What are the steps of the accounting cycle? 

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The accounting close cycle is a series of steps to validate, record, and report financial transactions. They’re done on a monthly basis, though some steps (i.e. Step 8 at the end of this article) are only done annually.

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The goal of the accounting cycle is to generate financial statements that are accurate and prepared in a timely manner. The following steps may look a little different based on the accounting software used; however, across industries or companies, the accounting cycle will look fairly similar.

Step 1: Collecting and analyzing financial data

The first step in the accounting cycle involves collecting and analyzing financial data. This data will eventually need to be entered into the financial system. The financial data ranges from invoices, email correspondences, or legal agreements.

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This stage is incredibly valuable as it sets the foundation for the ultimate accuracy and completeness of the full accounting cycle. All of the remaining steps are based on the information that's collected. For example, the invoices that are gathered from vendors that list the cost to be paid and the related dates contain all of the relevant data that will make up the financial statements.

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Step 2: Recording transactions in journals

Journals serve as a fundamental tool in accounting, and it’s the detailed log that records transactions. In this second step, accountants take the financial data collected from the first step and enter it into the financial statement software. This is done by posting individual journal entries that each represent different transactions.

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It’s important to understand that transactions can be entered in different ways. For example, an account payable module may help create the entries needed to record invoice transactions, while a general ledger module would help with recording transactions.

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Step 3: Posting journal entries to ledgers

Ledgers are used to summarize transactional data within accounting systems. They’re used to aggregate all of the journal entries posted in the previous step, and there’s different types of ledgers. For example, the accounts payable example mentioned above uses the accounts payable ledger. This means that all accounts payable transactions are added together, then summarized.

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The ledger is important because since it aggregates and organizes data, it offers a comprehensive overview of a company's financial position. In order to prepare its general ledger, a company must do the preceding two steps; without having collected accurate financial data and having posted journal entries to reflect that data, a company wouldn't be able to aggregate its data into a ledger. 

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Step 4: Preparing trial balance

Step four in the accounting process involves preparing a trial balance. A trial balance is a statement that lists all the general ledger accounts and their respective debit or credit balances. It’s important to note that a trial balance shows all of the account balances as of a specific date.

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To prepare a trial balance, you have to gather the balances from each ledger account and organize them into a two-column format, with debit balances on the left and credit balances on the right. This process allows accountants to detect errors in recording transactions and to verify the entire set of records at a very high level. 

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Step 5: Adjusting entries

Adjusting entries are usually needed to account for certain types of transactions. These entries are made at the end of an accounting period to update account balances, mainly to reflect accruals or deferrals.

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Common examples of adjusting entries include recognizing accrued expenses, prepaid expenses, accrued revenues, and unearned revenues. Accountants will post these entries if they need to prepare financial statements under the accrual method but not the cash method.

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Step 6: Preparing an adjusted trial balance

Assuming adjusting entries are made, accountants usually re-run a trial balance (called an adjusted trial balance). This step isn't needed if no adjusting journal entries are made. This step entails preparing an updated trial balance that now contains all of the transactions for the entire period.

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Step 7: Generating financial statements

The ultimate goal of the accounting cycle is to prepare financial statements. The main financial statements consist of the income statement, balance sheet, and statement of cash flows. These reports offer a comprehensive overview of a company's financial performance.

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The financial statements are prepared by taking the adjusted trial balance and incorporating the ledger accounts and balances into a specific report format. That format (along with the rules on how journal entries are recorded) is usually dictated by Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). 

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Step 8: Closing entries

At the end of each fiscal year, closing entries are made to reset the revenue and expense accounts to zero. This is usually done automatically by an accounting system.

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This process involves transferring the balances of revenue and expense accounts to a temporary summary account. Then, that temporary summary account is adjusted to retained earnings. Note that this last step is only done at the end of the fiscal year; this step isn’t done at every month-end. 

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Wrapping up: Navigating the accounting cycle steps

The accounting cycle encompasses a series of sequential steps designed to ensure the accuracy, completeness, and reliability of the financial reporting process. Beginning with identifying/recording transactions and ending with preparing financial statements and rolling year-end accounts, the accounting cycle is repetitive month-over-month.

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Because of this process, users of the financial statements (both internal management and external stakeholders) can have greater confidence that the reports have been prepared correctly.

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