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What is accounting cycle in finance?
Accounting process is a process, which keeps recording and processing the financial transactions of a firm. It identifies, analyses and records day to day transactions of a firm. Earlier, it was entered manually which takes lots of time and chances of making errors is high.
Computerisation helps to reduce the mathematical errors and save lots of time in preparing financial charts. Now-a-days new software are used, which reduce human efforts and errors are minimised.
Accounting period starts from the first day of financial year and ends at the last day, if financial year, which generally called accounting period. Accounting period varies and depends on various factors. Most commonly used accounting period is annual period.
Steps in accounting cycle
The steps in accounting cycle include −
Accounting cycle starts by recording the transactions. These are recorded as debit and credit. These may be purchases, sales revenue, debt payoff etc.
- Journal entries
Next step in accounting is to keep these records in firm journal in chronological order. Separate accounts are maintained for debit and credit. These accounts should always be equal.
- Posting to general ledger
In this, summary of individual accounts will be there.
- Trail balance
After adjusting the entries, company prepares a document, which contains account titles and balances of general ledger for an accounting period. This is not a financial statement and used internal purpose.
If the balances of different accounts are not matched, then the errors are re-adjusted and respective changes are made and hence, adjusted trail balance is prepared.
- Financial statements
After trail balance is adjusted, the firm prepares financial statements (balance sheet, income statement and cash flow statement).
After completing the current accounting cycle revenue, expenses accounts are closed for current period. Balance sheet accounts are not closed.
- Closing trail balance
As temporary accounts are closed, only permanent accounts appear on closing trail balance.
Fundamentals of accounting cycle
The fundamentals of accounting cycle include −
- Revenue recognition.
- Matching principle.
- Accrual principle.
It is important to understand the above concepts in accounting cycle. These tells about, when to record as a sales revenue, how to match the expenses to revenues of firm. This will also help to make financial statements.
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