The Accounting Process: Overview for Beginners to Learn the Accounting Cycle
Accounting is the language of the business. In this article, you will explore the financial side of a business by learning about the basic flow of accounting process.
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American Accounting Association defined Accounting
"the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information. "
American Institute of Certified Public Accountant defined Accounting
"the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof.
Accounting is a process. You cannot skip one of these steps except for the last step which is referring to the preparing of reversing entries. Learn the summary of each step and what importance it brings to accounting.
1. Source document
- as the word implies it is a document which serves as the source or evidence of a transaction.
- noun pertaining to an economic events that are financial in nature.
- Sometimes, there are nonfinancial event that are need to be recorded in General Journal. Example is Declaring Dividends.
1. Identify and Analyze the Transaction and event
What do you need?
Answer: Source document
- Receipt- When you buy an office computer
- Loan agreement- When you borrowed or lend money
What to do?
Answer: Analyze and Identify. It is important to analyze and identify to properly report what really happened. Also, a brief explanation is required in a journal entry too.
- Receipt- When you buy an office computer you have a purchasing transaction
- Loan agreement- When you borrowed or lend money. This source can be viewed as two point of view. Analyze by reading the agreement. If you are the borrower, you have a loan transaction. If you are the one who lend money, you have an investment transaction.
Example of a Source document
Double-entry of accounting is applied here. There is always a debit and a credit in a journal entry.
You have a receipt of a computer evidencing a purchase at 500 dollars in cash.
January 1, 2013
Office Equipment (Debit/ Dr) 500
Cash (Credit/ Cr) 500
Purchase a Computer at 500 dollars in cash. receipt # 315
2. Recording Journal entries
Journal is a Book of Original Entry as the entries are recorded as transactions happened. In chronological order.
- You can record a journal entry manually or electronically. Manually by writing in a book. Generally, now that we are already in the 2nd millennium, journalizing is done electronically thru computers either by excel or an accounting software.
Two types of Journal Books
1. Classified According to Transactions
Transactions that are frequently used.
All Transactions, except for those which can be entered in Special Journal
a. Purchase Journal
b. Sales Journal
c. Cash Receipts Journal
d. Cash Disbursements Journal
- copy the debit and credit from Journal to the Ledger
4. T- account
- is an accounting tool to show the debit and credit for a better understanding of the effect of double- entry.
3. Posting in the Ledger
Posting is important to finalize each account. This is where the classifying phase of accounting lies.
Ledger is a Book of Final Entry.
It is a collection of accounts that shows the changes made to each account as a result of past transactions, and their current balances. This is the center of classification phase.
Manually, a T- account is used by Accountants up to date to see the balance and the transactions affecting each account. .
How to Post entries from Journal to Ledger
4. Prepare the Unadjusted Trial Balance
A trial balance is prepared to test the equality of the debits and credits. All debit balances are added. All credit balances are also added. The total debits should be equal to total debits.
"Please note that it doesn't absolutely mean that when debit and credit have the same amount, everything is okay. No. It can be wrong if you miss transactions. Or you debit and credit at the same time wrong amounts.
Error of Omission ─ this occurs when a transaction is completely left out or omitted from the accounting entries.
Error of Commission – This occurs where proper double entry is observed except an entry is made to the wrong personal account.
Compensating Errors – These occur where two or more accounting errors cancel out their effect on the trial balance.
Complete Reversal of Entries – When accounting entries are mistakenly reversed the entries are still debited to one account and credited to another.
Transposition Error – A Transposition Error occurs when entries are made to the correct account but the figures are not entered in the correct order.
Errors of Duplication- Such errors arise when an entry in a book of original entry has been made twice and has also been posted twice.
5. Make Adjusting Entries
Accrual basis of accounting is applied in this step.
These are prepared to have the accounts updated. Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or liability method), prepayments (asset method or expense method), depreciation, amortization and allowances.
6. Prepare the adjusted trial Balance
An adjusted trial balance may be prepared after adjusting entries are made.
This is to test if the debits and credits are equal.
7. Prepare Financial Statements
If a baker's product is a stunning desert, and a painter's masterpiece is a fabulous painting, accountants have a reliable and relevant Financial Statements as the end-product. This is the summarizing phase of accounting.
A complete set of financial statements is made up of:
- Statement of Comprehensive Income or Income Statement and Other Comprehensive Income,
- Statement of Financial Position or Balance Sheet,
- Statement of Changes in Equity,
- Statement of Cash Flows, and
- Notes to Financial Statements.
Statement of Comprehensive Income
The users of this statement will see if the business entity is in a good or bad position in terms of income within a period of time
It is normally prepared yearly. In addition, some entities required it quarterly or semi-annual.
This will reflect the business entity's Net Income or (Net Loss)
8. Closing entries
What accounts are needed to be close?
Answer: Temporary or nominal accounts, i.e. income statement accounts, are closed to prepare them for the next accounting period. These items are measured periodically.
- Income Accounts
- Expense Accounts
- Withdrawal accounts
How to close?
In layman's term, the balance of these accounts needed to be nil or zero. In order to do that, if the balance is debit, you should credit it to make it's balance zero.
Since accounting need always a double-entry, the opposite entry is a summary account- Income Summary. Next, Income summary is closed to it's appropriate capital account.
Which Step in the Accounting Process did you find as the most interesting?
9. Reversing entries
This final step is optional.
As the name implied- reverse, in this step, the adjusting entries made for accrual of income, accrual of expenses, deferrals under the income method, and prepayments under the expense method are reversed.