Accounting Cycle

Note: This overview is intended for beginning students and will be more valuable upon a second reading after completing the book.

A business starts with an investment of cash and/or other personal assets.
Additional assets like land, buildings, equipment, and supplies are acquired.
Expenses such as salaries, advertising, and taxes are either paid or liabilities are incurred, which include accounts payable, notes payable, and taxes payable.
Revenue is generated either as cash or as a promise of payment (accounts receivable).
Accounting is the process of tracking these financial activities and summarizing them for interested parties like owners, managers, creditors, and potential investors.
The accounting cycle begins with the collection of financial data and ends with reports concerning financial activity (Income Statement) and financial position (Balance Sheet).

The accounting cycle starts with Journal Entries.
Journal Entries are a chronological record of financial activity stored in the General Journal, which is a book of original entry.
An "account" (data file) is created for each type of Asset, Liability, Equity, Revenue, and Expense that the company wants to track.
Accounts are stored in the General Ledger.
Posting is the process of copying data from the General Journal to each General Ledger account.
- For example, changes to Cash, which are spread throughout the General Journal, are summarized in the General Ledger Cash account, allowing a cash balance to be calculated.
This posting process is done for all accounts.
A Trial Balance is then prepared to check the dollar balances of all accounts in the General Ledger to ensure accounts are in balance.

Adjusting Entries are required at the end of the accounting cycle.
Reasons for adjusting entries:
- Some expenses have been estimated (e.g., taxes).
- Others are more efficiently recorded at the end of the cycle (e.g., depreciation).
- Others require special analysis (e.g., supplies used).
- Non-expense adjustments are also possible (e.g., Unearned Revenue).
All adjustments are made in the General Journal and then transferred to the appropriate ledger account.
An Adjusted Trial Balance is prepared to ensure accounts are still in balance after the adjustments.

A preliminary, informal calculation of the company's financial position is accomplished through a worksheet.
Revenues and expenses are compared; the difference represents income (Profit or Loss).
Assets are compared with liabilities and equity to ensure everything is in balance based on the accounting equation: $Assets = Liabilities + Equity$ .
Once the worksheet balances are verified, a formal Income Statement and Balance Sheet are prepared.

Completing the accounting cycle requires reducing expense and revenue accounts to zero so the next cycle's income may be properly calculated. This is typically achieved through closing entries.
A Post-Closing Trial Balance is prepared as a final check to ensure accounts are in balance after the closing entries.
Reversing entries, which simplify the adjusting process, and correcting entries, which are made to rectify errors, are part of completing the accounting cycle.

Two concepts must be understood before recording transactions:
- The relationship between Assets, Liabilities, and Owner's Equity, as demonstrated by the accounting equation. The accounting equation is expressed as: $Assets = Liabilities + Owner'sEquity$
The system of debits and credits is designed to change the variables of the accounting equation.