The Impact of Skipping a Step in the Accounting Cycle

To close your books, you need accurate numbers from the beginning of the accounting cycle.

The accounting cycle exists to ensure that business owners account for every penny spent and earned during the fiscal year. If it is followed completely, the accounting cycle traces the path of every transaction from the invoice to the income statement. Skipping steps in the accounting cycle primes your company's accounting books for error and miscalculation at the end of the fiscal year.

Accounting Cycle Steps

The accounting cycle is an ongoing process that starts with your first company transaction. For example, if you sell an item from inventory, you must post the transaction in the general ledger of your company, prepare a trial balance and adjust the trial balance when you actually receive the money for the item. Once the fiscal year ends, all inflows and outflows of cash are recorded in the financial statements of your company -- Balance Sheet, Statement of Cash Flows and Income Statement -- and the books for your company are "closed."

Internal Consequences

Management decisions regarding the growth and health of a company are often based on the internal accounting documents prepared throughout the fiscal year. Skipping steps in the accounting cycle creates information gaps that cause problems. For example, if your company skips creating a statement of cash flows, you cannot determine the inventory turnover ratio for your company. Without this ratio, you cannot determine if your company keeps too little or too much inventory on hand, which creates supply problems.

Investor Problems

Investors rely on the accounting books of your company to make informed investing decisions. If you skip steps in the accounting style, investors may not have the information necessary to inject capital into your company. For example, if you skip adjusting the entries in your general ledger, and you have money pending in an "Accounts Receivable," investors will question whether you have received the money for your products. Even if customers have actually paid cash for items -- which affects your total profit -- investors will assume that your company did not make as much money as you claim.

Legal Ramifications

Skipping steps in the accounting process creates legal problems for your company if the Internal Revenue Service decides to audit your books. The IRS requires full disclosure to perform audits. If you cannot trace the path of income or expenses from the general journal to the closing of your books, you cannot disprove claims made by the IRS. For example, if a customer claims he paid your company $20,000 for services, but you did not actually receive the money, the IRS will assume that you made the money and did not pay taxes for it.

References

• QuickMBA: The Accounting Cycle
• Thomas and Alex Financial Services: The Top 10 Accounting Problems In an Organization