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

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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.  

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:

  1. Identifying and analyzing the transactions
  2. Recoding these transactions into the general journal
  3. Posting to the General Ledger
  4. Preparing a trial balance
  5. Making adjusting entries
  6. Preparing an Adjusted Trial Balance
  7. Preparing financial statements
  8. Closing accounts

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

  • 1st 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 10th of July. Here, $50,000 is the monetary value, and two persons Mr. John & Mr. Alison exchange Office Equipment for money.

  • 2nd 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. 

3rd 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. 

  • 4th 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. 

  • 5th 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. 

  • 6th 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. 

  • 7th 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.

  • 8th 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 2nd 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

DateDescription (Account Name)Debit Credit
Jan 2. 2017Cash60,000 
 

Capital Stock

 60,000
Jan 2.House35,000 
 

Land

15,000 
 

Cash

 50,000
Jan 3.Cash30,000 
 

Notes Payable

 30,000
Jan 4.Furniture15,000 
 

Cash

 15,000
Jan 5.Prepaid Insurance6,000 
 

Cash

 6,000
Jan 6.Advertising Expense450 
 

Cash

 450
Jan 7.Cleaning Supplies950 
 

Account Payable

 950
Jan 15.Wages Expense4,230 
 

Cash

 4,230
Jan 16.Cash980 
 

Rent Received in Advance

 980
Jan 31.Cash8,300 
 Revenue- Rental of Rooms 8,300
Jan 31.Cash6,600 
 

Revenue- Restaurant

 6,600
Jan 31.Dividends600 
 

Cash

 600
    
  183,110183,110

 

3. Ledger Accounts

T account 1

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. 

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Hiffza Aziz - Author

She is a Xero Advisor Certified and Remote Account Assistant, where she prepare monthly financial reports for the clients. She is a highly motivated and detail-oriented individual with a passion for learning.

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