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M6: Discuss the steps of the accounting cycle. Explain how it is important to do every...

M6:

Discuss the steps of the accounting cycle. Explain how it is important to do every step in the cycle and what could happen if 1 step is skipped.

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teps in Accounting Cycle: The accounting cycle, also commonly referred to as accounting process, is a series of procedures in the collection, processing, and communication of financial information, 1. Identifving and Analvzing Business Transactions The accounting process starts with identifying and analyzing business transactions and events, Not all transactions and events are entered into the accounting system. Only those that pertain to the business entity are included in the process. For example, a personal loan made by the owner that does not have anything to do with the business entity is not accounted for. 2. Recording in the Journals A journal is a book - paper or electronic - in which transactions are recorded. Business transactions are recorded using the double-entry bookkeeping systenm They are recorded in journal entries containing at least two accounts (one debited and one credited) To simplify the recording process, special journals are often used for transactions that recur frequently such as sales, purchases, cash receipts, and cash disbursements. A general journal is used to record those that cannot be entered in the special books. 3. Posting to the Ledger Also known as Books of Final Entry, the ledger is a collection of accounts that shows the changes made to each account as a result of past transactions, and their current balances. After the posting all transactions to the ledger, the balances of each account can now be determined. For example, all journal ent debits and credits made to Cash would be transferred into the Cash account in the ledger. We will be able to calculate the increases and decreases in cash; thus the ending balance of Cash can be determined.4. Unadiusted Trial Balance A trial balance is prepared to test the equality of the debits and credits. All account balances are extracted from the ledger and arranged in one report. Afterwards, all debit balances are added. All credit balances are also added. Total debits should be equal to total credits When errors are discovered, correcting entries are made to rectify them or reverse their effect. Take note however that the purpose of a trial balance is only test the equality of total debits and total credits and not to determine the correctness of accounting records. 5. Adjusting Entries Adjusting entries are prepared as an application of the accrual basis of accounting. At the end of the accounting period, some expenses may have been incurred but not yet recorded in the journals. Some income may have been earned but not entered in the books 6. Adiusted Trial Balance An adjusted trial balance may be prepared after adjusting entries are made and before the financial statements are prepared. This is to test if the debits are equal to credits after adjusting entries are made. 7. Financial Statements When the accounts are already up-to-date and equality between the debits and credits have been tested, the financial statements can now be prepared. The financial statements are the end-products of an accounting system A complete set of financial statements is made up of: (1) Statement of Comprehensive Income (Income Statement and Other Comprehensive Income), (2) Statement of Changes in Equity, (3) Statement of Financial Position or Balance Sheet, (4) Statement of Cash Flows, and (5) Notes to Financial tatements.8. Closing Entries Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare the system for the next accounting period. Temporary accounts include income, expense, and withdrawal accounts. These items are measured periodically. The accounts are closed to a summary account (usually, Income Summary) and then closed further to the appropriate capital account. Take note that closing entries are made only for temporary accounts. Real or permanent accounts, i.e. balance sheet accounts, are not closed 9. Post-Closing Trial Balance In the accounting cycle, the last step is to prepare a post-closing trial balance. It is prepared to test the equality of debits and credits after closing entries are made. Since temporary accounts are already closed at this point, the post-closing trial balance contains real accounts only. 10. Reversing Entries: Optional step at the beginning of the new accountin period Reversing entries are optional. They are prepared at the beginning of the new accounting period to facilitate a smoother and more consistent recording procesS In this step, the adjusting entries made for accrual of income, accrual of expenses, deferrals under the income method, and prepayments under the xpense method are simply reversedImportance of Not Missing a Single Step in Accounting Cycle: Dependence You cannot afford to miss a step in the accounting cycle because each prior activity is a prerequisite for the succeeding task. The accuracy of the succeeding task is dependent on the accuracy of the immediate preceding activity and all the other previous activities before it. Activities along the accounting cycle are serially linked, so that a succeeding activity can only be performed after the completion of a preceding activity. For example, you can only prepare the adjusted trial balance after adjusting entries in the unadjusted trial balance Skipping any of the steps in the accounting cycle would create serious flaws in the entire financial reporting process. Dissemination All the steps of the accounting cycle are critical in facilitating the systematic dissemination of different aspects of financial information as they become due. This enables the management team to draw important decisions about the progress of business activities at different stages of the accounting cycle. It also ensures that any inaccurate information is detected and corrected before and after the production of financial information. The adjustment of entries in the trial balance is based on the accuracy of information processed in the prior stages of the accounting cycle.Updating Temporary accounts -- that is, expenses, revenues and dividends accounts must be zeroed out and their balances transferred to the retained earnings account during the closing process. However, the retained earnings account does not update automatically when expenses, revenues and dividends are posted to their respective ledger accounts. This means that retained earnings remains dormant until the closing process when it must be updated to reflect changes in the temporary accounts. Missing any of the steps in the accounting cycle would derail the monitoring of transactions, the tracking of ledger accounts and the updating of respective accounts during the closing process. Transition Each of the steps in the accounting cycle contributes towards smooth transition from one accounting period to another. The closing process sets the general ledger ready for the new accounting period. Omitting any of the steps distorts the accuracy of opening balances for the subsequent accounting period. example, whereas the temporary accounts are zeroed out during the closing process, real accounts are carried forward to the subsequent accounting period Real accounts are balance sheet items that include assets, stockholders equity and liabilities accounts. The real account must balance after the closing process, a status that is confirmed by the post-closing trial balance.

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