What Is the Accounting Cycle?

This excerpt was originally published in full on ScaleFactor’s blog.

In order for businesses to look back on how they did in the past, they need to follow a certain set of steps to verify that their financials are accurate. These steps are commonly referred to as the accounting cycle because, after each accounting period has ended, businesses repeat the same basic steps. 

The goal of the accounting cycle steps is to ensure that every cent that changed hands during the accounting period is accounted for properly and reflected in a company’s financial statements. Financial statements serve as the ultimate historical record for a business, and the stakes are high for getting them right. Outside parties like banks, investors, and the IRS will look at your financial statements to decide things like whether to give you a loan or whether you paid the right amount in taxes. 

You can think of the accounting cycle as a checklist that needs to be completed at the end of the accounting period. When all steps are checked off, you can move on to the next accounting period with a clean slate. 

An accounting period can be a month, quarter, or year depending on how often your business needs financial reports.

Before we go through each step of the cycle and the accounting terms associated with each, it’s important to remember that this process originated when accountants completed these steps by hand in physical ledgers and journals. We’ll highlight which of these steps now happen behind the scenes thanks to computers, but we’ll go through each so that you’ve got a full understanding of the process. 

Accounting Cycle Steps

Depending on who you ask, there can be anywhere from six to nine steps in the accounting cycle. Some prefer to consolidate a few steps into one, but it’s really a matter of personal preference. For simplicity’s sake, we’ll start by showing you the long version of the accounting cycle, with each step broken out clearly. 

Identify Transactions

Step one: gather together all the information you have on every transaction that took place during the period. Hopefully you or your bookkeeper are doing this throughout the period instead of waiting until the month ends and scrambling to find receipts. 

Remember that when you recognize income and expenses depends on the type of accounting you use. If you run on cash accounting, you’ll look for every time that cash changed hands during the period. If you’re using accrual accounting, you’ll only recognize financial transactions when incurred.  

Record Transactions

In the old days, recording a transaction meant writing down the transaction in the appropriate journals. These journals, or “books,” are how bookkeeping got its name. According to double-entry accounting, each transaction should be recorded as both a credit and debit in separate journals. 

Now, as long as you classify the transaction in your accounting software, the rest will happen more or less automatically. 

Post to General Ledger

Another hallmark of bygone days is the general ledger. The general ledger was a master list of all transactions. If a fire broke out in your back office, this would be the thing to save. After recording a transaction in the appropriate journals, you would also add it to the general ledger. 

Thanks to the magic of the internet and automation, the general ledger now lives in the background of the accounting cycle today. It’s transitioned from a physical book to a part of the cloud, and accountants don’t really have to touch it. 

Calculate Unadjusted Trial Balance

The first three steps of the accounting cycle can (and should) take place throughout the accounting period. Calculating the unadjusted trial balance is the first step that can only take place once the period has ended and all transactions have been identified, recorded, and posted to the general ledger. 

Creating an unadjusted trial balance is akin to checking your homework. Because every transaction is recorded as a debit and a credit, the goal of this step is to ensure that your total debit balance and total credit balance are equal. If not, something was missed or misclassified. It’s normal to discover anomalies at this stage. Invoices that you expected to be paid (but weren’t) can throw it off. Payments that you expected your vendors to collect (but didn’t) can also cause issues. 

Whatever the case, an unadjusted trial balance simply shows you all your debits and credits in a table. And if they don’t add up to the same amount, you can use this table to begin investigating why. 

Make Adjusting Journal Entries

This step simply resolves any anomalies that are found. First, you identify what is causing the debits and credits to be misaligned. Then you make journal entries to fix them. 

Create an Adjusted Trial Balance

Next up, time to double check your work one last time with the help of an adjusted trial balance. This table shows your unadjusted trial balance, your adjusting entries, and your adjusted amounts. It’s the final step before creating financial statements, so it’s worth triple checking everything.