The Accounting Cycle

Key Things To Know

Financial Accounting

Key Things To Know

The accounting cycle is:

1)  Record transactions as journal entries

See recording transactions on a spreadsheet and recording journal entries for further discussion

2)  Post amounts in “T” accounts for each account and balance the “T” account for each account to get the ending balance

See the section on journal entries for further discussion

3)  Prepare an unadjusted trial balance.  This is done before making adjustments so that you can see what accounts need adjusting.

The unadjusted trial balance will have 3 columns and debits must = credits

Account Name Debit $ Credit $

Assets and expense amounts go in the debit column. Liabilities, owner’s equity, and revenue amounts go in the credit column. Contra asset accounts go in the credit column

4)  Record adjusting journal entries

Entries made to adjust to the accrual basis – make sure the matching principle is followed – revenues when earned and expenses when incurred

See adjusting journal entries for further discussion 

5)  Post the amounts from adjusting journal entries in the “T” accounts and get a new final balance for each account.  This is the final balance.

6)  Prepare an adjusted trial balance

This will have 3 columns and will show the final amounts that will be reported on the financial statements.  Debits must = credits

Account Name Debit $ Amount Credit $ Amount

Assets and expense amounts go in the debit column. Liabilities, owner’s equity, and revenue amounts go in the credit column. Contra asset accounts go in the credit column

7)  Prepare an income statement

Put all revenue, expense, gain, and loss accounts on the adjusted trial balance on the income statement in proper format.

8)  Close all temporary accounts only – accounts reported on the income statement and the dividends paid account 

The income statement is for a period of time.  Income statement accounts must start at 0 at the beginning of each year. 

At the end of each period, income statement account balances are transferred to retained earnings so they can begin at 0 next period.

Dividends are paid out of retained earnings.  You must also transfer the dividends paid account to retained earnings so it can begin at 0 also

Retained earnings is the accumulated profit or loss less dividends paid
Revenue – expenses + gains – losses = profit or loss

See below for detail closing journal entries

9)  Prepare a post closing trial balance – this will show balance sheet accounts only and retained earnings will include this year’s earnings and dividend paid.

10)  Prepare the balance sheet.  Put the account names and the amounts for assets, liabilities, and owner’s equity on the balance sheet in proper format.

Trial Balance:

A list of all individual accounts in the left columns with two columns for the debit balance and the credit balance to the right of the account list.

The total of all debits must equal the total of all credits. This means the accounts are in balance.
It does not mean that all journal entries made were correct – wrong amounts and wrong accounts could have been used and the trial balance can still balance when debits equal credits for each individual journal entry.

Assets & Expenses must have debit balances
Liabilities & Owner’s Equity & Revenues must have credit balances

Contra asset accounts have a credit balance
Dividends paid has a debit balance

Permanent or Real Accounts:

Balance sheet accounts do not start over at the beginning of a period

The balance sheet reports what you have and owe at a particular point in time

Assets and Liabilities do not go away when a new period starts.   These accounts have beginning balances and as transactions occur, the balances change.

Temporary or Nominal Accounts:

Income statement accounts that are used to record transactions for a certain period of time.

These accounts must start over at the beginning of each period so that the amounts in the account is for this period only.

The net of these accounts – rev, exp, gains, losses- is transferred to retained earnings at the end of the period.  (See step 8 in the process)

Closing Entry:  

Transfers income statement accounts – revenues, expenses, gains, and losses and dividends paid to the retained earnings account.

You must list all expense, loss and dividends paid accounts as a credit.
The retained earnings $ amount is the total of all credit amounts

An expense and loss has a debit balance.  You must credit it for the same amount to make the balance go to 0.

Retained Earnings       $XXXXX
       ___expense                        $XXX
       ___expense                        $XXX
       ___expense                        $XXX
       ___expense                        $XXX
       cost of goods sold              $XXX
       loss on sale                          $XXX
       dividends paid                   $XXX

You must list all revenue and gain accounts.  The retained earnings $ amount is the total of all debit amounts.

A revenue and gain has a credit balance.   You must debit it for the same amount to make the balance go to 0.

Sales                            $XXX
Interest Income          $XXX
Dividend Income        $XXX
Service Revenue         $XXX
Gain on Sale               $XXX
       Retained earnings          $XXX