The Accounting Cycle

Lesson 1

Lesson Overview

Topics covered:
I. Introduction to Accounting
II. The Accounting Cycle

Learning Objectives:
At the end of this lesson, you are expected to:

1. Briefly explain the definition of accounting

2. Understand the purpose of accounting
3. Enumerate the steps of the accounting cycle

Assessment:
∙ Activity 1 – Fill the box

What is accounting?

Accounting is regarded as the language

of business. It is a means through which
business entities communicate
information to
different users.

The American Institute of

Certified
Public Accountants (AICPA) defined
accounting as: "the art of recording,
classifying,
and summarizing in a significant manner
and in
terms of money, transactions and events which
are, in part at least of financial character, and
interpreting the results thereof."
Figure 1. 1 Accounting
Purpose of Accounting

The AICPA also provided this definition: "Accounting is a service activity. Its function is to
provide quantitative information, primarily financial in nature, about economic entities that is intended to
be useful in making economic decisions, in making reasoned choices among alternative courses of
action."

The American Accounting Association (AAA) defined accounting as: "the process of identifying,
measuring and communicating economic information to permit informed judgment and decision by users
of the information."

Based on the above definitions and the very nature of accounting as the language of business, it is
evident that the basic purpose of accounting is to provide information needed by users in making
economic decisions.

These users include: current and potential investors, management, lenders, creditors, the
government, employees, customers, and the general public. These users have varied interests and therefore
have different information needs.

In our previous lessons from quarter 1, we already discuss the different users of Financial
Statements, The type of businesses, Branches of Accounting, and others. Now let’s proceed to the
Accounting Cycle. You may have encountered it already from your grade 11 but we need to review this
for better understanding of Accounting Cycle.
Have you heard about the water cycle?
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I am sure that all of us heard the word water cycle it is the

continuous movement of water within the Earth and atmosphere.
Liquid water evaporates into water vapor, condenses to form
clouds, and precipitates back to earth in the form of rain and
snow. Water in different phases moves through the atmosphere.

Water cycle is a process and it is the one responsible for rains

and providing us water on the earth. Just like the water cycle,
accounting also has a step-by-step process in providing the
Financial Statement. It is called the Accounting Cycle.

What is the Accounting Cycle?

Figure 1. 2 Water
Cycle

The accounting cycle is the various steps or stages of work or activity that we go through each year in
accounting.
The cycle is depicted diagrammatically below:

Illustration 1. 1 The Accounting Cycle

The cycle above is a cycle of actions we go through when accounting for any

business. Steps in the Accounting Cycle

1. Source
Documents

Source
documents
are
documents,
such as
cash slips, invoices,
etc. that form the
source of, and
serve as proof for, a
transaction. In other
words, they
are the first
documents that exist relating to a
transaction. Bookkeepers and accountants need to
keep source documents for each transaction.

In short, you are going to identify the

receipts, invoices, cash slips, receipts, check
counterfoils, bank deposit slips and keep it for the
recording of the economic transaction occurred in
the business.Figure 1. 3 Receipts
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2. Journals

Journal entries are that first basic entry of debit and credit for
each transaction, chronological (date-order) records of
transactions entered into by a business.

In the examples we have been doing in previous lessons, where

we debited one account and credited another, we have been doing
journal entries.

Journals also refer to the books of first entry, such as the cash
receipts journal, the general journal and more
F
3. Ledger (T-Accounts)

The ledger is a grouping of the accounts of a business. The

accounts are in the shape of a "T" and thus are often referred to
as T-accounts.

In this step we take all the journal entries (debits and credits)
relating to one account (in this example, bank) and draw up an
account with all the transactions relating to it.

igure 1. 4 Sample

Journal
Figure 1. 5 Sample T-Accounts
There are a few lessons on T accounts:

1. In the first lesson we'll look at the format of a T-account and how to draw one up.
2. In the second lesson we'll learn how to balance a T-account.

4. The Trial Balance

The trial balance is a sheet or report displaying all

the
accounts of a business, drawn up as a trial (test) of
whether
the total of all the debit balances equal the total of
all the
credit balances.

(A balance is the amount of an item at a point in

time. For
example, the balance in the bank account on the
1st of
January was $5,000.)

The trial balance is prepared as a final check before

drawing up the financial statements. When errors are shown up balance above.
in the trial balance, we make corrections through adjusting
entries. The purpose of the financial statements is to show the reader the
financial position, financial performance and cash flows of a
5. Financial Statements business.

The financial statements are the key reports of a business. As Financial statements are usually prepared once a year, and
mentioned, they are prepared from the information in the trial consist of an income statement, statement of changes in owners’
equity, balance sheet, cash flow statement and where needed, an
auditor’s report.
Closing Entries

Figure 1. 6 Sample Trial Balance

Figure 1. 7Sample Financial Statement
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There is a final step in the accounting cycle not shown above, which is the closing off of accounts (or
closing entries), which are done at the end of each year along with the production of the financial
statements.

This involves closing out temporary accounts (incomes and expenses), and transferring their balances
through a profit account into the owners’ equity (reserves).

Manual vs Computerized Accounting Systems

It is important to note that these days many businesses

use computerized accounting systems, and so the
accounting cycle is largely automated.

This means that the bookkeeper or accountantsimply

enters the basic data about a transaction, and the
posting is then automatically
done to the relevant
accounts and through the trial
balance to the financial
statements. Temporary accounts
are also
automatically closed off at the
end of the period.

Additionally, errors occur less

often with
computerized systems, but even when these do occur,
the bookkeeper or accountant can make a quick
adjusting entry and watch as the correction is
automatically carried through to the revised T
accounts, trial balance and financial statements.

But even with this automation, it is still important that and its various stages.
bookkeepers and accountants understand the accounting cycle Figure 1. 6 Manual Accounting
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