Accounting Cycle: What are the Accounting Cycle Steps? - financepal

Accounting Cycle: What are the Accounting Cycle Steps?

December 1st, 2020

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Accounting is integral to the success of any business, regardless of size. And integral to accounting is a process known as the accounting cycle. The accounting cycle is a standardized process for recording the accounting events of a business. This 8-step cycle is set in motion the moment a transaction occurs and culminates the moment the transaction is included in financial statements.

Why is the Accounting Cycle Important?

The purpose of the accounting cycle is to ensure that all money that changes hands during a transaction is properly accounted for and accurately reported in a business’s financial statements. This is important because banks and outside lenders will ask to see your business’s financial statements before they approve any loans. Additionally, investors will be able to use these statements to gauge your company’s financial health. It is also worth noting that having accountants well-versed in small business taxes can find potential tax savings for your business. In a similar vein, if the IRS asks for your financial statements in the event of an audit, having proper statements can save time, money — and perhaps, your business.

The Accounting Cycle Steps

As previously mentioned, the accounting cycle consists of eight steps, the first of which occurs at the moment a transaction occurs while the eighth and final step occurs with the recording of the transaction in financial statements. Here are the accounting cycle steps in order:

  1. Identify transactions
  2. Record transactions into a journal
  3. Post to the general ledger
  4. Calculate the unadjusted trial balance
  5. Worksheets and identifying adjusting entries
  6. Adjusting journal entries
  7. Create financial statements
  8. Close the books

Now let’s go into a little more detail:

1. Identify Transactions

The first step in the accounting cycle entails consolidating all the information you have on each transaction that occurred during a specific period. Consider the accounting method your business uses; if you are using the accrual method of accounting, you will record transactions the moment they occur, regardless of whether the cash is on hand or not. If you are using the cash method of accounting, you will record transactions the moment cash changes hands.

Ideally, a professional bookkeeper will be on top of this throughout the reporting period or you may find yourself scrambling to gather your receipts hours before the reporting deadline.

2. Record Transactions into a Journal

In the olden days, you would have to record each transaction as both a credit and a debit in the appropriate journals. This is called double-entry accounting, and thanks to technology, this is now more or less automatic, as long as you properly classify the transaction in your accounting software.

3. Post to the General Ledger

Once a transaction is recorded in the journals, it will post an account in the general ledger. The general ledger breaks down accounting activities on an account-by-account basis. The purpose of a general ledger is to give your bookkeeper a better picture of how much cash is currently on hand per account.

4. Calculate the Unadjusted Trial Balance

Once the accounting period ends, a trial balance is calculated. The purpose of this is to show the unadjusted balances per account and to provide a basis for the fifth step.

5. Worksheets and Identifying Adjusting Entries

The purpose of this step is to use a worksheet to ensure that the total credit balance equals the total debit balance. If there is a discrepancy, you can utilize the table to find out where they occur.

If your business utilizes accrual accounting, adjusting entries may be necessary to match your revenue with your expenses, which brings us to step six:

6. Adjusting Journal Entries

Your bookkeeper will make adjustments as needed. These adjustments are recorded as journal entries.

7. Create Financial Statements

The penultimate step of the accounting cycle is where the income statement, balance sheet, and, usually, the cash flow statement is generated. These financial statements are crucial indicators of your business’s financial health and outlook.

8. Close the Books

The eighth and final step of the accounting cycle entails closing out temporary accounts, such as revenue and expenses, and folding them into permanent accounts (e.g. retained earnings). Once this step is finalized, you can sit back and relax — but not for too long, of course. The next accounting cycle starts once the previous one ends.

Accounting Cycle Benefits

Adhering to the accounting cycle is conducive to impeccable financial statements, which can make your business more attractive to investors or help you get approved for loans. Additionally, during the process, your accountants may be able to find ways to save on your taxes. And as previously mentioned, if the IRS audits your business, utilizing this standard method for accounting will simplify the audit-defense process and help your business avoid any trouble.

How Outsourced Accounting Helps Small Businesses

Most small business owners started their companies because they were experts in providing a good or a service — not at balancing a book. Nevertheless, good accounting and bookkeeping are imperative to manage any company’s financial health, guide decisions for growth initiatives, and ultimately ensure your business is in good standing with its tax obligations throughout the year. However, it can also be tedious, complicated, and time-consuming — especially for those who own smaller businesses or sole proprietorships. Additionally, the IRS can be unforgiving when it comes to mistakes — for instance, filing your payroll taxes just one day past the deadline incurs a 2% penalty. To make matters worse, these penalties can add up to a hefty 15% of the initial amount owed.

There is good news, however; outsourcing accounting and bookkeeping to an outside firm is a simple and rewarding process that allows business owners to spend less time worrying over books and more time, well, running their businesses. Every day, more and more businesses make the switch to outsourced bookkeeping and accounting with FinancePal.

About the Author

Jacob Dayan, Esq.

Jacob Dayan is a true Chicagoan, born and raised in the Windy City. After starting his career as a financial analyst in New York City, Jacob returned to Chicago and co-founded FinancePal in 2015. He graduated Magna Cum Laude from Mitchell Hamline School of Law, and is a licensed attorney in Illinois.

Jacob has crafted articles covering a variety of tax and finance topics, including resolution strategy, financial planning, and more. He has been featured in an array of publications, including Accounting Web, Yahoo, and Business2Community.

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About the Author

Nick Charveron, EA

Nick Charveron is a licensed tax practitioner, Co-Founder & Partner of Community Tax, LLC. His Enrolled Agent designation is the highest tax credential offered by the U.S Department of Treasury, providing unrestricted practice rights before the IRS.

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About the Author

Jason Gabbard, Founder and CEO of JUSTLAW

Jason Gabbard is a lawyer and the founder of JUSTLAW.

About the Author

Andrew Jordan, Chief Operations Officer at FinancePal

Andrew is an experienced CPA and has extensive executive leadership experience.

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