How Many Steps Are There in the Accounting Cycle?

The accounting cycle is a series of procedures businesses follow to record, process, and report financial transactions. It organizes financial information over a specific period, such as a month, quarter, or year. This cycle ensures financial activities are accurately captured and compiled into useful financial statements. The eight steps of this cycle maintain organized financial records and help understand a business’s financial standing.

Initial Recording and Organization

The accounting cycle begins by identifying financial transactions, which are business activities impacting a company’s financial position, such as sales, purchases, or payments. Each transaction must be supported by source documents, which serve as evidence of the event. Examples include sales invoices, receipts, purchase orders, bank statements, and payroll records, providing details like transaction dates, amounts, and descriptions.

Transactions are recorded chronologically in a journal, a process known as journalizing. This is the initial entry of financial data into the accounting system. The double-entry bookkeeping method requires every transaction to affect at least two accounts with equal and opposite entries—a debit and a credit. This ensures the accounting equation (Assets = Liabilities + Equity) remains balanced after each entry. For instance, paying cash for an expense involves a debit to the expense account and a credit to the cash account.

After journalizing, entries are transferred, or “posted,” to the general ledger. The general ledger is a comprehensive record that organizes all financial data by individual account, such as cash, accounts receivable, or expenses. Each journal entry is posted to its respective account, allowing for a summary of all transactions impacting that account. This step classifies financial data, providing a running balance for each account and a detailed view of financial movement.

Periodic Review and Refinement

After transactions are journalized and posted, an unadjusted trial balance is prepared. This report lists all general ledger accounts and their balances at a specific point in time, with debits in one column and credits in another. The purpose of this step is to verify that total debits equal total credits, a check of the double-entry system’s mathematical accuracy. While it confirms the ledger is balanced, it does not detect all errors, such as omitted transactions or incorrect account classifications.

The next step involves journalizing and posting adjusting entries. These entries are made at the end of an accounting period to ensure revenues and expenses are recognized when earned or incurred, adhering to the accrual basis of accounting. Common types include accrued expenses (e.g., salaries earned but not yet paid), accrued revenues (e.g., services performed but not yet billed), deferred expenses (e.g., prepaid insurance consumed), and deferred revenues (e.g., unearned revenue now earned). Depreciation, which allocates an asset’s cost over its useful life, is also recorded through an adjusting entry.

After all adjusting entries have been journalized and posted, an adjusted trial balance is prepared. This report is similar to the unadjusted trial balance but includes the impact of the adjusting entries. Its primary function is to confirm that debits and credits remain in balance after all necessary adjustments have been made. The adjusted trial balance provides the final account balances used to generate the primary financial statements. It reflects a complete picture of the company’s financial position and performance for the accounting period.

Final Reporting and Preparation

The adjusted trial balance serves as the source for preparing financial statements. Businesses generate an income statement, a statement of retained earnings, and a balance sheet. The income statement reports a company’s revenues and expenses over a period, showing its net income or loss. The statement of retained earnings details changes in accumulated profits over the period, linking the income statement to the balance sheet.

The balance sheet presents a snapshot of a company’s assets, liabilities, and equity at a specific point in time, demonstrating the financial equation: Assets = Liabilities + Equity. These statements provide external users, such as investors and creditors, insights into the company’s financial health and performance. They are used for evaluating profitability, liquidity, and solvency.

The final step involves journalizing and posting closing entries. This process zeroes out all temporary accounts (revenue, expense, and dividend accounts). Their balances are transferred to permanent equity accounts, typically retained earnings, to prepare the books for the next accounting period. This ensures each new period begins with fresh revenue and expense figures. A post-closing trial balance may then be prepared to verify that only permanent accounts with correct balances remain open, confirming the ledger is ready for the new cycle.