What the Accounting Cycle Is
Some common misconceptions about the accounting cycle can be dispelled simply by understanding the steps of the accounting cycle and why it must be followed. The accounting cycle must be followed to ensure that proper records are kept for your business or for the company you are performing accounting tasks for. There are nine basic steps of the accounting cycle. These steps are:
- Collect and analyze incoming data from your company’s financial transactions and events.
- Record all transactions into the appropriate journal - for example, if the transaction involves adding an asset, add the transaction to your assets journal.
- Record all information into the general ledger.
- Balance your ledger by performing a trial balance.
- Make sure to record and prepare adjustments for the end of any period.
- Re-balance your ledger with the adjustments taken into account.
- Put together your financial statements - the balance sheet, the income and expense report, etc.
- Close out accounts by giving them a zero balance at the end of the period to avoid confusion.
- Put together a trial balance after the accounts have been closed out.
Now that you are familiar with the steps involved in the accounting cycle, it will be easier to understand misconceptions about the accounting cycle.
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Misconception #1: You Don’t Need to Track All Data
Sometimes your business has so much data that it can be overwhelming. Maybe you’re stepping into an accounting role at a firm that has put all of their data in several hundred pounds worth of files, all for you to go through. Whatever the situation is with the transaction and event data, you need to collect it all - at least as much of it as you can get - and you need to analyze it all. What’s worse? Being overwhelmed with organizing, sorting, tracking, and recording data now, or not being able to figure out where $20,000 went because inaccurate records were kept?
Misconception #2: You only Need to Go Through the Accounting Cycle at Tax Time
Are you serious?
Think about the headache that staving off important accounting tasks until that most stressful time of year comes about causes. Your job (and your tax accountant’s job) will be a million times easier if you follow the steps of the accounting cycle monthly, quarterly, and annually - even if you are just running a small business.
Misconception #3: You Only Need to Balance Your Ledger Once
You will notice on the above accounting cycle description of steps, that there is a trial balance prepared not one, not two, but three times over the course of the accounting cycle. One common accounting cycle misconception is that the only time you need to balance your ledger is right after you’ve entered in your information into journals. If you perform an unadjusted trial balance, you can test out whether the debits and credits equal one another and ensure your general ledger is accurate before proceeding any further in your accounting cycle. After you have made any adjustments to ensure that all accounts are at their correct balances, then you will perform a trial balance once again. Once you have closed out your accounts for the period, you will once again perform a trial balance. This ensures that your records are accurate.
Misconception #4: You Don’t Need to Close Out Accounts Each Accounting Period
When you close your revenue and expense accounts out, you will be zeroing them to prevent future problems. If you do not close out your accounts, it will be difficult for you to figure out whether January’s report included that last transaction that posted February 1st or not. Do yourself a favor and give the accounts zero balances at the end of each of your accounting periods. The balances (whether they are positive or negative) will be kept track of in your owners’ equity journal.
Misconception #5: The Accounting Cycle is Tedious
The final misconception about the accounting cycle that I will discuss here is the misconception that following the accounting cycle is tedious. If you perform your accounting tasks on a monthly basis rather than allowing tasks to build up, you will have an easier time of things. If the accounting cycle is not followed, many things can go wrong, and fixing this will be tedious. It is best, therefore, to follow the accounting cycle on a regular basis.