Accountants and bookkeepers follow standardized steps of the accounting cycle to record transactions and prepare financial statements for the accounting period. Accounting software is designed to allow users to follow accounting cycle steps for bookkeeping and financial accounting.
What is the Full Accounting Cycle?
The full accounting cycle is a step process for recording transactions, preparing financial statements, and making closing entries for the monthly or annual accounting period. At year-end, closing entries include transferring net income or loss to the retained earnings account and resetting income and expense accounts to zero for the next accounting period.
The full accounting cycle and accounting cycle meaning are the same for the accounting process to record transactions and close the books for an accounting period. Year-end close has extra steps compared to a regular monthly close.
How Does the Accounting Cycle Work?
An accounts receivable or accounts payable team member, full-cycle bookkeeper, or accountant records financial transactions, closes the books for the accounting period, and prepares financial statements, keeping rules of internal control and roles in mind to achieve separation of duties.
The accounting cycle steps vary slightly, depending on the source, when they are listed to include a series of 8, 9, 10, or 11 steps. Still, the essential process for recording business transactions and preparing financial statements remains the same. Accounting software or ERP systems are used to complete the accounting cycle.
Year-end steps of closing out revenue accounts, expense accounts, and net income temporary accounts to retained earnings and preparing a post-closing trial balance are not included in the monthly close. Instead, these accounts remain open to generate cumulative year-to-date revenue, expenses, and net income totals until the end of the accounting period at year-end.
Net income flows to retained earnings and the cash flow statement as a starting point to reconcile net income to cash flow from operations each month.
Businesses use accrual accounting rather than cash accounting to follow generally accepted accounting principles (GAAP). The matching principle matches revenue with related expenses by recognizing and assigning them to the proper accounting period in GAAP accounting. Journal entries record accruals and reverse them in the next accounting period when that month’s accruals are determined.
GAAP requires the use of deferrals for recording certain transactions. For example, cash advances received as deposits on orders awaiting delivery are initially recorded as deferred revenue or unearned revenue liability credit instead of revenue. Cash is the debit side of the entry. When goods are shipped (revenue recognition occurs), the deferred revenue liability account is debited, and revenue is credited to recognize the sale.
An accounts receivable or accounts payable team member, full-cycle bookkeeper, or accountant records approved financial transactions and prepares financial statements, keeping internal control rules and roles in mind to achieve proper separation of duties.
The accounting department uses a customized and detailed accounting close checklist that reflects items to be completed during each accounting cycle, with responsibilities and deadlines assigned and documentation of completion times and approvals for each task. The accounting close checklist doesn’t include the routine processing of daily transactions.
Businesses should reconcile balance sheet accounts, including bank account reconciliations to general ledger cash accounts at least monthly. Companies can perform some accounting process reconciliations like payments reconciliation automatically with AP automation software.
To reconcile inventory balances, businesses take cycle counts, which are sample inventory counts during the year. Companies take a comprehensive physical inventory to compare count quantities with perpetual inventory balances in a month with lower business activity. In the physical inventory reconciliation process, cost accounting makes necessary and approved adjustments to the detailed financial records and journal entries.
The auditors will request specific financial schedules from the client, including account reconciliations to review and test in their audit.
Financial management reviews the financial work prepared by their team, approving payments, and financial statements. The CEO and CFO executive management certify the accuracy of financial statements for public companies, as required by the SEC.
Accounting Cycle Steps
10 accounting cycle steps include:
1. Identify and analyze transactions
2. Record accounting transactions
3. Post journal entries to the general ledger
4. Generate unadjusted trial balance report
5. Reconcile balance sheet accounts with the general ledger
6. Prepare adjusting entries, including any consolidation entries
7. Generate adjusted trial balance report
8. Generate financial statements
9. Close temporary accounts into permanent accounts
10. Prepare post-closing trial balance report
We examine 10 accounting cycle steps in more detail.
Identify and analyze transactions.
The first step in the accounting cycle is to identify and analyze transactions. When financial activities or business events occur, transactions are recorded in the books and financial statements. Types of accounting periods for recording transactions include monthly and annually.
When accounting issues customer invoices, these invoices are issued in numerical sequences for internal control. If a company still issues paper checks, they’re controlled and recorded in sequential numerical series. Any erroneous checks are voided and retained to control the numerical sequence.
As an accounting period example, businesses use a calendar year with an accounting period start date of January 1 and an accounting period end of December 31. Or they may elect with the IRS to use a different month end as a fiscal year for the end of the annual accounting period, also known as the fiscal accounting period. Financial statements may present summarized quarterly and year-to-date information.
Record accounting transactions
Record accounting transactions in the accounting system using double-entry bookkeeping with balancing debits and credits. Generate subsidiary journals and a general journal. Types of subsidiary journals include aged accounts receivable, aged accounts payable, cash disbursements, and fixed assets & accumulated depreciation.
To record accounting transactions, use automatic journal entries or prepare journal entries.
Post journal entries to the general ledger
Your accounting software will create journal entries automatically as you create transactions. You can set up reversing journal entries for accruals that are reversed the next month. Your accounting system will let you set up automatic recurring transactions for subscription billing like SaaS software. You’ll be able to automatically set up a journal entry for a monthly transaction like prepaid insurance expense that needs to be recognized as insurance expense instead of a prepaid asset as time elapses.
Depreciation should automatically be generated as a journal entry when you correctly set up the fixed asset in the accounting software or ERP system.
For non-routine transactions like M&A transactions, you’ll need to analyze the transaction using worksheets and prepare and record journal entries for the deal.
Generate unadjusted trial balance report
When you generate an unadjusted trial balance report from the financial records, you’re checking for errors to ensure that all transactions are recorded in the general ledger. The trial balance format is that every general ledger account balance or total is listed without the details. With a double-entry bookkeeping system, total debits should equal total credits.
Reconcile balance sheet accounts with the general ledger
Beginning with cash accounts, each balance sheet account should be reconciled at least monthly to find and correct errors with adjusting journal entries. Compare each of the bank accounting statements to its general ledger cash account. A list of reconciling items will include outstanding payments and outstanding deposits that haven’t yet cleared the bank and bank service fees.
For other balance sheet items, reconcile the accounts receivable and accounts payable aging journals to the general ledger. Reconcile more assets and liabilities, including inventory, fixed assets, prepaid assets, accrued liabilities, retained earnings, and owner’s equity to the general ledger.
Prepare adjusting entries, including any consolidation entries
Use worksheets where necessary to prepare adjusting entries. Use the capabilities provided by your accounting system.
For multi-entity companies, income statements and balance sheets need to be combined. But intercompany profit needs to be eliminated as a worksheet adjustment because these transactions are not third-party transactions with outsiders. Otherwise, the profit would be too high.
Generate adjusted trial balance report
After entering adjusting entries and posting them to the general ledger, total debit balances should equal total credit balances as an accounting control process.
Generate financial statements
Choose your customized financial reports to generate financial statements for the accounting period, whether monthly or year-end. Your financial statements can be set up to show quarterly totals in many accounting systems. The SEC requires quarterly financial reporting for public companies.
Types of financial statements of a company include:
• Balance sheet
• Statement of owner’s equity
• Income statement
• Statement of cash flows
The accounting equation for the balance sheet is assets minus liabilities equals owner’s equity.
Close temporary accounts into permanent accounts (Year-End Accounting Cycle Steps)
(Perform steps 9 and 10 only at fiscal or calendar year-end, but not for a normal month-end close.)
Temporary accounts include the revenue and expense accounts. At year-end, net income or loss is closed into the permanent account, retained earnings. Revenue and expense ledger account balances are reduced to zero through a closing entry in the system.
Prepare post-closing trial balance report
Prepare a post-closing trial balance report at the end of the accounting period for the year. Again, ensure that total debits equal total credits. The temporary ledger accounts should be zeroed out if you’ve completed the year-end accounting close process correctly. Verify the beginning balance of retained earnings that will be used starting with the next monthly accounting period close in the following business year.
When the post-closing trial balance is good, you’ve reached the completion of the accounting cycle.
Although you’ve technically reached the last step of the accounting cycle, you may still need to enter adjusting entries from the CPA firm’s financial audit into the accounting system for the year. You can open a new accounting period to begin recording transactions for the accounting cycle of the next month and year.
Accounting Cycle vs Operating Cycle
The accounting cycle vs operating cycle are entirely different financial terms. The accounting cycle consists of the steps from recording business transactions to generating financial statements for an accounting period. The operating cycle is a measure of time between purchasing inventory, selling the inventory as a product, and collecting cash from the sales transaction.
The operating cycle can be expressed in a formula as the sum of the financial analysis ratios for days’ sales outstanding and the average collection period. Understanding the operating cycle in your business is essential for cash flow management.
Importance of the Accounting Cycle
The accounting cycle is used by businesses and organizations to record transactions and prepare financial statements. The standardized process, supported by accounting systems, is important because it helps business owners, small businesses, and established companies close their books for the accounting period and generate financial information to perform financial statement analysis and manage the business.
CPA firms can review or audit the financial statements and drill down to the underlying financial transactions and accounting records to test account balances.
Stakeholders, including management, the Board of Directors, lenders, shareholders, and creditors, can analyze the financial statement results for the accounting cycle period.