Tell Me What I Need to Know: The Accounting Cycle

Overview

• Understanding the accounting cycle is crucial for solidifying accounting knowledge.
• The cycle consists of steps that originated from manual accounting systems, which were prone to human error.
• Procedures are integrated to minimize errors.
• Modern accounting software automates many steps, making them seem redundant.

Importance of Studying the Accounting Cycle

• Establishes a solid foundation on how accounting information from source documents influences financial statements.
• Helps in understanding the impact of actions on financial statements.
• The main objective is to prepare financial statements for external users, including:
  • Balance Sheet
  • Income Statement
  • Statement of Cash Flows
  • Statement of Changes in Owner's Equity

Key Terms

Accounts

• A record or list of activities related to financial statement elements, e.g., cash, accounts receivable, accounts payable, etc.

Journal

• A book for recording accounting events in chronological order.
• Can be physical or digital in modern accounting systems.
• Information from journals is transferred to accounts (posting).

Ledger

• A compilation of accounts used by businesses.
  • General Ledger: Contains general accounts.
  • Subsidiary Ledgers: Contain specific details of individual accounts.

Journal Types

• General Journal: Used for all transactions.
• Special Journals: Group similar transactions (e.g., cash receipts, sales).

Posting Process

• Posting transfers transaction details from journals to ledger accounts.
• Individual transactions are posted to subsidiary ledgers; totals are posted to the general ledger.
• Temporary imbalances can occur during posting but should equal out after completing posting.

Double Entry Accounting

• Each journal entry affects at least two accounts, ensuring debits equal credits.
• Proper formatting enhances readability and helps avoid omissions.

Trial Balance

• A tool to verify that total debits equal total credits at various points in the accounting process.
• Important for teaching concepts of debit and credit equality, though less relevant in computerized systems.

Adjusting Journal Entries

• Necessary due to the principles of accrual accounting:
  • Accruals: Action first, cash later.
  • Deferrals: Cash first, action later.
• Adjusting entries are needed for:
  • Accrued Revenues: Revenue earned but not yet received in cash.
  • Accrued Expenses: Expenses incurred but not yet paid.
  • Unearned Revenue: Cash received before goods/services are delivered.
  • Prepaid Expenses: Cash paid for future expenses.

Depreciation

• A method for allocating the cost of fixed assets over their useful lives.
  • Example: Purchase of a fixed asset for $1,100 with a 4-year life.
  • Straight-line method used for equal annual depreciation.

Supplies Accounting

• Supplies treated as prepaid expenses; recorded when purchased and adjusted as used.
  • Differentiate between Supplies (asset account) and Supplies Expense (expense account).

Adjusted Trial Balance

• Prepared after adjusting entries to ensure accuracy before financial statements are created.

Financial Statement Preparation

1. Income Statement: Uses revenue and expense accounts.
2. Statement of Changes in Owner's Equity: Based on previous period's balances.
3. Balance Sheet: Based on permanent accounts on the adjusted trial balance.
4. Statement of Cash Flows: Matches cash balances from the balance sheet.

Closing Entries

• Temporary accounts (revenue, expenses) are closed at the end of the accounting period.
• Two methods:
  1. Close to Income Summary then to Retained Earnings.
  2. Close directly to Retained Earnings.

Post-Closing Trial Balance

• Conducted after closing entries to ensure only permanent accounts are reflected.

Conclusion

• The accounting cycle is a continuous process, repeating for each accounting period.