The accounting cycle is the accounting process of recording, summarizing and presenting business and financial information to a company’s interested parties. The accounting process consists of a sequence of steps, or stages of the accounting cycle, that serve as the logical progression of carrying out related accounting tasks. Major tasks in the accounting cycle include recording business transactions, making adjusting entries, summarizing account information, verifying information in accounts and preparing financial statements.
Transaction Journalizing
The accounting cycle starts with identifying business transactions and recording them in the original journal entry books. Companies record business transactions as transactions take place during an accounting period and also make adjusting recordings on accrued revenues and expenses that are not linked to specific transactions. Transaction journalizing helps collected financial information on various transaction accounts to be used as the information source in later stages of the accounting cycle.
Account Posting
Account posting refers to posting previously recorded transaction information from journal books to a company’s general ledger. A general ledger is a collection of all accounts organized in the order in which they will appear on future financial statements, often starting with asset, liability and owners’ equity accounts, followed by various revenue and expense accounts. Transferring account information from journal books to the general ledger helps better classify and summarize account information by individual accounts rather than by transaction dates.
Trial Balancing
Information recorded and posted is later checked to make sure that it’s free of errors. Companies use the so-called trial balance to prove the mathematical equality of the debits and credits from earlier recording and posting. A trial balance is a list of all accounts of the general ledger and their balances, with all debits in one column and credits in another column. Absent any recording and posting errors, the totals of the two columns should be in balance with each other.
Statement Preparing
The accounting cycle ends with compiling financial statements and performing necessary closing entries. Companies prepare various financial statements at the end of an accounting period, namely the balance sheet, the income statement, the statement of cash flows and the statement of shareholders’ equity. To construct these financial statements, companies use the verified information in the trial balance to fill out statement accounts with the amount of account balances found in the respective accounts in the trial balance. Any temporary accounts such as revenue and expense accounts are closed to show zero balance in the general ledger so they are ready for recording for the next accounting cycle.
Reflecting on the accounting processes thus far described reveals the
following typical steps: It appears that the accounting cycle is completed by
capturing transaction and event information and moving it through an orderly process that results in the production of useful financial statements. Importantly, one is left with substantial records that document each transaction (the journal) and each account’s activity (the ledger). It is no wonder that the basic elements of this accounting methodology have endured for hundreds of years. There remains one final process known as the
closing process. Closing has two objectives: Closing is a mechanism to update the Retained Earnings account in the ledger to equal the end-of-period balance. Keep in mind that the recording of revenues, expenses, and dividends do not automatically produce an updating debit or credit to Retained Earnings. As such, the beginning- of-period retained earnings amount remains in the
ledger until the closing process “updates” the Retained Earnings account for the impact of the period’s operations.Objective 1: Update Retained Earnings
Objective 2: Reset Temporary Accounts
Revenues, expenses, and dividends represent amounts for a period of time; one must “zero out” these accounts at the end of each period (as a result, revenue, expense, and dividend accounts are called temporary or nominal accounts). In essence, by zeroing out these accounts, they are reset to begin the next accounting period. In contrast, asset, liability, and equity accounts are called real accounts, as their balances are carried forward from period to period. For example, one does not “start over” each period reaccumulating assets like cash and so on; their balances carry forward.
Closing involves a four-step process:
This process results in all revenues and expenses being “corralled” in Income Summary(the net of which represents the income or loss for the period). In turn, the income or loss is then swept to Retained Earnings along with the dividends. Recall that beginning retained earnings, plus income, less dividends, equals ending retained earnings; likewise, the closing process updates the beginning retained earnings to move forward to the end-of-period balance.
Following are the closing entries for England Tours for 20X3. Compare the accounts and amounts to those that appeared in the 20X3 adjusted trial balance:
The effect of the above entries is to update the Retained Earnings account and cause a zero balance to occur in the temporary accounts. The Income Summary account is also “zeroed” out ($32,800 (cr.) = $30,200 (dr.) + $2,600 (dr.)). The following T-accounts reveal the effects of the closing entries:
Post-Closing Trial Balance
The post closing trial balance reveals the balance of accounts after the closing process, and consists of balance sheet accounts only. The post-closing trial balance is a tool to demonstrate that accounts are in balance; it is not a formal financial statement. All of the revenue, expense, and dividend accounts were zeroed away via closing, and do not appear in the post-closing trial balance.
Revisiting Software
Many accounting software programs are based on database logic. These powerful tools allow the user to query with few restrictions. As such, one could request financial results for most any period of time (e.g., the 45 days ending October 15, 20XX), even if it related to a period several years ago. In these cases, the notion of closing the accounts becomes far less relevant. Very simply, the computer can mine all transaction data and pull out the accounts and amounts that relate to virtually any requested interval of time.
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Articulate the steps in a the accounting cycle process. |
When and why are the books “closed?” |
Define temporary (nominal) and real accounts. |
Be able to prepare closing entries related to revenues, expenses, the Income Summary, and the Dividend account. |
What benefit is a post-closing trial balance, and what type of accounts would be found there? |
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