What is the accounting cycle?
The accounting cycle is the ordered set of tasks that an organization uses to record every financial transaction from the moment it happens until the books are closed and financial statements are produced. It enforces double‑entry bookkeeping discipline (every debit has a matching credit), supports accurate reporting, and helps meet regulatory and management information needs.
Key terms (defined on first use)
– Accounting period: the span of time covered by financial reports (monthly, quarterly, annual).
– Journal entry: the initial record of a transaction showing debits and credits.
– General ledger: the set of accounts that collects all posted journal entries.
– Trial balance: a worksheet that lists account balances to check that total debits equal total credits.
– Adjusting entry: an end‑of‑period journal entry to recognize revenues or expenses in the proper period.
– Closing entries: journal entries that transfer temporary account balances (revenues, expenses, dividends) into permanent equity accounts.
– Financial statements: primary reports such as the income statement, balance sheet, and statement of cash flows.
Why it matters
A repeatable accounting cycle ensures transactions are recorded consistently, reduces math and classification errors (especially when automated), produces reliable financial statements, and helps firms comply with reporting requirements (for example, public companies filing with regulators).
Typical eight-step walkthrough
1. Identify transactions and source documents
– Gather invoices, receipts, bank statements, payroll records, etc.
2. Record journal entries
– Enter each transaction in a journal with proper debits and credits.
3. Post to the general ledger
– Move journal totals into the ledger accounts to update balances.
4. Prepare an unadjusted trial balance
– List ledger balances to verify debits equal credits.
5. Make adjusting entries
– Recognize accruals, deferrals, depreciation, and corrections so revenue/expense recognition follows accrual accounting.
6. Prepare an adjusted trial balance
– Confirm ledger balances after adjustments.
7. Prepare financial statements
– Produce the income statement, statement of retained earnings (or equity), balance sheet, and cash flow statement.
8. Close the books / prepare post‑closing trial balance
– Reset temporary accounts to zero and verify final permanent account balances.
When to run the cycle
– The cycle is completed within an accounting period. Commonly monthly or annually; public companies often align with regulatory filing deadlines. Smaller sole proprietorships may use a simplified process or outsource.
Accounting cycle vs. budget cycle
– Accounting cycle: records historical events and produces audited financial statements for external and internal users.
– Budget cycle: plans and allocates expected future resources; used primarily for internal management.
Who performs the cycle
– Accountants or bookkeepers usually perform the cycle. In small businesses the owner may handle it or hire external accountants. Modern accounting systems automate many steps, reducing manual work.
Benefits (summary)
– Accurate books and financial statements
– Reduced manual errors through standard procedures and automation
– Better compliance with reporting rules
– Timely management information for decisions
Short checklist (use this each period)
– Define accounting period and deadlines
– Collect all source documents
– Enter all journal entries
– Post to general ledger
– Run unadjusted trial balance
– Create and post adjusting entries
– Produce adjusted trial balance
– Prepare financial statements
– Execute closing entries and run post‑closing trial balance
– Archive documents and, if needed, prepare regulatory filings
Worked numeric example (small, monthly; accrual accounting; no beginning balances)
Transactions during April:
A. Owner invests $10,000 cash.
B. Buy equipment for $3,000 cash.
C. Credit sales (on account) $5,000.
D. Pay cash rent $500.
E. Collect $2,000 from customers (accounts receivable).
F. Record monthly depreciation on equipment (assume 5‑year life, straight line): monthly depreciation = 3,000 / (5*12) = $50.
Selected journal entries (debit = left, credit = right)
1) Cash 10,000
Owner’s Capital 10,000
2) Equipment 3,000
Cash 3,000
3) Accounts Receivable 5,000
Sales Revenue 5,000
4) Rent Expense 500
Cash 500
5) Cash 2,000
Accounts Receivable 2,000
6) Depreciation Expense 50
Accumulated Depreciation 50
Postings and balances (end of period)
– Cash = 10,000 − 3,000 − 500 + 2,000 = 8,500
– Equipment = 3,000
– Accumulated Depreciation (credit) = 50
– Accounts Receivable = 5,000 − 2,000 = 3,000
– Sales Revenue = 5,000 (credit)
– Rent Expense = 500 (debit)
– Depreciation Expense = 50 (debit)
– Owner’s Capital = 10,000 (credit)
Unadjusted/Adjusted trial balance (sums must match)
Debits: Cash 8,500; Accounts Receivable 3,000; Equipment 3,000; Rent Expense 500; Depreciation Expense 50 = Total debits 15,050
Credits: Owner’s Capital 10,000; Sales Revenue 5,000; Accumulated Depreciation 50 = Total credits 15,050
Income statement (April)
– Revenue: 5,000
– Expenses: Rent 500 + Depreciation 50 = 550
– Net income: 5,000 − 550 = 4,450
Balance sheet (April end)
– Assets: Cash 8,500 + Accounts Receivable 3,000 + Equipment net (3,000 − 50) = 2,950 → Total assets 14,450
– Liabilities: 0
– Equity: Owner’s Capital 10,000 + Net Income 4,450 = 14,450
Formulas to remember
– Trial balance check: sum(debits) = sum(credits)
– Net income = Revenues − Expenses
– Depreciation (straight line per period) = (Cost − Salvage) / Useful life (in periods)
– Retained earnings (or owner’s equity) after closing = beginning equity + net income − distributions
Assumptions and limitations
– Example uses simple accrual accounting with no beginning retained earnings and no liabilities. Real businesses may have more complex transactions (loans, payroll taxes, inventory adjustments, deferred revenue, etc.) and must follow relevant accounting standards (GAAP or IFRS).
Fast fact
– Modern accounting systems automate most cycle steps (journal creation, posting, trial balances), reducing manual entry and arithmetic errors, but professional review and adjusting judgment remain necessary.
Further reading and authoritative resources
– Investopedia — Accounting Cycle overview: https://www.investopedia.com/terms/a/accounting-cycle.asp
– U.S. Securities and Exchange Commission — Filings & Forms: https://www.sec.gov/filings
– American Institute of CPAs (AICPA): https://www.aicpa.org/
– IFRS Foundation — International Financial Reporting Standards: https://www.ifrs.org/
Educational disclaimer
This explainer is for educational purposes only and does not constitute professional accounting, legal, or financial advice for your situation. For specific accounting treatments, regulatory filing requirements, or tax guidance, consult a qualified accountant or appropriate regulator.