and managers. However, nowadays, most of these processes are automated by different software, benefiting many businesses with more profitability.

Accounting cycle vs. operating cycle?

Before jumping on the process, we will clarify the common confusion with the two similar terms, i.e., the accounting and operating cycles. Also, why is the accounting cycle important?

The accounting cycle is an in-depth process to create financial statements of all the financial transactions in an accounting year. On the other hand, the operating cycle accounts for the time period for the businesses’ inventory to turn into cash.

Importance of the accounting cycle:

  • It presents an accurate and organized financial report.
  • It makes financial accounting more effortless and more systemic for business owners.
  • It is required to comply with governmental regulations and taxation systems.
  • It also reduces the financial risks as owners can take preventive steps promptly.

6 Crucial steps of the Accounting Cycle

An accounting cycle might have different steps depending on the type of business and its need. Here, we are explaining the 6 crucial steps of the accounting cycle.

1. Identifying Income or Expense Head

The accounting cycle begins with old balances, which include the assets, liabilities, and owner’s equity accounts. The next step, i.e., the start of the accounting cycle, is identifying and categorizing the income and expense heads.

You need to identify each financial transaction as an income or an expense and analyze and document or record them carefully, which is also our next step.

2. Transaction Record

The next step is to record all the financial and business transactions as journal entries in chronological order in our books of accounts. All the entries need to be registered following the double-entry and accrual accounting system.

In the double-entry system, each transaction affects two accounts- one is debited, and the other is credited.

In an accrual accounting system, the transaction is recorded as soon as it takes place, whether cash is involved or not.

3. Posting in Ledgers and generating trial balance

The next step after the information is contained in journals will be transferred to ledgers and displayed in account type order. This is the last step in terms of the accounting process.

The general ledger presents a picture of the business’s surplus or deficit.

4. Adjustment of Journal Entries

Now, you need to adjust the journal entries in case of any errors while doing the previous steps. This is to be done using the trial balance. A trial balance shows the unadjusted balances of the business if any.

To adjust these errors, adjusting journal entries and transactions are made in the bookkeeping system adhering to the debits must equal credits rule. And finally, an adjusted trial balance is prepared.

5. Preparation of Financial Statement

After removing all the errors in the entries, it’s time to close the accounts, i.e., to prepare the financial statements. The financial statements are prepared using the adjusted trial balance and by assembling other information. The following financial statements are prepared:

  • Cash Flow Statement (cash inflow & outflow)
  • Income Statement (financial performance)
  • Balance Sheet (financial position)

6. Finalization of Accounts

The accounting cycle’s last step is to finalize and close the accounts for that particular accounting year.

Temporary or nominal accounts (income statement accounts) like income accounts, expense accounts, cash accounts, etc., get closed(transferred) to the appropriate capital account (permanent accounts) or use closing entries, and their balances are carried forward to the following year.

FAQs

1. What is the accounting period?

The accounting period is a range of time for which financial transactions are recorded and for which financial accounts are prepared. Generally, it is a time period of 12 months, but it can also be of a week, month, quarter, semi-year, etc. Furthermore, it can be a calendar year or a fiscal year.

2. Why is accounting cycle automation in demand?

It is because automation helps better time management, reduces administrative burden, and increases accuracy and reliability. It is also cost-efficient and can present financial data in real-time.

3. What are the golden rules of accounting and accounting standards?

There are three golden rules of accounting and accounting standards. They are

  • Debit what comes in, credit what goes out.
  • Debit the receiver, credit the giver.
  • Debit expenses and losses, credit income and gains.

4. How does the RBI regulate accounting practices?

RBI acts as a supervisor and always keeps an eye on whether accounting systems follow Generally Accepted Accounting Principles (GAAP) and Accounting Standards while also considering public interest and trust.

Accounting Cycle Automation – How we can help!

The step-by-step accounting cycle makes the tedious work of financial accounting more systematic and ensures that every penny that flows through your business is accounted for.

However, as much as the accounting cycle is essential, you must acknowledge that it consumes a lot of time. That’s why lots of companies are investing in accounting cycle automation and using their freed-up time for more important tasks and core business.

In this era of high competition, you must stay caught up and invest in accounting cycle automation. We at FinAccountants, are a team of financial experts with a wide range of experiences serving in 8+ countries.

We have different packages customized according to your business needs.

So without any further delay, Book a call NOW!

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