The 8 Steps in the Accounting Cycle | A Step-by-Step Example Guide

As an accounting student or professional, you must be well aware of the complete accounting cycle. The whole accounting revolves around the Accounting Cycle. It is a complete process where an accountant or the bookkeeper performs accounting tasks.

What is Accounting Cycle?

In This Article

The Accounting Cycle is the complete accounting process that starts with the identification of financial transactions and ends with the preparation of financial statements and the closing process.

Steps in the Accounting Cycle

The accounting cycle comprises eight important steps. They are:

Identifying and analyzing the transactions
Recoding these transactions into the general journal
Posting to the General Ledger
Preparing a trial balance
Making adjusting entries
Preparing an Adjusted Trial Balance
Preparing financial statements
Closing accounts

Let’s take a closer look at each individual step of the accounting cycle:

1^st Step: Identifying and Analyzing Transactions

The cycle starts when a financial transaction occurs such as the purchase of an asset or sale of an inventory. A transaction is a business event that involves two things: monetary value (money) and an exchange of goods or services. For example: Mr. John purchased office equipment from Mr. Alison for $50,000 on the 10^th of July. Here, $50,000 is the monetary value, and two persons Mr. John & Mr. Alison exchange Office Equipment for money.

2^nd Step: Recording these transactions into the general journal

After analyzing transactions, now is the time to record these transactions in the general journal. A general journal records all financial transactions in chronological order. The general journal format includes the date, accounts affected, amounts, and a brief description of the transaction.

For Example: Mr, Ahmed made a purchase of equipment worth $1200, then the transaction would be Debit Equipment with the amount of $1200 and credit cash with the same amount of $1200.

3^rd Step: Posting to the General Ledger

When you record all transactions in the general journal, now, is the time to post these all transactions in the appropriate T account (General Ledger). The accounting cycle is a very easy step-by-step process.

For example, you have made an entry where you debited the Entertainment account for $40 and credited cash $40. Now, this transaction will affect the Cash and Entertainment account only, where, on the Cash T Account, you will decrease or put his $40 amount on the right side of the T account.

4^th Step: Preparing a Trial Balance

This step will tell you whether your all debits and credits are equal or not. Trial Balance has 3 columns: Particulars, Debit, and Credit. The total of all debits should equal the total of all credits.

5^th Step: Making Adjusting Entries

Adjusting entries are made at the end of an accounting period to adjust those accounts that need to be updated or adjusted. Adjustments include the recording of depreciation expense, the gradual release of prepayments, and the recording of earned revenue from unearned revenues at the end.

6^th Step: Preparing an Adjusted Trial Balance

After adjustments, there is a need to prepare a trial balance again that ensures that all credits and debits are equal. This new trail balance is termed an adjusted trail balance.

7^th Step: Preparing Financial Statements

The seventh step requires to prepare financial statements including the income statement, balance sheet, Statement of Retained Earnings, and cash flow statement. These statements are helpful and show the company’s current financial position and performance.

8^th Step: Closing Accounts

Closing accounts is the last step, where you have to close all temporary accounts such as expenses and revenues (mostly income statement items) to retained earnings and owner’s equity account. This is very essential step to restarting your accounting cycle for the next accounting period.

Step-by-Step Example of Accounting Cycle

1. Identifying and Analyzing Transactions

Now, let’s have a closer look on the complete accounting cycle process by performing the following example step by step.

During the month of January, Haram’s Company process the following transactions.

TRANSACTIONS

02/01/2023. Salim started business with cash investment of $20000.
02/01/2023. Purchased Office building worth $35,000 and land costing $15,000. The Office building will have estimated salvage value of $5,000 with a useful life of 25 years.
03/01/2023. A promissory note of $30,000 was executed at a State Bank. Both the principal and interest will be paid on the maturity date of January 3, 2019.
04/01/2023. Furniture was purchased with a cost of $15,000, paid in cash. It has a useful life of ten years and is not anticipated to have any salvage value.
05/01/2023. A property insurance policy, spanning 24 months, was acquired in cash $6,000.
06/01/2023. The company placed an advertisement in the local newspaper, making a cash payment of $450 for the ad, which will run throughout the month of January.
07/01/2023. Cleaning supplies purchased on credit, with a total cost of $950. The invoice is payable within a 30-day period.
15/01/2023. Total of $4,230 in wages for the first half of the month was paid in cash.
16/01/2023. A guest paid a cash deposit of $980 for a two-week stay. The guest plans to stay from the last week of January through the first week of February.
31/01/2023. Total cash receipts from room rentals for the month amounted to $8,300.
31/01/2023. The cash receipts from the operation of the restaurant for the month totaled $6,600.
31/01/2023. Each stockholder received a cash dividend payment of $200.

2. General Journal

The 2^nd step in the Accounting Cycle is to prepare the General Journal. Now it’s time to record the above transaction in the general Journal. Let’s get started.

*General Journal*
*Date*	*Description (Account Name)*	*Debit*	*Credit*
Jan 2. 2017	Cash	60,000
	Capital Stock		60,000
Jan 2.	House	35,000
	Land	15,000
	Cash		50,000
Jan 3.	Cash	30,000
	Notes Payable		30,000
Jan 4.	Furniture	15,000
	Cash		15,000
Jan 5.	Prepaid Insurance	6,000
	Cash		6,000
Jan 6.	Advertising Expense	450
	Cash		450
Jan 7.	Cleaning Supplies	950
	Account Payable		950
Jan 15.	Wages Expense	4,230
	Cash		4,230
Jan 16.	Cash	980
	Rent Received in Advance		980
Jan 31.	Cash	8,300
	Revenue- Rental of Rooms		8,300
Jan 31.	Cash	6,600
	Revenue- Restaurant		6,600
Jan 31.	Dividends	600
	Cash		600

		183,110	183,110

3. Ledger Accounts

4. Preparing a Trail Balance

	Haram’s Company Trial Balance January 31
*Account*	*Account*	*Balance*
#	*Title*	*Debit*	*Credit*
111	Cash	29,600
117	Prepaid Insurance	6,000
119	Cleaning Supplies	950
144	Furniture	15,000
146	House	35,000
148	Land	15,000
212	Account Payable		950
213	Notes Payable		30,000
216	Rent received in advance		980
312	Capital Stock		60,000
313	Dividends	600
411	Revenue- Rental of Rooms		8,300
412	Revenue- Restaurants		6,600
511	Advertising Expense	450
521	Wages Expense	4,230

		106,830	106,830

5. Making Adjusting Entries

*General Journal*
*Date*	*Description (Account Name)*	*Debit*	*Credit*
Jan 31.	Depreciation Expense (W-1)	100
	Accucm Dep- House		100
Jan 31.	Depreciation Expense (W-2)	125
	Accum Dep- Furniture		125
Jan 31.	Interest Expense (W-3)	300
	Interest Payable		300
Jan 31.	Insurance Expense (W-4)	250
	Prepaid Insurance		250
Jan 31.	Rent Received in Advance (W-5)	490
	Revenue- Rental of Rooms		490
Jan 31.	Wages Expense	5,120
	Wages Payable		5,120
Jan 31.	Supplies Expense	720
	Cleaning Supplies		720
Jan 31.	Utilities Expense	740
	Utilities Payable		740
Jan 31.	Income Tax Expense	1,007
	Income Tax Payable		1,007

		8,852	8,852

Working

W-1

House- 35000 ((35000-5000)/25)/ (1/12))

S.V= 5000

U.L= 25 yrs

W-2

Furniture- 15000 ((15000/10)/ (1/12))

S.V= 10

W-3

Promissory Note- 30000, Rate 12%

(30000*12%)/12

W-4

Prepaid insurance- 6000, years -2

(6000/2)/12)

W-5

Receive in Advance- 980

Used- 980/2

6. Preparing an Adjusted Trial Balance

	Haram’s Company Adjusted Trial Balance January 31
*Account*	*Account*	*Balance*
#	*Title*	*Debit*	*Credit*
111	Cash	29,600
117	Prepaid Insurance	5,750
119	Cleaning Supplies	230
144	Furniture	15,000
145	Accum Dep- Furniture		125
146	House	35,000
147	Accucm Dep- House		100
148	Land	15,000
212	Account Payable		950
213	Notes Payable		30,000
214	Wages Payable		5,120
215	Utilities Payable		740
216	Rent Received in Advance		490
217	Interest Payable		300
218	Income Tax Payable		1,007
312	Capital Stock		60,000
313	Dividends	600
411	Revenue- Rental of Rooms		8,790
412	Revenue- Restaurants		6,600
511	Advertising Expense	450
512	Wages Expense	9,350
513	Insurance Expense	250
514	Supplies Expense	720
515	Utilities Expense	740
516	Depreciation Expense	225
517	Interest Expense	300
518	Income Tax Expense	1,007

		114,222	114,222

7. Preparing Financial Statements

Profit and Loss Statement

Another name widely used for Profit & loss statements is the income statement which represents the company’s expenditures and revenues over a given period of time. The structure of the Profit and loss account is different from the Balance sheet statement which predicts a line-wise reporting style. The main content and items of the Profit and loss account include the revenues, cost of goods sold, gross profit, all expenses, and the year-end income. If the amount is negative, it means that the company had incurred a loss and if the amount is positive, it means that the company had earned a significant profit within the specific time period.

*Haram’s Company*
*Income Statement*
*For the Month Ending January 31*

Revenues:
From rental of rooms	8,790
From restaurant	6,600
Total Revenue		15,390

Less: Expenses
Advertising	450
Wages	9,350
Depreciation	250
Interest	720
Insurance	740
Supplies	225
Utilities	300
Income Taxes	1,007
Total Expenses		(13,042)

Net Income		2,349

Income before taxes		3,355

Statement of Retained Earnings

*Haram’s Company*
*Statement of Retained Earnings*
*For the Month Ending January 31*

Retained Earnings, January 1
Add: Net Income	2,349
Subtotal	2,349
Less: Dividends	(600)
Retained Earnings, October 31	1,749

Balance Sheet Statement

Another name widely used for a balance sheet is the statement of financial position which shows the current financial position of the company. The structure of the balance sheet is designed to distinguish the two major amounts and their balance should represent the same amount. Balance sheets could be prepared by using two methods: T-method or the reporting method. Both represented two sides of the balance sheet including the assets, liabilities, and owner’s equity. The main content and items of the balance sheet include current and non-current assets, current and non-current liabilities, and owner’s equity.

*Haram’s Company*
*Balance Sheet*
*January 31*

Assets:	Balance
Current Assets:	Debit
Cash	29,600
Cleaning Supplies	5,750
Prepaid Insurance	230
Total current assets		35,580
Property, Plant, and Euip.:
Land	15,000
House, net of accum. Depr.	34,900
Furniture, net of accum. Depr.	14,875
Total Property, Plant, and Euip.		64,775
Total Assets		100,355

Liabilities and Stockholders’ Equity
Liabilities:
Current Liabilities:
Accounts Payable	950
Interest Payable	300
Wages Payable	5,120
Income Taxes Payable	1,007
Rent received in advance	490
Utilities Payable	740
Total current liabilities		8,607
Long-term Debt:
Notes Payable	30,000
Total Liabilities		38,607

Stockholders’ Equity:
Capital Stock	60,000
Retained Earnings	1,749
Total Stockholders’ Equity		61,749

Total Liabilities & Stockholders’ Equity		100,355

8. Closing Accounts

*General Journal*
*Date*	*Description (Account Name)*	*Debit*	*Credit*
31-Jan	Revenue- Rental of Rooms	8,790
	Revenue- Restaurants	6,600
	Income Summary		15,390
31-Jan	Income Summary	13,042
	Advertising Expense		450
	Wages Expense		9,350
	Insurance Expense		250
	Supplies Expense		720
	Utilities Expense		740
	Depreciation Expense		225
	Interest Expense		300
	Income Tax Expense		1,007
31-Jan	Income Summary	2,349
	Retained Earning		2,349

31-Jan	Retained Earning	600
	Dividends		600

		31,380	31,380

Preparing a Post-Closing Trial Balance: After the closing entries are made, a post-closing trial balance is prepared to ensure that the closing entries were recorded correctly and that all temporary accounts have a zero balance.

	Haram’s Company Post-Closing Trial Balance January 31
*Account*	*Account*	*Balance*
#	*Title*	*Debit*	*Credit*
111	Cash	29,600
117	Prepaid Insurance	5,750
119	Cleaning Supplies	230
144	Furniture	15,000
145	Accum Dep- Furniture		125
146	House	35,000
147	Accucm Dep- House		100
148	Land	15,000
212	Account Payable		950
213	Notes Payable		30,000
214	Wages Payable		5,120
215	Utilities Payable		740
216	Rent Received in Advance		490
217	Interest Payable		300
218	Income Tax Payable		1,007
311	Retained Earning		1,749
312	Capital Stock		60,000


		100,580	100,580

Key Points

Here are the key points for the accounting cycle:

The accounting cycle is the complete process of recording, analyzing, and tracking all accounting data of a business.
It starts when a transaction is incurred and ends when the financial statements are published and books of accounts are closed.
The accounting period could be a month or a year.
Now, it has become very easy to complete the accounting cycle because of the accounting software that automates the whole process.
Bookkeeper has to ensure that all transaction are accurately recorded and catagoried.