Completing the accounting cycle
The accounting cycle is the repeated sequence of steps that turns transactions into financial statements each period.
Steps of the cycle
The accounting cycle typically includes: analysing transactions, journalising, posting to the ledger, preparing an unadjusted trial balance, recording adjusting entries, preparing an adjusted trial balance, preparing financial statements, recording closing entries, and preparing a post-closing trial balance. The cycle repeats each accounting period.
Accounting periods
Businesses report for periods such as months, quarters, and years. A fiscal year is any 12-month period used for reporting; it need not match the calendar year. Retailers often end their fiscal year after the holiday season, in late January. US public companies file quarterly (10-Q) and annual (10-K) reports with the SEC.
Adjusting entries overview
Adjusting entries at the end of a period ensure revenues and expenses are recorded in the correct period, following accrual accounting. They update accounts for items such as used-up supplies, expired insurance, depreciation, earned but unbilled revenue, and unpaid wages. They are covered in detail in the accrual accounting unit.
The worksheet
Some accountants use a worksheet, a multi-column spreadsheet, to organise the trial balance, adjustments, adjusted trial balance, and statement columns in one place. It is a working tool, not a formal statement, and is now mostly built into accounting software.
Closing entries
Revenues, expenses, and drawings are temporary accounts: they measure activity for one period and are reset to zero at the end. Closing entries transfer their balances into equity (capital or retained earnings), often through an Income Summary account. Assets, liabilities, and equity are permanent accounts that carry forward.
The post-closing trial balance
After closing, a post-closing trial balance lists only permanent accounts (assets, liabilities, and equity) to confirm debits still equal credits and the books are ready for the next period. All temporary accounts should have zero balances.
Accounting software and controls
Today most businesses use accounting software, such as QuickBooks, Xero, or enterprise systems like SAP and Oracle, which automates posting and statements. Accountants still need to understand the cycle to set up systems, make adjustments, catch errors, and maintain internal controls such as separating duties and requiring approvals.
Worked example
At year end, a business has Service Revenue 50,000 (credit), Rent Expense 12,000 and Wages Expense 20,000 (debits), and Drawings 5,000 (debit). Closing entries move revenue and expenses to Income Summary, giving net income of 18,000, then close Income Summary to Capital (credit 18,000), and close Drawings to Capital (debit 5,000). Capital increases by 13,000 overall.
Key takeaways
The accounting cycle runs from analysing transactions through journalising, posting, trial balances, adjustments, statements, closing entries, and a post-closing trial balance. Reporting periods include months, quarters, and fiscal years. Adjusting entries match revenues and expenses to periods. Temporary accounts (revenues, expenses, drawings) are closed to equity; permanent accounts carry forward. Software automates the cycle, but understanding it remains essential for accuracy and controls.
Flashcard
Repeated steps from transactions to statements
Check your understanding
Which account would NOT appear on a post-closing trial balance?