Accounting Cycle

Accounting Cycle and Financial Statements

Accounting Cycle

1. Identify Transactions: Detect financial transactions that affect the business (sales, purchases, expenses, etc.).
2. Record Transactions in the Journal: Transactions are recorded as journal entries using the double-entry system.
3. Post to the Ledger: Entries from the journal are transferred to the general ledger, where transactions are categorized by account.
4. Prepare an Unadjusted Trial Balance: A trial balance is prepared by summing up the ledger accounts to ensure total debits equal total credits.
5. Make Adjusting Entries: Adjustments are made for accrued revenues, accrued expenses, depreciation, and prepaid items.
6. Prepare an Adjusted Trial Balance: After adjustments, an updated trial balance is created to verify debit-credit balance.
7. Prepare Financial Statements: Use the adjusted trial balance to create the income statement, retained earnings statement, balance sheet, and cash flow statement.
8. Record Closing Entries: Transfer balances from temporary accounts (revenues, expenses) to permanent accounts (retained earnings).
9. Prepare a Post-Closing Trial Balance: Ensure only permanent accounts have balances, confirming closing accuracy.
10. Reversing Entries (optional): Reverse certain adjusting entries at the beginning of the next period.

Financial Statements

1. Income Statement (Profit and Loss Statement)

   Purpose: Reports on the company’s revenues, expenses, and profits over a specific period.

   • Revenue
   • Cost of Goods Sold (COGS)
   • Gross Profit
   • Operating Expenses
   • Operating Income
   • Net Income (Revenue - Expenses)

2. Statement of Retained Earnings

   Purpose: Shows changes in retained earnings over the period due to net income and dividends.

   • Beginning Retained Earnings
   • Net Income (from the Income Statement)
   • Dividends Paid
   • Ending Retained Earnings

3. Balance Sheet (Statement of Financial Position)

   Purpose: Shows the company’s assets, liabilities, and equity at a specific point in time.

   • Assets: Current and Non-Current
   • Liabilities: Current and Non-Current
   • Equity: Shareholders’ equity, retained earnings

4. Statement of Cash Flows

   Purpose: Summarizes the cash inflows and outflows over a period.

   • Operating Activities
   • Investing Activities
   • Financing Activities

5. Statement of Comprehensive Income

   Purpose: Includes net income and other comprehensive income (OCI), providing a more complete earnings picture.

   • Net Income
   • Other Comprehensive Income (OCI)
   • Comprehensive Income (Net Income + OCI)