Accounting Cycle and Its Various Phases

The Accounting Cycle is a systematic process of recording, classifying, and summarizing financial transactions of a business. It ensures that financial statements are prepared accurately and in compliance with accounting principles.

Phases of the Accounting Cycle

The accounting cycle consists of eight major phases, as detailed below:

1. Identifying and Analyzing Transactions

• Every financial transaction (e.g., sales, purchases, expenses, revenues) must be identified and analyzed based on supporting documents like invoices, receipts, and contracts.
• The nature of the transaction is determined to classify it correctly under assets, liabilities, equity, revenue, or expenses.

2. Recording Transactions in Journal (Journalizing)

• Transactions are recorded chronologically in the journal using the double-entry system, where each transaction affects at least two accounts (debit and credit).
• Example:
  • If goods worth ₹50,000 are purchased on credit, the journal entry will be:

Purchases A/c       Dr. ₹50,000

To Creditor A/c      ₹50,000

(Being goods purchased on credit)

3. Posting to the Ledger

• Entries from the journal are transferred (posted) to the ledger accounts, which classify transactions under respective account heads.
• The ledger contains accounts like Cash A/c, Sales A/c, Purchases A/c, etc.
• Example: The purchase transaction from the journal will be posted under the Purchases Account and Creditor Account in the ledger.

4. Preparing an Unadjusted Trial Balance

• A trial balance is prepared by listing all ledger balances to check if total debits equal total credits.
• If there is a mismatch, it indicates an error that needs to be corrected.

Example of a Trial Balance:

 

Account Name	Debit (₹)	Credit (₹)
Cash A/c	1,00,000	—
Purchases A/c	50,000	—
Sales A/c	—	1,20,000
Creditors A/c	—	50,000
Capital A/c	—	80,000
Total	1,50,000	1,50,000

5. Making Adjusting Entries

• Adjustments are made for accrued expenses, prepaid expenses, depreciation, and other necessary corrections before preparing final accounts.
• Example: If rent of ₹10,000 is prepaid, an adjusting entry is made:

Prepaid Rent A/c    Dr. ₹10,000

To Rent Expense A/c  ₹10,000

(Being rent prepaid for next period)

6. Preparing an Adjusted Trial Balance

• After recording adjustments, a new trial balance is prepared to ensure total debits still equal total credits.
• This serves as the basis for preparing financial statements.

7. Preparing Financial Statements

Once the adjusted trial balance is finalized, the following financial statements are prepared:

1. Income Statement (Profit & Loss A/c) – Shows revenue and expenses to determine profit or loss.
2. Balance Sheet – Displays assets, liabilities, and equity to reflect the financial position of the business.
3. Cash Flow Statement – Reports cash inflows and outflows categorized into operating, investing, and financing activities.

8. Closing Entries and Post-Closing Trial Balance

• Closing entries transfer revenue and expense balances to the capital or retained earnings account, ensuring all temporary accounts reset to zero for the next cycle.
• A Post-Closing Trial Balance is prepared to confirm that only permanent accounts (assets, liabilities, and equity) remain open.

Conclusion

The accounting cycle is essential for ensuring accurate and reliable financial reporting. By systematically following these steps, businesses can maintain financial transparency, comply with regulations, and make informed decisions.

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