Employee Handout: Understanding the Accounting Cycle

The accounting cycle also known as the bookkeeping cycle, is a 10-step process of how a company processes the flow of debits and credits in chronological order.  (McCarthy, 2009)  This process is a detailed and captious one, where the accountants as well as other financial executives track each individual transaction, linking them to the associated account.  This provides accurate record keeping as well as the know-abouts of the amount of available credit and debts of our company.

In this handout, we will be discussing eight of the 10 steps but before we get into the 8-steps of the accounting cycle, you must first be educated about certain terms that are affiliated with the process.

These terms are as follows:

The Accounting Equation – which is the equation applied to the company’s financial records to summarize the balance between the entity’s liabilities and the owner’s equity.  (Putman, 2004)

Assets = Liabilities + Owner’s Equity

Assets – Liabilities = Owner’s Equity

Owner’s equity + Liabilities = Assets

Accounts Payable – is the amount owed to another company for providing short-term business operational needs (liabilities), such as supplies and services on company credit.  Usually this type of credit does not include interest, unless the unfortunate event of a late payment then a penalty percent can apply to the amount owed.  (Accounts Payable, n.d.)

Accrual Basis Accounting – When transactions are recognized when they take place, such as sales (revenues) are recorded before, the customer pays the amount due.  Assets and Liabilities are reported as the event happens prior to the amount being paid, this is how accounts can be calculated within the benefited period.  (Tracy, 2008, p. 344)

Accrued Expense Payable – also known as Accrued Liabilities, it is the progressive collected amount of unpaid expenses and or liabilities, such as accumulated vacation days for an employee paid in the following accounting period.  (Tracy, 2008, p. 344)

Double-entry Accounting – is the process of recording debits and credits from associated accounts, for example if our company were to receive a payment, the payment would be added to the affiliated asset entry and then deducted from the associated liability entry. (McCarthy, 2009) (See figure 1-1)

                  Assets                                                             Liabilities            

Sale of Equip.  |    + $500                                Sale of Equip.   |    – $500

Assets + Liabilities = $0.00

Figure 1-1

The first step to the accounting cycle is to analyze the transaction or transactions; this means the accountant or financial executive will gather and prepare receipts having to do with the financial event or events. For example to show proof of a sale a receipt shows amount paid time date and department as well as the employee number who processed the purchase, or supplier and driver number depending on if it was a sales receipt or packing order from a shipment. In any respect these documents are gathered and prepped for the next step in the accounting cycle.

The next and second step is to enter the information from the previously mentioned documents as an entry into a journal.  A journal is a diary kept to record financial events in chronological order, such as if you where to keep track of your daily events in a personal diary; the same goes for an accountant recording daily transaction in the company’s journal.  The entries recorded will not only list the amount of the event but also the affects from it, with every cause there is an effect, such as the example in Figure 1-1.

The third step is to post all entries to the ledger, usually an account number is assigned to each ledger and the entries from the receipts and journal in which are associated to that particular account are then posted to it, this is the final entry part of the process.  (ledger, 1475-85) In addition, the ledger will also include the effects of the financial events as well as list the appropriate references, such as receipts to the event.

The fourth step is to prepare the unadjusted trial balance.  In this step the accountant, bookkeeper, or financial executive will calculate amortization, depreciation, calculating the physical inventory and so on, one of the main reasons of this to bring the books or the recorded entries up-to-date to prepare for the end of the financial period.  A financial period can be on a monthly, quarterly, semi-annually, or annual basis, but normally companies insist on a financial period to begin and end on a month-to-month schedule. (Tracy, 2008, p. 57)

The fifth step to the accounting cycle is to prepare adjusting journal entries; this includes totaling the transactions and financial events for future tax return, accounting reports, and financial statements.  Accountants do this by applying the accounting equation and checking for errors as well as backtracking to find discrepancies.

The sixth step is to review the above-mentioned entries and totals, making sure the assets zero out with the liabilities.  This step is to ensure all the information is accurate and ready to populate end-of-period financial statements such as the balance sheet, statements of cash flow and or income statements.

The seventh step is to prepare the financial statements, which descriptively are:

The Balance Sheet – also known as the statement of financial condition is a summary of the current financial period’s amount of assets, liabilities, and owner’s equity and applies to each of the different individual company accounts.  (Tracy, 2008, p. 345)

Statement of Cash flow – is a statement that displays all the affects of money that went in to the company and all the money that went out. 

Income Statement – shows the amount of revenue and company income earned for the accounting period as well as company expenses and losses.

In this step, the accountant must compile the above statements as well as tax returns and other like accounting reports in order to close out the accounting period and be ready for the next.

The eighth and final step this handout will be discussing is to close out the entries or zero out and close the books for the accounting period. During this part of the process the bookkeeper, accountants as well as financial managers are ending the process so they can begin the next accounting period, this is also where they calculate accrued the expenses payable and receivable as well as how they will impact the following period. (McCarthy, 2009)

In conclusion, the above accounting cycle although at times is tedious and time consuming it is an imperative procedure to the liquidity of a company and its business operations.  All businesses must comply with GAAP standards and regulations to ensure fraud; money laundering and misplaced funds are not taking place as well as preserving the financial integrity of the company as well as its employees.

References

Accounts-Payable. (n.d.). Wall Street Words. Retrieved April 16, 2009, from Dictionary.com Web site: http://dictionary.reference.com/browse/Accounts%20Payable%20

ledger. (1475-85). Based on Random House Dictionary. Retrieved April 17, 2009, from Dictionary.com Web site: http://dictionary.reference.com/browse/ledger

McCarthy, M. (2009, April 16). Phase 2: Live Chat #3. Retrieved April 16, 2009, from Colorado Technical University Online Web site: http://breeze.careeredonline.com/p93849181/?session=breezzq73nway72mo7ach

Putman, R. L. (2004, December 6). Financial Accounting I. Retrieved April 16, 2009, from UTM.edu Web site: http://www.utm.edu/staff/bputman/put7.htm

Tracy, J. A. (2008). Slashing through the accounting jargon jungle. In J. Friedman (Ed.), Accounting for Dummies (4th ed., p. 345). Hoboken, NJ: Inc.-Wiley Publishing.

Tracy, J. A. (2008). Slashing through the accounting jargon jungle. In J. Friedman (Ed.), Accounting for Dummies (4th ed., p. 57). Hoboken, NJ: Inc.-Wiley Publishing.

Tracy, J. A. (2008). Slashing through the accounting jargon jungle. In J. Friedman (Ed.), Accounting for Dummies (4th ed., p. 344). Hoboken, NJ: Inc.-Wiley Publishing.