The Accounting Cycle

The sequence of accounting procedures used to record, classify, and summarize accounting information in financial reports at regular intervals is often termed the accounting cycle. The accounting cycle begins with the initial recording of business transactions and concludes with the preparation of a complete set of formal financial statements. The term cycle indicates that these procedures must be repeated continuously to enable the business to prepare new, up-to-date financial statements at reasonable intervals.

Transactions.  Changes in assets, liabilities, and equities are recorded as a result of transactions. A transaction is financial in nature, is expressed in terms of money, and generally results in the exchange of economic resources between parties. The two types of transaction are external transactions in which other entities participate and internal transactions in which only the enterprise participates.

Account.  A systematic arrangement that shows the effect of transactions on a specific asset or equity. A separate account is kept for each asset, liability, revenue, expense, and for capital (owner’s equity).

Real and nominal accounts.  Real accounts are asset, liability, and equity accounts and they appear on the balance sheet. Nominal (also called temporary) accounts are revenue and expense accounts and they appear on the income statement. Nominal accounts are periodically closed; real accounts are not.

Ledger.  The book (or computer print outs) containing the accounts is called a ledger. It usually has a separate page for each account. A general ledger is a collection of all the asset, liability, owners’ equity, revenue, and expense accounts. A subsidiary ledger contains a group of accounts that constitute the details related to a specific general ledger account.

Journal.  The book of journal entry were the essential effects and figures in connection with all transactions are initial recorded. From the book of original entry the various amounts are transferred to the ledger.

Posting.  The mechanical process of transferring the essential facts and figures from the book of original entry to the accounts in the ledger.

Trail balance.  A list of all open accounts in the ledger and their balances are trial balance may be prepared at any time,  a trial balance taken immediately after all adjustments have been posted and adjusted trial balance, a trial balance taken immediately after closing entries have been posted in designated and after closing or post closing trial balance.

Adjusting entries.  Entries made at the end of an accounting period to bring all accounts up to date on an accrual accounting basis so that correct financial statements can be prepared.

Financial statements.  Statements that reflect the collection tabulation and final summarization of the accounting data, basically four statements are involved: (1) the balance sheet which show the financial condition of the enterprise at the end of a period (2) the income statement which measures the result of operations during the period (3) the statement of changes in financial position which measures the resources providing during the period and usages to which they are put and (4) the statement of retained earnings which reconciles the balance of the retained earnings accounts from the beginning to the end of the period.

Closing entries.  The formal process by which all nominal accounts are reduced to zero and the net income or net loss is determined and transferred to capital account is known as “closing the ledger”, “closing the books”.