The Accounting Cycle of Merchandising Business

The accounting cycle is a series of steps followed to ensure accurate and consistent financial reporting. Here’s a detailed description of each step:

 

Identifying and Analyzing Transactions:

The process begins with identifying and analyzing business transactions and events. This involves examining source documents (like invoices and receipts) to determine the impact of each transaction on the company's accounts.

 

Journalizing:

Once transactions are identified and analyzed, they are recorded in the journal (also known as the book of original entry) in chronological order. Each entry includes the date, accounts affected, amounts, and a brief description.

 

Posting:

Journal entries are then posted to the ledger, where each account has its own page. This step helps in organizing transactions by account, providing a complete view of each account's activity and balance.

 

Unadjusted Trial Balance:

After posting, an unadjusted trial balance is prepared. This involves listing all ledger accounts and their balances to check if total debits equal total credits, ensuring that the accounting records are in balance.

 

Adjusting Entries:

Adjusting entries are made at the end of the accounting period to account for accruals, deferrals, and other adjustments necessary to reflect the true financial position and performance of the company. These adjustments ensure that revenues and expenses are recognized in the period they occur.

 

Adjusted Trial Balance (and/or Worksheet):

An adjusted trial balance is prepared after posting adjusting entries. This trial balance ensures that the accounts are still balanced after adjustments. Sometimes, a worksheet is used to facilitate the preparation of financial statements.

 

Financial Statements:

Using the adjusted trial balance, the main financial statements are prepared: the income statement, balance sheet, statement of retained earnings, and cash flow statement. These statements provide a comprehensive view of the company’s financial performance and position.

 

Closing Entries:

At the end of the period, closing entries are made to transfer the balances of temporary accounts (revenues, expenses, and dividends) to permanent accounts (retained earnings). This step resets the balances of temporary accounts to zero in preparation for the next accounting period.

 

Post-Closing Trial Balance:

After closing entries are made, a post-closing trial balance is prepared. This ensures that all temporary accounts have been closed and verifies that total debits equal total credits for the remaining permanent accounts.

 

Reversing Entries:

The final step, performed at the beginning of the next accounting period, involves reversing certain adjusting entries made at the end of the previous period. Reversing entries simplify the recording of subsequent transactions related to accruals by removing the need for double counting.

 

By following these steps, businesses ensure that their financial records are accurate and complete, providing reliable information for decision-making.

Summary:

The accounting cycle is a systematic process that ensures accurate financial reporting. It begins with identifying and analyzing transactions, followed by journalizing and posting entries to the ledger. The trial balance is then prepared to check for balance, and adjusting entries are made to reflect the true financial position. Financial statements are generated using the adjusted trial balance, and closing entries are made to transfer temporary account balances to permanent accounts. Finally, a post-closing trial balance is prepared, and reversing entries may be made at the start of the next period. The accounting cycle is vital for businesses to maintain accurate financial records and produce reliable financial statements. By following the steps of the cycle, companies can ensure transparency, compliance, and informed decision-making. It serves as a framework for organizing financial transactions, facilitating analysis, and providing stakeholders with a clear understanding of the company's financial health. Overall, the accounting cycle is a cornerstone of financial management, enabling businesses to navigate the complexities of financial reporting with confidence.