Study: Overview of the Accounting Cycle
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Study the (6m:31s) video for this topic provided below: Overview of the Accounting Cycle - Slides 1-10
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Slides 1-3 (0m:57s)
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Welcome to Introduction to Accounting Preparing for a User's Perspective
Overview of the accounting cycle
In previous topics we studied the general-purpose financial statements Links to an external site., their equations and how the financial statements can help external users make debt and equity financing decisions.
In this topic, I will discuss the Accounting Cycle Links to an external site., which is a set of recurring procedures and thought processes used by entities to convert economic data from source documents into general purpose financial statements.
The accounting cycle is called a "cycle", because its procedures and thought processes are performed over, and over, and over again, year, after year, after year. Each year, when all of the proper steps have been successfully performed in order, a set of reliable financial statements will be produced and the company will be ready to account for a new year.
Slides 4-6 (3m:22s)
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Five key steps in the accounting cycle are as follows:
1) identify economic transactions and the related source documents to help determine what accounts need to be updated.
2) analyze the impact of the information on the company's accounts by determining the answer to the following questions a) What accounts were affected? b) For each affected account, did the account increase or decrease? c) What is the account's increase or decrease amount? d) Will the account need to be debited Links to an external site. or credited Links to an external site.? Don't worry, if you don't yet understand what debits and credits are because they will be the focus of one of the upcoming topics in this learning module.
3) record journal entries to reflect the impact of the information on the company's accounts determined above.
The full accounting cycle
Because I think the full accounting cycle is better presented horizontally the following slide will show the 5 steps just discussed but in a way that indicates a progression from original transaction entries, to adjusting entries
Links to an external site., to closing entries. I will also point out when, during the full accounting cycle, you would prepare the financial statements
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4) post the impact of the recorded journal entries to each account's general ledger account so its revised account balance can be computed.
5) prepare a trial balance which lists all accounts and their respective debit or credit balances to ensure that the balance sheet equation is still in balance.*
* After the adjusted trial balance Links to an external site. is prepared, the company will prepare its general-purpose financial statements.
1) record entries related to original transactions with customers, employees, suppliers, governments, lenders, owners, etc.
2) record entries related to adjusting entries to correct any misstated accounts from 1 above. For example, prepaid rent may need to be adjusted to reflect the using up of a few more months, or interest expense Links to an external site. related to outstanding loans may need to be accrued Links to an external site.. IMPORTANT: Once the final adjusted trial balance has been prepared, the company can prepare its financial statements for distribution to external parties.
3) record closing entries to close all nominal Links to an external site. accounts (i.e. all revenues, expenses and dividends) into the retained earnings account. After the closing entry steps are fully completed, the company will be ready for a new year thus sending it back to the recording of original transactions again.
Let's take just a moment to discuss the purpose of closing entries Links to an external site.. After the financial statements for a given year have successfully been produced, the company must close all of its nominal (i.e. temporary) accounts into Retained Earnings Links to an external site.. Nominal accounts are temporary equity accounts, such as Revenues, Expenses and Dividends that cause Retained Earnings to change during the year. All nominal accounts are closed into Retained Earnings at the end of each year. By closing all nominal accounts into Retained Earnings (a permanent account) at the end of every year, the company will be able to start the new year with zero balances in revenues, expenses and dividends, and their old balances will be carried forward on the balance sheet within the Retained Earnings account. Closing entries also ensure that no old revenues Links to an external site., expenses, or dividends from prior years get accidentally mixed up with current year revenues, expenses and dividends, thus avoiding the risk of being double-counted.
Slide 7-10 (2m:13s)
Links to an external site.Right now you might be asking yourself, "Why do I need to understand the accounting cycle?" Here are my thoughts on the subject. Over your lifetime, you can pretty much guarantee that you will somehow be involved or impacted by the accounting cycle, because you will perform it, manage it, program it, audit it, or certify the results of it in the form of reliable financial statements. Regardless of your future involvement, a strong understanding of the accounting cycle will help you speak accounting: the language of business.
Summary
What you just received was a super-condensed, super-speed discussion of the accounting cycle. Over the next several topics, we will dig into the steps of the accounting cycle in more detail to ensure you fully comprehend it and can do it.
Please note, I do not yet expect that you are an expert on the accounting cycle because we haven't really even dug into the component steps yet. Don't worry, it is OK if you don't yet fully understand it, the subsequent topics in this and other modules will help you master it. As of now, just make sure that you remember the 5 recurring steps of the accounting cycle below and make sure you know them in order:
1) identify relevant economic information
2) analyze the impact on the accounts
3) record journal entries
4) post the entries to the general ledger
Links to an external site. accounts
5) prepare a trial balance
Also make sure you know the three types of entries that are made during the accounting cycle and when the financial statements would be prepared as noted below:
1) original transaction entries
2) adjusting entries (including the preparation of financial statements)
3) closing entries
If you would like to see another professor's summarized discussion of the accounting cycle, you might like the following (7m:53s) one on YouTube titled: lecture 6 - the accounting cycle
Links to an external site.If you have even more time to spare (i.e. 57m:15s) here is a video of a full, live lecture on the accounting cycle posted on YouTube that you might find interesting: Chap 04 Lecture - The Accounting Cycle
Links to an external site.Good luck on the quiz.