Accounting Cycle 101

What is the accounting cycle? 

The accounting cycle is an organized set of steps for identifying and maintaining transaction records within your company. This process typically involves a bookkeeper or accountant who documents, categorizes and summarizes each transaction your business makes during a given period. The time frame of an accounting cycle can vary based on factors that are unique to each business. However, most business owners start a new accounting cycle annually.

Once the accounting period ends, the books are closed and financial statements detailing the captured information are created. These financial statements are shared with company stakeholders and government entities.

Many businesses automate the accounting cycle with software to minimize the accounting mistakes that can arise when you manually process financial data. 

8 steps of the accounting cycle

The exact steps of the accounting cycle may vary according to a company’s unique needs. However, the following process for tracking activity and creating financial statements doesn’t change. Here is a breakdown of the eight-step cycle.

1. Identify the transactions.

The first step of the accounting cycle is to identify each transaction that creates a bookkeeping event. Bookkeeping events are sales, refunds, bill payments from accounts payable, and any other financial transactions in your business. 

In accounting, transaction types include cash, noncash and credit events. Transactions can be identified through invoices, receipts and other documents that record business activity.

2. Record the transactions. 

Next, document each transaction as a journal entry. Also known as a “book of original entry,” this is the book or spreadsheet where all transactions are initially recorded. 

Each entry should list details about every transaction in chronological order. If your company uses double-entry accounting, the details include a debit and credit for each transaction. This method makes it easier to track how events affect your finances. 

3. Post the transactions. 

After you enter transactions into the journal, post them to your general ledger. Posting occurs when the initial entries are added to the general ledger, which summarizes all business transactions balanced using debits and credits.

Transactions posted to the general ledger should be separated into five categories:

• Assets
• Liabilities
• Capital
• Expenses
• Income

These categories make it easy to find transactions quickly. However, if debits and credits aren’t balanced, it’s a sure sign your financial statements won’t be accurate. 

4. Prepare a trial balance. 

Once journal entries are posted to designated general ledger accounts, it’s time to prepare an unadjusted trial balance. The unadjusted balance is used to analyze account balances to ensure that the debit and credit totals in the ledger accounts are correct.  

To create an unadjusted trial balance, list all general ledger account balances before adjusting entries for your financial statement. You can use the trial balance to create basic financial statements without sorting through the general ledger. While these balances can be listed manually, the trial balance process is built into many accounting software systems. 

5. Fix any errors. 

This is a crucial step when you find that your trial balance’s debits and credits aren’t equal. To locate the error, compare the information in question to previous journal entries on the spreadsheet.

One common error is posting to the incorrect account. When this happens, debits and credits are equal but the account’s activity may seem unusual. This is the time to make the necessary adjustments.

6. Add the adjusting entries.

As you approach the end of the accounting period, you’ll need to add adjusting entries to your journal. These end-of-period adjustments ensure that your accounts reflect the correct expenses and revenues for the accounting period. 

Include prepayments, accruals and noncash expenses in these entries. This step is especially important when you list transactions that affect more than one accounting period. 

7. Create your financial statements.

Now that your adjusting entries are posted, create an adjusted trial balance and complete your financial statements. The adjusted trial balance should list all ending balances for your general ledger accounts.

Once the adjusted trial balance is complete, create your financial statement or annual report. In your financial statement, list information in a simple, organized format. Tax authorities, employees and other parties interested in your business’s financial position will review the information in your financial statement. 

The three major types of financial statements (or accounting reports) are the balance sheet, income statement and cash flow statement. These statements explain a company’s financial standing and serve as indicators of operational performance. 

8. Close the books. 

After you prepare your financial statement, end the accounting period. You’ll use closing entries to finalize your expense and revenue records. 

The closing entry process involves transferring your net income to retained earnings. When earnings are transferred, all temporary accounts should be closed. 

The final step is to document the post-closing trial balance to review debits and credits before the next accounting period begins. Because this step zeroes out your revenue, the post-closing trial balance would only include balance sheet accounts.  

When does an accounting cycle begin and end?

The accounting cycle time frame is based on an accounting period you select according to your company’s needs. During the chosen accounting period, financial statements are created and shared. To ensure compliance, business owners often end each accounting period annually. 

On the other hand, some business owners opt for accounting periods of three or six months. International Financial Reporting Standards guidelines allow the accounting period to span 52 weeks. This period is known as the fiscal year. 

Accounting software and the accounting cycle

Accounting software saves time and effort by automating the entire accounting cycle. As your business grows, you may find you need more than one person to handle the accounting cycle steps for your company. The best accounting software is an investment that can save you money in the long run.  

Even if you hire a CPA or get a bookkeeper to oversee your accounting cycle, accounting software can simplify their duties. They can use accounting software to record business transactions and automatically generate financial statements. Software platforms will help your team minimize costly errors.

Best accounting software

Below, we’ve highlighted some top accounting software solutions to help you choose the right accounting software for your business and make it easy to maintain your accounting cycle.

• FreshBooks: FreshBooks is an excellent option for helping small businesses manage their accounting cycles. It can generate invoices and alert you when customers have received and read them, thus helping you stay on top of accounts receivable. Our FreshBooks review provides details on pricing and additional features.
• QuickBooks: QuickBooks is a market-leading solution with top-notch features and an affordable price. Our QuickBooks review explains how this platform can help you simplify your accounting cycle with automation and use your general ledger report to see all transaction details and your trial balance for the period.  
• Xero: Xero is a scalable solution with various pricing tiers (starting at $15 per month) based on the features you need. Its easy-to-use interface was designed for business owners who don’t have a background in accounting or bookkeeping. Our Xero review explains the software’s smart reconciliation feature, which uses machine learning to streamline this time-consuming process and thus ensure accuracy in your accounting cycle. 

Jennifer Dublino contributed to this article.