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The term accounting cycle refers to the framework and processes followed in each accounting period. The accounting cycle begins with the identification of events and transactions, and ends with the after-close trial balance
Accounting cycle is a step-by-step process of recording, classification and summarization of economic transactions of a business. It generates useful financial information in the form of financial statements including income statement, balance sheet, cash flow statement and statement of changes in equity.
The time period principle requires that a business should prepare its financial statements on periodic basis. Therefore accounting cycle is followed once during each accounting period. Accounting Cycle starts from the recording of individual transactions and ends on the preparation of financial statements and closing entries.
The cycle goes as follows:
1)Analyze and record transactions via journal entries
2)Post journal entries to ledger accounts
3)Prepare unadjusted trial balance
4)Prepare adjusting entries at the end of the period
5)Prepare adjusted trial balance
6)Prepare financial statements
7)Close temporary accounts via closing entries
8)Prepare post-closing trial balance
Every financial transaction of an organization needs to be identified and captured into the accounting system. Transactions are recorded (posted) using the double-entry bookkeeping system, whereby at least one account is debited, and one account is credited.
The general ledger (G/L) is a group of accounts that reflects changes to the balances, based on transaction recorded. Once all transactions are posted to the ledger, the balances of each account can be determined.
Unadjusted Trial Balance
All account balances from the ledger are arranged in a report; all the debit balances are added and compared to the total of all the credit balances. The sole purpose of this report is to validate that total debits equal total credits. It does not validate the correctness of the journal entries posted.
Adjusting Journal Entries (AJEs)
These journal entries are prepared as an application of the accrual basis of accounting, whereby income earned but not received and expenses incurred, but not yet paid, have yet to be reflected in the Unadjusted Trial Balance. AJEs are prepared for revenue accrual or deferral, expense accrual, expense prepayments, depreciation and allowances.
Adjusted Trial Balance
Once all AJEs are posted, the Adjusted Trial Balance is generated to once again test that all debits equal all credits, prior to generating the financial statements.
Reports generated are comprised of the following: income statement: balance sheet; cash flow statement; statement of changes in equity; and notes to the financial statements. The financial statements are the “scorecard,”as they report on the entity’s financial health to its readers.
Temporary accounts (i.e. income statement accounts) are zeroed out to an income summary account and then closed to the appropriate equity account on the balance sheet, in preparation for the next fiscal period. Temporary accounts include all income, expense and withdrawal accounts. Balance sheet accounts are not closed.
Post-Closing Trial Balance
The last step in the accounting cycle, as debits and credits for only the balance sheet accounts are tested to ensure that they equal. This trial balance consists of balance sheet accounts only as all temporary accounts have been closed.