Accounting follows a series of steps to accurately report financial information. These steps occur in the same order each accounting period. A key cog in this wheel is the matching concept. Companies must match all income earned with the expenses necessary to earn the income. From this basic principle, the accounting cycle will direct the steps in the accounting sequence.
Accountants must record transactions throughout the accounting period. This requires frequent access to the general ledger and financial data. Transactions often occur every day and need recording in order to update the company’s ledger. Financial accounts hold specific information for different transactions. Common accounts include revenue, cost of goods, expense, asset, liability and equity. Accounts must have all information posted prior to entering the accounting closing process.
The month-end close process begins with accountants adjusting accounts. Accrual accounting requires companies to recognize all information that a company has a right to earn. For example, income accruals recognize future cash a company receives from the sale of goods. Deferrals may also be necessary. A deferral may involve recording an insurance policy as a prepaid expense. The item still has value and is therefore not a true 100 percent expense in accounting terms.
Financial statement preparation is the third part of the accounting cycle. Accountants will place the aggregate total from each account into readable statements. The balance sheet reports account information from asset, liability and equity accounts. The income statement includes revenue, cost of goods and expense accounts, resulting in the period’s net income figure. The statement of cash flows reports cash movements based on activity in financial accounts from the balance sheet and income statement.
Close Temporary Accounts
Once a company’s management approves the current financial statements, accountants will close the accounting books. This involves moving the balance from temporary accounts to permanent accounts. Temporary accounts include revenue, expense and dividends. The information goes to the company’s retained earnings, reported on the balance sheet. Once complete, a new accounting period begins and the accounting cycle repeats.