Updated: Dec 26, 2020
The accounting cycle is the process of recording your business’s financial activities. The accounting cycle looks back in time at the end of a designated period. The cycle includes several steps, starting when a transaction occurs. The cycle ends when you record the transaction as part of your financial statements.
The accounting cycle makes accounting easier, breaking your bookkeeping down into smaller tasks. It helps you see what you need to accomplish next.
You can improve consistency and accuracy by following the accounting cycle. Start and end dates allow you to manage time and set goals. You can compare one cycle to another, and reconcile bank statements.
If you use accounting software, you can program dates for your accounting cycle. The software will generate reports based on the dates you select.
Accounting cycle steps
Full cycle accounting can be broken down into several steps. Depending on how you do your accounting, you may be able to modify or skip some of the steps.
Many steps in the accounting cycle are meant for accrual accounting. The double-entry accounting system allows you to cross reference entries for accuracy. If you use accrual accounting, you can follow all the steps in the accounting cycle.
If you use a single-entry accounting system (cash-basis), you can still use the accounting cycle. You will begin the accounting period on a certain date, record entries, and close your books at the end of the period. You do not need to follow the steps that require you to check entries for debits and credits.
How many steps are in the accounting cycle?
Usually, there are eight steps in accounting cycle processes. However, you can add or subtract certain steps when necessary. Use the steps that help you stay organized and maintain accurate records.
What are the steps of the accounting cycle?
The following accounting cycle steps can help you keep financial records.
1. Identify transactions
First, separate your business transactions from all of the transactions you made. You only want to include transactions related to your company in your financial records. For example, you won’t record your grocery bill as a business expense in your books.
Use source documents to identify business transactions, such as receipts and invoices. Save these kinds of financial documents to support your records. As you identify business transactions, decide which account they fall under.
2. Record transactions in your journal
The journal is where you initially record business transactions. It is a running list of financial activities, like a checkbook. Track transactions in your journal chronologically as they happen.
If you use double-entry bookkeeping, record two entries for each transaction. Enter a debit for one account and a credit for another. The debit and credit should be equal.
3. Post entries to the general ledger
The general ledger is also known as the book of final entry. General ledger entries are changes made to each account in your books. Using your journal, organize transactions into different accounts. For example, if a customer paid for a product with cash, enter the transaction under the cash account in your books.
4. Unadjusted trial balance
For your books to be accurate, the debit and credit entries must be equal. Use an unadjusted trial balance to test if your debits and credits match.
Make a note of each account balance. Add all the debit balances together and all the credit balances together. If the two totals are not the same, you might have an error in your books. Or, you might need to make adjusting entries.
5. Adjusting entries
At the end of an accounting period, you might have incurred expenses but not paid for them yet. And, you might have earned income but not collected it yet. Use adjusting entries to recognize transactions that have occurred but not been recorded.
For example, you earned interest on a bank account balance. You have not recorded the interest in your books, but it appears on your bank statement. Use an adjusted entry to recognize the interest in your books.
6. Adjusted trial balance
Do an adjusted trial balance after making adjusting entries and before creating financial statements. This step tests to see if the debits and credits match after making adjusting entries.
7. Create financial statements
Once your accounts are up-to-date, create statements. The following are common financial statements for small business:
Income statements compare your profits and losses for the period.
Balance sheets determine progress by detailing assets, liabilities, and equity.
Cash flow statements show money coming into and out of the business.
Use your financial statements to measure performance, make improvements, and set goals. You can also use statements to talk with lenders and negotiate terms with vendors.
8. Close your books
The final step in the accounting cycle is to close your accounting books. Closing your books wraps up financial activities for the period. Do tasks like updating accounts payable, reconciling accounts, reviewing your petty cash fund, and counting inventory.
When you close your books, you should get your accounting set up for the next period. Decide which processes are moving your business forward. Create a calendar for completing future tasks. File any financial documents from the last period and get rid of old documents that are no longer useful.
Flow chart of the accounting cycle
The accounting cycle can help you keep your books organized. Use this flow chart of the accounting cycle as a reference for completing your books.