The Accounting Cycle

Accounting is a process that has:

an INPUT of large quantities of diverse and uncollated financial information extracted from financial source documents or other evidence of financial transactions; and
an OUTPUT of simplified information in the form of financial reports (Profit and Loss Statement, Balance Sheet) which the owners and managers use to understand and manage the business

The process has the following important steps:

Analysing and categorising the information contained within source documents that continually flow into the business as a result of financial transactions taking place.
Recording all the financial transactions represented by source documents in Journals.
Summarising, on a monthly basis, all the financial transactions recorded within Journals and transferring (the term is "posting" in accounting terminology) to the General Ledger.
Collating all the information contained within the General Ledger to produce Financial Reports

The following diagram represents these four steps. As each step occurs, financial information is summarised and simplified.

The Financial Statements are a summary of the General Ledger, the General Ledger is a summary of the Journals and the Journals is a summary of all the Source Documents that have been received and recorded.

This process is referred to as cyclical (The Accounting Cycle) due to the nature of the work which, in most organisations and businesses, follow a monthly cycle. The inputs (source documents) are recorded, analysed and summarised on a monthly basis so that business owners and managers have updated financial report at the end of the monthly cycle.

Here is another way of looking at things.

A transaction occurs which gives rise to a source document

Transaction refers to a financial event that occurs in a business and affects the elements of the accounting equation. The accounting equation states that every debit must have a corresponding credit.

Example of some transactions are:

purchased goods from J Jones
returned goods to J Jones (source document - credit note)
paid cash to J Jones (source document receipt).

These transactions are posted into a Journal. The purpose of a journal is to diarise transactions and then to summarise these transactions to simplify information ready for posting to the General Ledger. A journal often has a number of columns and similar transactions are place into appropriate columns. For instance in the Cash Payments Journal, all payments for wages can be entered into the "Wages" column. Then at the end of the month the column is totalled to provide

An example of a journal include:

Purchases Journal
Purchase Returns and Allowances Journal
Cash Payment Journal
General Journal

There are seven journals in total.

Journal entries are posted into the general ledger.

A ledger is a book, set of loose cards, or file of all the accounts. The purpose of the general ledger is to summarise the monthly postings from the Journal Books throughout the year.

The ledger will be set out in a particular order. For example, we may use the order Proprietorship, Assets, Liabilities, Expenses and Revenue that are referred to as PALER order. Definitions for each of these are on page two.

A trial balance is prepared. A trial balance is a list of all general ledger account balances prepared on a particular day.

From the trial balance, the financial reports (Profit & Loss Statement, Balance Sheet) are prepared for presentation to management, owners and other interested parties.

The accounting cycle is therefore: