The importance of the accounting cycle in organizations cannot be underestimated. Companies invest a lot of money in the accounting department to hire the best talent in the market. Accounting is a systematic process that follows the steps of the accounting cycle leading to the generation of different outputs that play a significant role in organizations.
There are seven steps in the accounting process. First is the evaluation of business transactions that encompass all company dealings involving money such as, purchasing, borrowing, and selling products using source documents like invoices. The second one is journalizing commercial business transactions by following the double entry rule, which requires all operations to affect accounts; for example; selling commodities increases the cash amounts, which is a debit, and reduces the inventory amount, which is a credit. The third step posting all the entries recorded in the journal to ledgers to summarize and present the information in a simple and understandable method: For example, all sales are incorporated under the sales ledger, while the purchases are accumulated under the purchase ledger. The fourth phase of the accounting process is creating an unadjusted trial balance to determine whether the credit and debit amounts are equal (Brigham et al., 2016). Afterwards, the fifth step is preparing to adjust entries to correct errors, and the information leads to the sixth step of creating the adjusted trial balance. The last step in the accounting cycle is using the adjusted trial balance to generate the final financial statements.
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Financial statements are the final output of the accounting cycle. The income statement is the first type of financial report that focuses on the revenue and expenses of a company to determine the amount of revenue and loss made every fiscal year (Cañibano, 2018). Examples of business costs included in the income statement are depreciation, wages, and taxes; while revenues are sales amounts. Thus, the income statement helps businesses determine the efficiency of business operations. The statement of financial position commonly known as the balance sheet is the second output of the accounting cycle. Three broad categories of information are presented in the balance sheet report including assets, shareholders investments, and equity. The balance sheet helps organizations determine their financial health at intermittent periods; for example, balance sheets are often prepared after every financial year. Cash flows statements are another product of the accounting cycle and they summarize the cash inflow and outflow to establish the net cash position of an organization. Therefore, the cash flow statement assesses organizational liquidity to determine whether a company has enough money to meet short-term obligations. Lastly, there is the statement of retained earnings, which is used to identify a company’s value after fulfilling all obligations including dividend payments. Notably, there is an interrelationship between the financial statements. Changes in the balance sheet directly affect the income statement; for example; increased inventory implies that the company incurred additional costs purchasing the material. The net income calculated in the income statement is included in the report of retained earnings to determine changes in the equity value. The net retained earnings are then included in the balance sheet under the equity section (Okab, Al-Oqool, & Bashayreh, 2014). Lastly, the cash flow statement is prepared from information found in the balance sheet and income statement; for example; changes in expenses and value of current assets. Therefore, it is impossible to think of one financial statement without considering the impact on other reports.
The accounting cycle supports proper information analysis resulting in the generation of accurate information. All the seven steps in the accounting cycle support the systematic correction of data and eliminating all chances of error. For example, analyzing business transactions ensures that all company events are recorded, and this is confirmed in the unadjusted trail balance by examining whether the credit and debit sides are equal. The journal entry process is essential in ascertaining the completion of business transactions, and ensuring that double entry rule is observed. The unadjusted trial balance, on the other hand, summarizes all the accounts into debit and credit, and at this phase it is possible to determine if error and fraud is ongoing in a company. Therefore, the financial reports are prepared using accurate data, thus investors and managers can use the details to make reliable decisions.
In conclusion, all the steps in the accounting process should be followed in the required sequence. Adherence to the accounting cycle ensures informational accuracy in all four types of financial statements. As a result, businesses make correct decisions.
References
Brigham, E. F., Ehrhardt, M. C., Nason, R. R., & Gessaroli, J. (2016). Financial Managment: Theory And Practice, Canadian Edition. Nelson Education.
Cañibano, L. (2018). Accounting and intangibles. Revista de Contabilidad-Spanish Accounting Review, 21(1), 1-6.
Nielsen, L. B., Mitchell, F., & Nørreklit, H. (2015, March). Management accounting and decision making: Two case studies of outsourcing. In Accounting Forum (Vol. 39, No. 1, pp. 64-82). Elsevier.
Okab, R., Al-Oqool, M. A., & Bashayreh, M. M. (2014). The Importance of the Accounting Information and the Role of the Scientific Accounting Research in Developing the Economic Development Service in the Developing Countries (Case Study Jordan). Research in Applied Economics, 6(1), 240.
