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The accounting cycle refers to the complete process of accounting procedure followed in recording, classifying and summarizing the business transactions. The accounting cycle starts right from the identification of business transactions and ends with the preparation of financial statements and closing of books.
The process of accounting cycle consists of several steps that help record and analyse your financial data. The key steps in the eight-step accounting cycle include recording journal entries, posting to the general ledger, calculating trial balances, making adjusting entries, and creating financial statements.
Whether you are a business owner or aspiring accountant, it is important to know and understand the process involved in the accounting cycle. The accounting cycle consists of 8 steps listed below:
The first step of the accounting cycle beings with the identification of financial transaction that have occurred in the business. In this accounting cycle, the accountant or the bookkeeper collects the data of all the transactions such as purchases, sales, payments, receipts etc. and keeps the data ready to complete the next step of the accounting cycle. Here, the accountant or bookkeeper analyze the nature of transactions, accounts impacted etc.
The next step of the accounting cycle is the most crucial and important. In this accounting cycle, the bookkeeper or accountant records the financial transaction in the book of accounts. This step of the accounting cycle is also known as a journal entry and the book in which it is recorded is a journal book.
Here, all the transactions are recorded in chronological order along with the ledger accounts involved, amounts in Dr/Cr and narration (a brief note on the transactions)
Ledger posting simply refers to posting the financial transactions recorded in journal books to individual ledger statements. For example, in preparing a cash ledger account, you must post all Debits (receipts) and Credit (payments) into a statement and the difference between these two including the opening balance of cash will be the closing balance.
This part of the accounting cycle includes posting all the Debit and Credit transactions into a statement belonging to a ledger account as shown in the below image.
In this step, you must list all ledger accounts with closing balance posted from individual ledger accounts statement (discussed above). The format of the trial balance consists of the Debit column and Credit column in which the closing balance of each ledger accounts will be posted. After posting the closing balance of all the ledger accounts, the debit balance should match with the credit balance.
This is the primary source for preparing the final accounts and all other financial statements.
Here, adjustment entries such as accrued incomes, depreciation, etc. are posted considering the unadjusted trial balance prepared earlier.
Adjusted trial balance is a statement listing all the closing balance of the ledger accounts after all the adjustment entries related to the accounting period is posted into the books of accounts.
This is the most important step of the accounting cycle. Once you have followed all the above steps of the accounting cycle, it’s time for you to start preparing financial statements. Profit & Loss account and Balance sheet are the two key financial statements.
Closing books of accounts refer to freezing books from recording the business transaction. This is done after the closure of the accounting period and posting all the adjustment entries. At this stage of the accounting cycle, all the financial statements are prepared and new books for the subsequent financial year will be started.
It is already understood and established that accounting cycle helps maintain accurate financial records to make informed decisions by business owners and accountants. But why is it crucial for this cycle to be a part of your accounting process? Let's take a look at the advantages accounting cycle offers businesses:
With the growth of trade and commerce and the diversity of business operations, businesses are using accounting software to get rid of the complex procedure involved in the accounting cycle. Accounting software automates the entire accounting cycle by just recording the transactions. For business owners, it saves time and effort involved in the manual accounting cycle. Not just automating the accounting cycle but the capabilities to auto-generate various financial statements such as cash flow, accounts receivables reports, projections, etc. makes accounting software invaluable to the business.
Accounting software will not only automate your accounting cycle but also simplify the recording and analysing these financial records. TallyPrime offers a whole lot of features that help keep track of your company's overall financial health. With features like “Go To” and “customisable reports” in TallyPrime, you can discover and look at reports, slicing and dicing them the way you want. To help you in your growth journey, TallyPrime enables you to manage multiple companies and incrementally add features such as multiple go-downs, multi-currency, order process, cost centres etc. This helps you get rid of complexities, and in turn, focus on business growth.
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The main purpose of the accounting cycle is to adhere to the statutory changes and accounting standards to increase business' efficiency. With the help of accounting cycle, you can take account of and track all the financial transactions, to make informed decisions to increase your business' efficiency.
The 8 steps in the accounting cycle are:
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