The Accounting Cycle
The accounting cycle refers to the cyclical nature of accounting.
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Firstly, a transaction occurs which gives rise to a source document
A 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/s must have a corresponding credit/s.
Example of some transactions are:
n purchased goods from J Jones (source document - invoice);
n returned goods to J Jones (source document - credit note);
n paid cash to J Jones (source document receipt).
Secondly, 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 a summary of all Wages transactions for the month.
An example of a journal include:
n Purchases Journal;
n Purchase Returns and Allowances Journal;
n Cash Payment Journal;
n General Journal.
There are seven journals in total.
Thirdly, 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.
Fourth, a trial balance is prepared.
A trial balance is a list of all ledger account balances prepared on a particular day.
Finally, the end of period reports (Profit & Loss Statement, Balance Sheet) are prepared for presentation to management, owners and interested parties.
The accounting cycle is therefore:
Transaction (source document) è Journal è Ledger è Trial Balance è Reports