The Accounting Cycle
Accounting has three basic activities; it identifies, records, and communicates the numbers to the interested parties of the company. The internal users who rely on accounting information are the people who plan, organize, and run the business. The most common external users that rely on the accounting information are investors and creditors, because neither of the two would invest into a business with inaccurate accounting information. To ensure accuracy we have to follow the accounting cycle which has nine steps.
The first step is to analyze the business transactions because it identifies the economic events relevant to its business. When we analyze we figure out whether a transaction is an asset, liability, or owner’s equity. Next we would journalize the transaction data into a journal. This process contributes to the recording process of the accounting cycle because it discloses the effects of a transaction, provides a chronological order, and helps prevent or locate errors of a transaction. When we journalize we would separate each transaction by date, amount, and description. Journalizing means we would post the information to a general ledger. The ledger is helpful because it takes all the information about changes in specific account balances and keeps it in one place. The ledger would provide the balance of each account and arranged in sequence as it would show on the financial statement. The accounts are numbered for easier classification and the order would go as assets, liabilities, owner’s capital, owner’s drawing, revenue, and expenses.
After the ledger account is created we would then prepare a trial balance. A trial balance gives you a list of balances at a time determined by the company. Usually the trial balance is created at the end of an accounting period. The trial balance would list all the debit and credits from the ledger and it calculates to total all debits on the left and credits on the right. When the trial balance is calculated we would have to journalize the adjusting entries of the company.
Adjusting entries are necessary because the trial balance may not be up to date or complete. So adjusting entries will convert a company’s records to the accrual basis of accounting. In the accrual basis of accounting, companies would record transactions that change a company’s economic events in the periods in which they occur. After the adjusting entries are posted to a ledger we would then create an adjusted trial balance, because we have to calculate the adjustments within the accounting period.
From the trial balance we separate the amounts into financial statement. Financial statements are necessary because financial statements tell you the performance and the value a company, it helps you measure the company, and it will help you manage your company when you can no longer be hands on with all the details. Included in the financial statement are the income statement, owner’s equity statement, and the balance sheet. The income statement calculates service revenue and all the expenses from the adjusted trial balance. The balance sheet calculates all the assets, liabilities, owner’s capital,