8 Steps Of The Accounting Process (With Key Terms)
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The accounting process is an eight-step cycle to detail, analyse and process a company's financial transactions during a reporting period. It is a bookkeeper's responsibility to understand and implement the steps of an accounting procedure. Understanding each of the eight processes in depth will help you figure out the best way to secure financial data while also enabling you to double-check your work and ensure that your financial data is correct. In this article, we discuss some key concepts behind the accounting method and explain the steps of accounting processes in detail.
8 Steps of the accounting process
The accounting process includes steps that accountants and bookkeepers follow to document transactions and review data accuracy efficiently. Some organisations adopt software for a seamless automated accounting method. Accounting professionals conduct steps one to seven throughout the accounting period, while step eight only occurs at the end of the fiscal year. The eight standard steps of the accounting cycle are:
1. Recording transactions
The first step in the accounting procedure is to identify and record all business transactions. Organisations have many transactions throughout the fiscal year and it is crucial to record individual transactions accurately. Organisations use automated point of sale algorithms and software to record sales. Apart from sales, transactions may include debt payments, employee payroll, purchases and reimbursements. Transactions do not include creating purchase orders and signing contracts. Bookkeepers record exact amounts during this step of the accounting cycle. Transactions are the first requirements for the upcoming accounting procedure.
2. Entering journal entries
The second step in the accounting method is the establishment of journal entries for every transaction in a paper or electronic journal. Many organisations use point of sale technology to combine steps one and two. They also keep a record of the expenses of the organisation. Bookkeepers record transactions chronologically, with the oldest transaction at the top and the newest at the end. Single-entry bookkeeping is equivalent to maintaining a chequebook.
Double-entry bookkeeping requires you to record two entries for every transaction under two accounts that have equal credits and debits. This is further classified into two types, accrual accounting, which involves matching revenues with expenses, and cash accounting, for which you require documenting transactions when the organisation receives cash for the transaction.
3. Posting entries to the general ledger
Once you have listed every transaction in a journal, the third step is to record the transactions in the general ledger. A business's general ledger keeps a record of all financial activities, organising every account by category. This allows accountants and bookkeepers to gauge the business's economic position through one centralised document. The general ledger aids authorities to monitor the influence of expenses and income of every individual account on the business's finances. It is a bookkeeper's responsibility to post the journal entries in the general ledger to provide uniformity and efficiency.
4. Creating an unadjusted trial balance
Accounting professionals of a company enter the data from the general ledger to a trial balance at the end of an accounting period. Accountants create a trial balance to identify and correct any errors that might have occurred during the initial stages of accounting proceedings. This trial balance is unadjusted because of the difference between the total debit and credit of a company's account. A trial balance is successful when the debit is equal to the credit section of the ledger.
The accountant requires identifying inconsistencies in the ledger and rectifying them to maintain parity to ensure both sections of the ledger are equal.
5. Using worksheets
Creating and analysing a worksheet is the fifth step of the accounting cycle. Accountants draft worksheets to ensure a balance between debits and credits and make adjustments if there are any differences. In addition, bookkeepers use worksheets as a visual aid to recognise typing errors, inconsistencies and entry mistakes in the ledger and identify the adjustments to make. The bookkeeper makes adjustments and explains the adjustments made in the ledger by using the worksheet.
6. Balancing entries
Bookkeepers adjust all ledger and journal entries based on accruals and deferrals in the sixth step of the accounting procedure. Some financial transactions may take several days to process most times. So this step helps accountants identify sales or expenditures that were not recorded in the journals. The bookkeeper also adjusts the trial balance by reviewing past journal entries. It is a bookkeeper's job to recognise unusual account activity and unaccounted balances and fix existing errors. This step also involves a calculation of depreciation of assets, prepayments, loans, among other accruals and deferrals that affect the accuracy of the ledger.
7. Preparing financial statements
The seventh step involves bookkeepers to create a financial statement report which summarises all transactions in an accounting period. During this step of the accounting cycle, accountants classify financial statements into categories like income statements, statements of retained earnings, balance sheets and cash flow statements in the respective order.
It is important that an accountant prepares these financial documents in this order because they use gross income from the income statement to prepare a statement of retained earnings. Accountants use the final balance of the statement of retained earnings to prepare the balance sheet. Professionals prepare the cash flow statement at the end, as it utilises data from the first three statements.
The last step of the accounting process includes the closing of temporary accounts and producing a closing statement which delivers the analysis of the business's financial performance during the accounting period. Accounts in the income statement are temporary accounts. The bookkeeper closes out or zeroes out these accounts at the end of the fiscal year, meaning they transfer balances from these accounts to permanent accounts on the balance sheets. The aim of this step is to reset debit and credit balances to zero and document and organise data systematically.
Understanding the purpose of the steps in the accounting cycle
The accounting cycle is an eight-step method for performing bookkeeping activities in an organisation. It gives a step-by-step method for documenting, analysing and reporting a company's financial activity. Bookkeepers and accountants can segregate complex sets of financial data into manageable, simple categories by processing data at regular intervals during the accounting cycle. The steps of the accounting procedure give users a framework for understanding their finances and seeing any confusing or contradictory data before it affects their work.
Accounting professionals employ the accounting cycle in its entirety over the course of a single reporting period. As a result, being well organised throughout the duration of the process can be a critical component in maintaining overall efficiency. The length of the accounting cycle depends on the reporting requirements. Most businesses aim to evaluate their performance on a monthly basis. Some may have a greater emphasis on quarterly or annual outcomes.
Important terms for understanding the accounting cycle
It is crucial to understand essential accounting terms to be a successful accountant. Some of them are:
Transaction: A transaction is a business agreement that involves the transfer of funds from one account to another. A transaction occurs whenever a company receives or spends money.
Accounting period: The accounting period specifies the start and end dates of the accounting cycle. It normally spans a set period and classifies a company's transactions according to the date of completion of the transaction. Businesses aim to evaluate their performance on a monthly, quarterly or annual basis.
Accrual: Accrual refers to how transactions add up over an accounting period.
Deferral: Deferral refers to the postponement of business transactions over an accounting period.
Debit: A debit is when the amount is payable for a transaction.
Credit: A transaction's credit is the amount coming in from a transaction.
General ledger: The general ledger is the final book of entry. It provides an insight into all transactions organised by category.
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