Ready to Master the Accounting Cycle? Dive Into Your Comprehensive Guide!

Embark on Your Journey to Financial Mastery with This Comprehensive Guide to Mastering the Accounting Cycle and Understanding the Basis of Accounting!

By: Inderjeet Jeed

Updated: May 10th, 2024 5:15PM

Have you ever wondered how businesses keep track of their financial transactions and prepare their financial statements? The answer lies in the field of accounting. In this blog post, we'll explore the basics of accounting, including the five main accounts, financial statements, and each step of the accounting cycle. Let's dive in!

Key Stats and Facts:

• According to the Bureau of Labor Statistics, the median annual wage for accountants and auditors was $73,560 in May 2020.
• The American Institute of Certified Public Accountants (AICPA) reports that there are over 2.9 million accountants and auditors employed in the United States.
  

The Five Main Accounts

1. Assets: Assets are resources that a company owns and can use to generate revenue. Examples include cash, inventory, and equipment.
2. Liabilities: Liabilities are obligations that a company owes to external parties. Examples include loans, accounts payable, and accrued expenses.
3. Shareholders Equity: Equity represents the owner's stake in the business. It is calculated as assets minus liabilities and reflects the company's net worth.
4. Revenue: Revenue is the income generated from the sale of goods or services. It is recorded when the sale is made, not when the cash is received.
5. Expenses: Expenses are the costs incurred to generate revenue. Examples include salaries, rent, utilities, and supplies.

Financial Statements

Financial statements are reports that provide an overview of a company's financial position and performance. The main financial statements include:

1. Income Statement (Statement of Financial Performance): The income statement shows a company's revenues, expenses, and net income or loss over a specific period.
2. Statement of Changes in Equity (or Statement of Retained Earnings): This statement tracks changes in a company's equity over a period of time, including items such as dividends paid, stock issuances, and changes in retained earnings.
3. Balance Sheet (Statement of Financial Position): The balance sheet provides a snapshot of a company's assets, liabilities, and equity at a specific point in time.
4. Statement of Cash Flows: The statement of cash flows shows how changes in balance sheet accounts and income affect cash and cash equivalents performance.

These financial statements provide valuable information to investors, creditors, and other stakeholders about a company's financial health and performance.

The Accounting Cycle

The accounting cycle is the process of recording, summarizing, and reporting financial information. It consists of several key steps:

Step 1: Analyze Transactions:

• Identify the nature of each transaction (e.g., sale, purchase, expense).
• Determine which accounts are affected (e.g., cash, inventory, accounts payable).

Step 2: Journalize Transactions:

• Record transactions in the general journal, including the date, accounts debited and credited, and a brief description.
• Ensure each entry follows the double-entry accounting principle, with debits equaling credits.

Step 3: Post to the General Ledger (T-Accounts):

• Transfer journal entry information to the appropriate T-accounts in the general ledger.
• Update each account balance with the transaction amounts.

Step 4: Prepare the Unadjusted Trial Balance:

• List all ledger accounts and their balances (debit or credit).
• Verify that the total debits equal the total credits, indicating that the accounts are in balance.

Step 5: Prepare Adjusting Entries:

• Make adjustments for accruals (revenues or expenses that have occurred but not yet recorded) and deferrals (revenues or expenses that have been recorded but not yet earned or incurred).
• Adjust for depreciation, bad debts, prepaid expenses, and unearned revenues.

Step 6: Prepare the Adjusted Trial Balance:

• List all ledger accounts and their adjusted balances after applying the adjusting entries.
• Verify that total debits still equal total credits.

Step 7: Prepare the Financial Statements:

• As discussed above

Step 8: Prepare Closing Entries:

• Close revenue and expense accounts to the income summary account.
• Transfer the balance of the income summary account to the retained earnings account.
• Close dividends to retained earnings.

Step 9: Prepare the Post-Closing Trial Balance:

• List all ledger accounts and their balances after closing entries have been made.
• Verify that total debits equal total credits, ensuring that the accounts are ready for the next accounting period.

Step 10 (Unofficial) Repeat Every Year (or Accounting Cycle):

• The accounting cycle is an ongoing process that repeats each fiscal year to provide updated financial information for decision-making and reporting purposes.

Following these steps ensures that financial transactions are recorded accurately and that the resulting financial statements reflect the true financial position and performance of the company.

Conclusion: Mastering the Basics of Accounting

Understanding accounting basics is key for financial management or an accounting career. Learn about main accounts, financial statements, and the accounting cycle for insights into tracking finances. Whether you're a business owner, student, or future accountant, this knowledge is crucial.

Call to Action: Apply these principles in your financial management or studies. Take courses, read, or find mentorship to deepen your understanding. A strong accounting foundation will help you make informed decisions and succeed in your career.