Bookkeeping can be challenging because there are many entries to balance in a given period, with little to no space for errors. Setting predictive procedures helps accountants and finance experts to document and report financial activity, staying compliant and true to the deadlines.
This article will help you learn the definition and the main purpose of the accounting cycle, ensuring we follow each step when the closing time comes by.
The accounting cycle is a process that starts with recording business transactions and ends with preparing financial statements, usually after the books are closed. Its main purpose is to turn records of income, expenses and other transactions into clear reports like the balance sheet, income statement, statement of changes in equity and cash flow statement. These reports help stakeholders understand the company’s financial health.
Some businesses prepare these statements every quarter, while others make them once a year. In general, each company has a different closing period that depends on internal work or industry requirements. These statements providе financial insights at the end of the year while keeping the financial activities compliant and consistent.
The accounting cycle provides a structured process for recording, classifying and summarising financial transactions, no matter if they’re internal or external. It ensures accuracy, consistency and completeness in financial reporting, supporting regulatory compliance. By following the accounting cycle, businesses can maintain organised financial records and produce timely, reliable financial statements.
Using accurate financial data helps in making important decisions on financial strategy and budget forecasting. Although some of the accounting cycle steps are done manually, the most time-consuming ones can be automated using appropriate software that supports automated transaction matching or scheduled intercompany invoicing.
In this section, we will overview the seven basic accounting cycle steps. Keep in mind that these are the main ones, while companies may follow specific accounting and closing roadmaps the main steps in the traditional accounting cycle are:
The first step of the accounting cycle is identifying and collecting transaction data, such as a store's cash register, employee payroll, expenses and any other costs incurred. These are often categorised following the company's accounting system roadmap.
Identifying transactions ensures all financial activities are ready to be recorded accurately during the financial close process. This step supports timely reconciliations and leaves enough time for proper adjustments. It also helps detect errors early, improving audit and compliance-readiness.
The next step is to record the transactions in the ledger as journal entries. The best practice is to record them with the date of transaction, the amount of money involved and accounts affected.
Recording entries in a journal organises all financial transactions in chronological order, providing a clear audit trail. It ensures accurate classification of income, expenses, assets and liabilities for the period, resulting in reliable financial statements in each phase.
Once the journal entry is generated, we’re ready to reconcile the general ledger. The general ledger (GL) is a central part of the accounting cycle that records all financial transactions so we can use them later. It combines data from journals into individual accounts, such as cash, revenue and expenses, providing a complete and categorised financial overview.
The GL is essential for preparing trial balances and accurate financial statements at the end of the accounting period. Also, it ensures accuracy by summarising all journal entries into organised accounts.
The fourth step is the trial balance, ensuring the sum of credit balances equals the sum of debit balances. If the totals are not equal, an error has been made in the process and needs to be identified and corrected.
The trial balance helps confirm the accuracy of all recorded transactions. It proves the summary of all general ledger account balances, which is essential for preparing financial statements. By identifying any discrepancies or errors early, the trial balance supports a smoother and more accurate financial close process.
The fifth step is to make sure all expenses are recorded in the correct accounting period. This includes adding entries for accruals, deferrals and any other necessary updates. These adjustments are important to keep the financial statements accurate and ensure they follow accounting rules like the matching principle.
They show the company’s true financial performance and position. Without these adjustments, the financial close could be prone to errors, give a misleading view of the business and lead to compliance problems.
After the reconciliations and matching, there comes the book closing, which is an equivalent of financial closing. These records provide a detailed and precise report to analyse and compare the company’s performance. Once books are closed, the finance team is ready for the next accounting period.
Book closing prevents further changes and ensures the accuracy of the financial data for the given period. Closing the books ensures no further changes can be made for that period, allowing for accurate reporting and a clean starting point for the next cycle.
The next step in the accounting cycle is preparing the financial statements, which include a reconciled balance sheet, income statement, statement of retained earnings and cash flow statement. This step shows the main purpose of accounting, which is to present a clear picture of a company’s finances.
Financial statements usually come after the financial close process is done, i.e., when the finances are closed for the given period. They guide internal decisions, share information with external parties, and meet accounting standards.
The accounting cycle steps ensure timely period-end close and consistent reporting. Each step in the cycle helps create a clear and complete picture of a company’s finances, or even better, the financial health.
By following these steps regularly, companies keep their finances accurate, stay compliant and make smart decisions using trustworthy information.
Did you know? Aico's financial close solution automates all these steps thanks to the ERP live integration! This way, you ensure a concise period-end close. Discover how with our closing task manager!