Accounting cycle: Steps and Fundamentals

What is accounting cycle?

Accounting cycle for a business indicates the process of recording every financial transactions in the company’s books of accounts from the time the transaction occurs to its ultimate presentation in financial statements.¹ Financial statements are important for any business as without them, you cannot plan your expenses, obtain loans or sell your business. Accounting cycle involves various steps while converting your raw financial data into meaningful financial statements.

In this article, we're going to explain bits and pieces of the accounting cycle which includes the following:

• Accounting cycle fundamentals
• The step by step approach of a complete accounting cycle
• How to cut the cost on your financial transactions

We'll also introduce a fast and secure global payment solution, Wise, to help you cut the cost on international payments and provide solutions in a few phases of the accounting cycle such as recording financial transactions and keeping track of all your local and international payments through an integration with Xero.

Let's get started!

Accounting cycle fundamentals

This article will explain the basics of an accounting cycle in a simple and easy to understand manner. A transaction is recorded in Journal, classified in Ledgers, summarized in Trial Balance and presented in the form of financial statements for end users. A complete set of financial statements comprise of income statement, a balance sheet and a cash flow statement. Every year a company closes its books of accounts by following this procedure. Financial statements are prepared using a set of accounting principles and rules. These rules vary from region to region; however, the basic accounting principles remain the same.

What are the steps in the accounting cycle?

There are 8 important steps in a complete accounting cycle.² The period of accounting cycle is usually one year.

• Analyze and identify transactions

First step in the accounting cycle is to gather relevant accounting records such as receipts, invoices, bank details, bank statements etc. for the current accounting period. All these transactions form the basis of the accounting cycle.

• Record transactions

Second step is to record all the identified transactions in a book known as Journal. A Journal is a book in which each transaction is recorded by mentioning the date of the transaction, the description and the amount. Double entry is made in Journal which records both debit and credit sides of the transaction. The total debit side must equal the total credit side.

• Post Journal Entries to applicable T-accounts or Ledger Accounts

All the recorded transactions in Journal are then posted to Ledger accounts. A Ledger classifies journal entries into their respective account heads. For example, all the journal entries related to sales are classified into one ledger account by the name of Sales Account.

• Prepare unadjusted trial balance

A trial balance is prepared taking unadjusted balance from all the Ledger Accounts. All the Ledger accounts may either have a debit balance or a credit balance. These debit and credit balances, however, must be equal to each other when shown in a trial balance.

• Prepare and analyze Worksheet

In the fifth step, the accountant prepares a worksheet to make necessary adjusting and or correcting entries in order to match the two sides of the trial balance.

• Pass adjusting entries

Adjusting entries are required in the sixth step in order to comply with accrual concept of accounting and to record depreciation. Also, any errors are rectified or any missing entries are recorded at this stage through appropriate journal entries.

• Prepare financial statements

In the seventh step, financial statements are prepared using the adjusted trial balance. Adjusted trial balance is the one that incorporates all the adjusting entries. A complete set of financial statements include an income statement, balance sheet and cash flow statement. An income statement is prepared using all the income and expense accounts. A balance sheet is prepared using the asset, liabilities and equity accounts. While, a cash flow statement is prepared using both the income statement and balance sheet accounts.

• Close the books of account

At the end of the cycle, the books of accounts are closed. Only income statement accounts are closed as they represent a specified period only. Balance sheet accounts are not closed as they give the details at a point in time. The closing report is used to analyze performance for a specified period of time. When the closing is complete, a new accounting cycle begins with the start of a new accounting period.

How to cut the cost on your financial transactions

If you’re using Xero as an accounting software, you can easily sync it with Wise multi-currency account. This keeps all your financial transactions in one place as you can use the account to receive, send and convert in 45+ different currencies. This means that you could receive and send funds to different countries locally and get rid of the receiving and intermediary fees most traditional banks charge. You can also take advantage of the mid-market rate without any hidden fees or mark-ups. Here are some additional services Wise offers:

• Manage payroll in 38 different currencies – see which countries you can and can’t send to here.
• USD global – pay overseas contractors in USD
• Borderless account – hold, send and receive funds all through one multi-currency account
• Direct debit for GBP and EURO accounts
• Easy integration with accounting software – including Xero.
• Powerful open API – customize services to suit you, from automating payments to connecting business tools

Set up Wise multi-currency account for free, and start saving time and money today.

Sources:

1. Corporate finance institute blog post
2. Investopedia blog post