The Accounting Cycle

Accounting Cycle is the collective and repetitive process of recording and processing the accounting events of a company in different accounting periods. The series of steps begin when a business transaction occurs and end with the period closure where the cycle is again repeated.

Steps of Accounting Process

We have discussed the five steps of the accounting process in the article “The Accounting Process”.

Those five steps were:

• Step1: Identifying Business Stakeholders
• Step2: Understanding Accounting Needs
• Step3: Identifying Accounting Transactions
• Step4: Recording Transactions
• Step5: Preparing Accounting Reports

The Accounting Cycle

The prerequisite for the accounting cycle to begin in automated systems is that you have already identified your stakeholders and have designed an automated accounting system to cater to their reporting and recording needs. You have established a system in place to identify accounting transactions. Once you have identified your accounting transactions, the next step is to record them into your accounting system.  Before you can start recording financial transactions in any books you need to have some basic information available. The minimum required information is:

1. Nature of parties entering into the transaction (This leads to having a chart of accounts).
2. Date when the transaction took place (This leads to having accounting periods and calendars).
3. The money involved in the financial transaction (This leads to having currencies).

Once you have all the three above, the typical accounting cycle has eight recurring steps that are explained below:

1. Manage Accounting Periods/Calendars:

The accounting Period in bookkeeping is the period with reference to which accounting books of any entity are prepared. It is the period for which books are balanced and the financial statements are prepared. As a general practice the accounting period consists of 12 months and might follow the natural calendar, however, many companies define different lengths of dates as their accounting periods as explained in Accounting Periods and Calendars article.

The accounting period groups the transactions pertaining to a specified date range and facilitates the reporting of financial activity for that period. You define accounting periods in automated accounting systems to generate financial reports at the end of the period. Periods needs to be opened before any transaction can be entered for any accounting period. The first step in the accounting cycle is to make available the “Accounting Period” in which the transaction will be recorded.

2. Manage Currency:

Currency is the generally accepted form of money that is issued by a government and circulated within an economy. Currency is used as a medium of exchange for goods and services. Every nation has its own currency and global trade results in the exchange of currencies of different countries.

Accounting Currency is the monetary unit used while recording transactions in the company's financial books. “Accounting Currency” is also known as “Functional Currency” and is the main currency used by a business entity. The accounting currency may not necessarily be the same as the transacting currency. Transacting currency is the currency that customers deal with when conducting a transaction. Companies are likely to use their home country's currency (Accounting Currency) when recording transactions, even if the sale was denominated in some other currency (Foreign Currency). You can explore currency concepts in the article on “Currency”.

However, the automated systems provide you with the flexibility to enter a transaction in the transacting foreign currency and have the capability to convert that entered amount into functional or accounting currency using the appropriate exchange rate. For this to happen, relevant currencies must be defined in the system and need to be available for recording the transaction.

3. Import Transactions/Record Transactions:

In the previous lesson, we saw some examples of commonly used subsidiary ledgers. Companies extensively use modules like accounts receivable subsidiary ledger, accounts payable subsidiary ledger or creditors' subsidiary ledger, inventory subsidiary ledger, fixed assets or property or plant & equipment subsidiary ledger, projects subsidiary ledger, work in progress subsidiary ledger and cash receipts or payments subsidiary ledger, to capture their source transactional data.

If you are recording transactions in your subsidiary ledgers, you need to import the financial and economic impact, that is, Debit and Credit of transaction amounts and accounts to the general ledger. Importing transactions in automated accounting systems is an automated process.

General Ledger also allows users to directly add transactions in the GL. In that case, you need to follow the accounting principles and the steps explained in the accounting process. This step completes the recording transactions process.

4. Review Transactions/Edit Transactions:

The transactions can be reviewed for accuracy and completeness once they have been entered into the automated accounting system. If a review is done by another person who is not responsible or involved in recording the transaction it can help to ensure that financial information in the journals accurately reflects actual activity.

A review of transactions is done to ensure that the transaction is within the guidelines of the purpose of the accounts used and is appropriately charged to the account following the concepts defined in the accounting equation. In the case of manual journals, one must ensure that the transaction is consistent with available supporting documents. If any errors are found in the transaction, they can be edited and corrected at this stage.