What are the steps of the accounting cycle? Describe each in your own words using specific examples
Accounting is a crucial aspect in any organization as it helps in establishing the flow of tangible and intangible assets and liabilities. Accounting is not a one-time activity but rather an ongoing and cyclic process sustained throughout the organization's lifetime. There are about nine steps in the accounting cycle and each of these steps is associated with outputs, which are in the form of financial statements. The financial statements are interrelated as each of the steps builds on to the next, having derived figures from the first step. The accounting cycle begins with identification and analysis of business transactions to determine the accounts that have been affected and from here, source documents are prepared. The next step involves archival recording the transactions in double-entry journals to reflect credits and debits (Singh, 2016). These journals are used in the third step as these figures are posted into books of final entry or ledgers to determine balances for each account.
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The fourth stage involves creating an adjusted trial balance which is derived from the ledger and from here, the accountant ensures that total credits equal total debits. The trial balance only determines the equality of total credits and debits but cannot measure the correctness of figures. The fifth stage, which is the adjustment of entries, is concerned with rectifying the issues that are not reflected in the trial balance such as failure to record transactions or double posting (Franklin, Graybeal, & Cooper, 2019). The sixth stage focuses on preparing an adjusted trial balance that reflects allowances, depreciation a well as to test whether debits equal credits after the adjustments. The seventh stage involves the preparation of various financial statements having ensured that the accounts are updated and that credits and debits are equivalent.
What are the outputs of the accounting cycle? Why are they important? Identify and explain the purpose of each financial statement, including how they are interrelated
At the end of the accounting cycle, an organization will have various financial statements reflecting the financial health of the organization. The first accounting output is the balance sheet, which indicates the organization's liabilities, assets, expenditure, income, and capital in the preceding period. Cashflow statements establish how an organization generates income to pay its financial obligations or to fund its expenses (Hermanson, Edwards, & Maher, 2018). An income statement establishes an organization’s revenue and costs within a particular accounting period. By subtracting expenses from the revenues, an organization can determine whether it has made a net loss or a net profit. The three financial statements are related in that the net income that is posted from the income statement moves to the balance sheet and in turn, the cash flow statement (Scott, 2018). The income statement is prepared first and from it, the accountant prepares the balance sheet and then the cash flow statement. An error in the income statement will be reflected in the balance sheet and in turn, the cash flow statement.
Why is the accounting cycle important to a business?
The accounting cycle is essential to businesses that are keen on monitoring their financial health to determine if it is profitable or not. The cycle ensures that the company has maintained and updated all of its accounts so that all the payments owed to the business are addressed. Additionally, the accounting cycle ensures that each transaction is analyzed in detail and recorded as required to allow for the creation of annual reports and budgets. According to Webster (2018), the accounting cycle helps the business to determine it's current financial standing for tax purposes to avoid under or over taxation. The accounting cycle allows companies to track their financial performance over some time, and in this way, predict its future financial performance. The financial information generated by the accounting cycle allows top management to make critical decisions aimed at ensuring the business is profitable, competitive, and sustainable.
References
Franklin, M., Graybeal, P., & Cooper, D. (2019). P rinciples of Accounting, Volume 2: Managerial Accounting, Volume 2. Houston, TX: OpenStax.
Hermanson, R. H., Edwards, J. D., & Maher, M. W. (2018). Accounting Principles: A Business Perspective, Volume. Suwanee, GA:12th Media Services.
Scott, P. (2018). Introduction to Accounting . Oxford: Oxford University Press.
Singh, S. K. (2016). Accountancy Class IX. Agra: SBPD Publications.
Webster, A. (2018). Introduction to Financial Accounting. Chicago, IL: Applied Finance, LLC.
