The Complete Accounting Cycle

Accounting is the backbone of every business. In today’s world, out of all the disciplines available, Accounting is one which every person should keep some knowledge of. It is most pervasive among all the other disciplines.

Did you know that each and every accounting transaction passes through a predetermined cycle in your company’s books? Well, Yes and it is termed as Accounting Cycle. Accounting cycle is the financial process starting with recording business transactionsand leading up to the preparation of financial statements. This process demonstrates the purpose of financial accounting which is to create useful financial information in the form financial statements. In simple terms Accounting cycle refers to the complete set of transactions associated with a specific business activity.

 

Let us understand in detail the process of Accounting Cycle.

Identifying: The accounting process starts with identifying business transactions and events. An event is anything which has a significant impact on the profit or loss of the company. Business events can be purchase/ sale of goods and services, payment of expenses, payment of money to the suppliers, receiving payment from the customers etc. Once the event has been identified you must also prepare the business document (source documents) associated with the accounting transaction, such as a supplier invoice, customer invoice, petty cash voucher, or cash receipt. You also need to identify the necessary vouchers and the registers to be prepared with regards to the transaction.

Recording:Recording is concerned with preparation of vouchers and then from vouchers, recording information into primary books/registers and then from primary books/registers to writing up the day book.

 

Classifying:This is concerned with the classification of the recorded business transactions so as to group the transactions of similar type at one place. i.e. in ledger accounts. Also known as Book 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 of all transactions to the ledger, the balances of each account can be determined.

 

Summarising: Summarising involves presenting the already classified data in a summarised form.The classified information is summarised in the form of a Trial Balance. This information available from the trial balance is used to prepare Profit and Loss Account and balance sheet in a manner useful to the users of accounting information.

 

Analysing:‘Analysing’ includes:

  • Verification of assets and liabilities: The accuracy of the balance sheet and the estimated profits of a concern depend upon the correct valuation of the assets and liabilities. If the assets and liabilities are overstated or understated the Balance Sheet shall not represent a true and fair view of the state of affairs of company. Similarly the profit and loss account will be incorrect.
  • Confirmation of debtors, suppliers, etc.: Confirmations represent an external source of evidence provided in support of the assertion of existence, valuation and completeness with respect to debtors and creditors.
  • Reconciliation of account balances with the confirmations received: Reconciliation is the process of comparing information that exists in two systems or locations, analyzing differences and making corrections so that the information is accurate, complete and consistent in both locations. Balance sheet accounts must be reconciled on a periodic and timely basis to verify that all items were correctly posted to the account.

 

Interpreting and Communicating is concerned with preparation and dissemination of MIS Reports.The process of the cycle are focused on providing external users with useful information in the form of financial statements. These statements are the end product of the accounting system in any company. Basically, preparing these statements is what financial accounting is all about.

 

The users of Accounting Information can be internalas well as external.

Internal:

  • Owners – To know the profitability and financial soundness of the business.
  • Management – To take prompt decisions in order to manage the business efficiently.
  • Employees – To know the earning capacity of the business since their remuneration and bonus depends on it.

 

External:

  • Creditors, Banks – To determine whether the principal and the interest towards the loan taken will be paid when it is due.
  • Current Investors – To know the position, progress and prosperity of the business in order to ensure the safety of their investment.
  • Potential investors – To decide whether to invest in the business or not.
  • Government – To assess tax liabilities of the business
  • Regulatory agencies – To evaluate the business operation under the regulatory legislation.

 

Accounting forms a vital element of any business. The growth of the business can be closely monitored and analysed with the help of Accounting Cycle. Accounting is one language that is universal to any type of business. A fruitful decision could be taken only through the financial statements of the company where the information is collated and also interpreted.

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About the author

FAME is a leading Accountancy training provider. FAME brings together under one roof a wide range of accounting courses blended with real world experience and practical application. FAME aims to bridge the gap between theoretical knowledge and practical challenges that accountants face in their day to day working. We provide practical workplace skills for finance staff meeting the needs of employers, bankers, government and learners, both now and in the future. Our students are integral to the success of an organisation and at the heart of ensuring the smooth running of an accounting department.