What Are the Steps of the Accounting Cycle?

The accounting cycle is a systematic process businesses use to identify, record, summarize, and report financial transactions over a specific accounting period. This structured framework ensures the accuracy and consistency of financial data, providing valuable insights into a company’s financial health and performance. Its cyclical nature means the process repeats each period, ensuring a continuous flow of financial information. This ongoing cycle is fundamental to financial management, transforming raw financial activities into organized, actionable reports.

Recording Business Activities

The initial phase of the accounting cycle involves capturing raw financial data by identifying financial transactions, which are economic events affecting a company’s financial position. These transactions, such as sales, purchases, or payments, are evidenced by source documents like invoices, receipts, or bank statements. Only events with a measurable financial impact are considered transactions.

Once identified, transactions are chronologically recorded in a journal, often called the “book of original entry.” This process, known as journalizing, involves noting the date, affected accounts, and corresponding debit and credit amounts, along with a brief description. The double-entry accounting system mandates that every transaction impacts at least two accounts, ensuring total debits always equal total credits.

Following journalizing, entries are transferred, or “posted,” to individual account ledgers within the general ledger. This ledger serves as a comprehensive collection of all accounts, such as Cash, Accounts Receivable, and Sales Revenue, providing a running balance for each. This step organizes chronological journal entries into categorized accounts, making it easier to track financial activity of specific elements like assets, liabilities, equity, revenues, and expenses.

Preparing for Financial Reporting

After recording daily business activities, this stage focuses on preparing and verifying financial data accuracy before formal reports are generated. This begins with creating an unadjusted trial balance, a list of all general ledger accounts and their balances at period end. Its purpose is to confirm total debit balances equal total credit balances, indicating the double-entry system has been applied correctly. This internal document serves as a preliminary check for mathematical errors.

Adjusting entries ensure financial statements accurately reflect a company’s financial position and performance. These entries adhere to the accrual basis of accounting, recognizing revenues when earned and expenses when incurred, regardless of when cash is exchanged. Common examples include accrued expenses like unpaid salaries, deferred revenues, or depreciation. Adjustments ensure financial information aligns with Generally Accepted Accounting Principles (GAAP), the framework for financial reporting in the United States.

Once adjusting entries are made and posted, an adjusted trial balance is prepared. This updated list of accounts and their balances provides the figures used to construct primary financial statements. Like its unadjusted counterpart, the adjusted trial balance must show total debits equal total credits, confirming the ledger’s mathematical accuracy after all adjustments. This balanced adjusted trial balance is an internal document, ensuring data is complete and reliable for external reporting.

Generating Reports and Preparing for the Next Cycle

The culmination of the accounting cycle involves generating formal financial reports and preparing the system for a new period. Using figures from the adjusted trial balance, businesses prepare their primary financial statements. The Income Statement, also known as the Profit and Loss Statement, summarizes a company’s revenues and expenses over a period to show profitability. The Balance Sheet presents a company’s financial position at a point in time, detailing its assets, liabilities, and equity.

After financial statements are prepared, closing entries reset temporary accounts to zero. These accounts include revenues, expenses, and dividends or owner’s drawings, which track financial activity for a single accounting period. By transferring their balances to a permanent equity account, such as Retained Earnings or Owner’s Capital, closing entries prevent data mixing between accounting periods. This process ensures each new period begins with a clear slate for measuring performance.

The final step is preparing a post-closing trial balance. This trial balance lists only permanent accounts—assets, liabilities, and equity—which carry their balances forward into the next accounting period. Its purpose is to verify the general ledger remains in balance after closing entries are posted and all temporary accounts are zeroed out. A balanced post-closing trial balance confirms the closing process accuracy and provides a reliable starting point for the subsequent accounting period.