Sandrene is an ACCA candidate pursuing a B.C degree in accounting and finance with 5 years of experience in financial services/accounting.
What Do We Mean by the Words "Process" and "Cycle"?
In accounting, a certain sequence of actions has to be carried out to achieve a specific result. We call these sequential actions a process. A process may be used over and over, as there are no limitations regarding the number of times the process may be used.
In fact, the same process has to be used every single time in order to achieve the desired result of accurate accounting. A process that is continuously repeated is called a cycle. Hence, the words are used interchangeably.
The Accounting Process
There are normally nine (9) stages in the accounting process, but there may be fewer depending on the data available and the policy of the business using it. Each stage uses different data, documents, and systems in order to be completed. The steps are outlined below:
- Identifying and analyzing transactions
- Recording transactions
- Posting transactions
- Balancing accounts
- Adjusting entries and rebalancing
- Reporting information
- Closing entries
- Post-closing balancing
- Reversing entries at the beginning of the new accounting period
1. Identifying and Analyzing Transactions
Before we can do anything to business transactions, we have to ensure we have identified what qualifies as a transaction for business purposes. Evidence has to be presented to prove that the transaction actually took place. This evidence is normally referred to as source documents. Once the transaction has been identified, then one has to analyze or determine how the transaction is going to affect the business accounts.
2. Recording Transactions
After business transactions have been identified and analyzed, the dates, details, and amount of money involved are then entered into journals. This is how a record of a transaction is created. Back in the day, journals used to be hard copy books, but due to technological advancements, some journals are now stored on electronic systems. There are two types of journals: general journals and specialized journals.
3. Posting Transactions
The information entered into the journals is then used to post entries to individual accounts in ledgers using what is called the double entry system. There are two types of entries that can be recorded into ledgers, debit and credit. The double entry system stipulates that each transaction must have two types of entries and the totals of those entries must be equal.
4. Balancing Accounts
After entries are posted in the ledgers to the individual accounts, those accounts are then checked to see how much was accumulated or how much is left (the balance). These balances are then enlisted in what is called a trial balance in two separate columns, debit and credit. The balances are then totalled to check the accuracy of the previous steps taken in the process.
5. Adjusting Entries and Rebalancing
Before reports can be made about how the business is performing, one has to ensure that the accounting records are true and faithfully represent the business. In order to achieve this, alterations have to be made to certain accounts.
Sometimes a business may estimate expenses for a certain period because the information was not available at the time. Or, other times, an event might have occurred in the period but was not dealt with until a subsequent period. And sometimes, there are just errors that were overlooked that need to be corrected.
When this happens, journal entries have to be made to bring these up to date. After the entries are posted, another trial balance is created to check for accuracy once more.
6. Reporting Information
When it is ascertained to the best of the preparer's knowledge that all entries are correct, then the information can be organized, analyzed and made available to the interested parties. This is normally done at the end of each accounting period (month, quarter, or year). There are certain formats that are followed in reporting financial information in accounting. The main ones are:
- Income statement/profit and loss statement
- Statement of cash flows
- Balance sheet/statement of financial position
- Statement of changes in equity
- Annual report (which normally includes all of the above and more general information)
However, reporting is not limited to these formats. There is information that managers may need that other stakeholders do not, such as information needed for budgeting and making other business decisions. In addition, countless other reports can be prepared for various stakeholders, including managers, the government, oversight bodies, etc. The aim of the stage is to make the information easily understood.
7. Closing Entries
In accounting, there are two types of accounts called permanent and temporary accounts. Permanent accounts are those accounts that, as the name suggests, accumulates amounts over the life of the business and so the balances are carried forward to each new accounting period. Examples of these are asset and liability accounts.
Conversely, temporary accounts accumulate balances only for a specified period (normally yearly). They are closed at the at of the period and the balances transferred to permanent accounts. The balances at the start of the new accounting period would therefore be zero. Examples of these are revenue and expense accounts. This is what is meant by closing entries.
8. Post-Closing Balancing
This is another balancing stage where a trial balance is created to check the accuracy of the closing entries that were made. Only permanent accounts are listed in this trial balance since the temporary ones would have been closed in the previous accounting stage.
9. Reversing Entries at Beginning of New Accounting Period
Recall that in stage five (5) of the accounting process that sometimes estimated amounts are posted to certain accounts when information is not available. Normally, this information becomes available in the new accounting period, and so if the estimated amount that was posted is different from the actual amount (it usually is) then the entries will be reversed and new entries made to reflect the true figures. If there is no difference in the estimated figure and the real figure, then no reversal of entries is needed, and so this stage would not be necessary.