Accounting Cycle: Definition and Steps in Accounting Cycle Process

| Updated on: May 6, 2022

What is accounting cycle

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.

How does accounting cycle work?

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.

Steps in accounting cycle process

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:

accounting cycle process

Identification of business transactions

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.

Recording of transactions in the books of accounts

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)

journal books

Ledger posting

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.

ledger account format

Prepare un-adjusted trial balance

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.

trial balance format

Post the adjustment entries

Here, adjustment entries such as accrued incomes, depreciation, etc. are posted considering the unadjusted trial balance prepared earlier.

Prepare the adjusted trial balance

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.

Prepare financial statements

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.

  • Profit and loss account: Profit and loss accounts is a financial statement prepared to know the profitability of the business. This is also known as Income Statement.

  • Balance sheet: Balance sheet is one of the topmost financial statements prepared by businesses. The financial details of the balance sheet help you and the external stakeholders to evaluate the financial performance of the business on a given date. Click here to know the Balance Sheet format, steps to prepare the balance sheet, etc.

Closing the books of accounts

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.

Why is accounting cycle so important?

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:

  • Since financial statements give you an overall perspective about your business, accounting cycle ensures that it allows you to analyse these data points and provide insights to business owners to make better decisions. They help business owners analyse the performance of your business
  • Any kind of future investments or decisions will depend on your current financial performance or status. It is thus advised that business owners maintain accurate and updated financial records so that in case you want to raise funds for your business in the future and are looking to get investors for your company, these financial statements will come in handy. And the only way to have accurate financial statements is by following the accounting cycle to the T
  • Statutory and federal compliance is important for any business. Following the accounting cycle ensures that you remain compliant with these regulations and accounting standards.

Modern-day accounting cycle

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.

How to automate the accounting cycle using accounting software?

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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Frequently asked questions

What is the main purpose of the accounting cycle?

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.

What are the 8 steps in the accounting cycle?

The 8 steps in the accounting cycle are:

  • Identification of business transactions
  • Recording of transactions in the books of accounts
  • Ledger posting
  • Prepare un-adjusted trial balance
  • Post the adjustment entries
  • Prepare the adjusted trial balance
  • Prepare financial statements
  • Closing the books of accounts
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