What are the Steps in the Accounting Process?
The accounting process is the series of steps followed by the business entity to record the business financial transactions that include steps for collecting, identifying, classifying, summarizing and recording of the business transactions in the books of accounts of the company so that the financial statements of the entity can be prepared and the profits and the financial position of the business can be known after regular intervals of time.
Steps in Accounting Process
The various steps of the accounting process are:
#1 – Identify the Transaction
Identifying the business transaction is the initial step in the process of accounting. The business entity has to identify financial and monetary transactions. Therefore, only those transactions that are monetary is recorded. Also, the transactions that belong to the business are to be recorded, and not the personal transactions of the owner are included in the books of accounts of the business.
#2 – Recording of the Transactions in the Journal
After identifying the transactions, the second step of the accounting process is to create the Journal entry for every accounting transactionAccounting TransactionAccounting Transactions are business activities which have a direct monetary effect on the finances of a Company. For example, Apple representing nearly $200 billion in cash & cash equivalents in its balance sheet is an accounting transaction. . The point of the recording of transactions is based on the policy followed by the entity for accounting, i.e., accrual basisAccrual BasisAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. or cash basis of accountingCash Basis Of AccountingCash Basis Accounting is an accounting method in which all the company's revenues are accounted for only when there is an actual cash receipt, and all the expenses are recognized when they are paid. Small companies and individuals generally follow this accounting method.. In the accrual basis of accounting, the revenues and expenses are recorded in the books of the entity in the period when they are earned and incurred respectively, regardless of the actual cash receipt and payment. However, in the case of cash accounting, the transactions are recorded only when the actual cash is received/paid. In a dual entry system, every transaction affects at least two accounts, i.e., one account is debited, and another account is credited. For example, if the purchases are made in cash, then the purchases account will be debited (purchases increases), and the cash account is credited (cash decreases).
#3 – Posting in the Ledger
After recording the transaction in the Journal, the individual accounts are then posted in the general ledgerGeneral LedgerA general ledger is a book of accounts that records the everyday business transactions in separate ledger accounts. The entries made in a ledger can be verified by getting a NIL balance on summing up all the ledger account amounts in the trial balance.. This helps the owner/accountant to know the balance of each account individually. For example, all the debits and credits of the bank account are transferred to the ledger account, which helps to know the increase and decrease in bank balance during a period, and finally, we can determine the ending bank balance from it.
#4 – Unadjusted Trial Balance
The trial balance of the company is prepared to check whether the debits are equal to the credits or not. Basically, trial balance’s main purpose is to identify the errors, if any, made during the above process. Trial balance reflects all the balances of accounts at the given point of time. After the preparation of the trial balance, it is checked that the total of all credits is equal to the total of all debits, and if the total is not the same, then an error is to be identified and corrected. There can be other reasons for error also, but still, firstly, an accountantAn AccountantAn accountant is a finance professional responsible for recording business transactions on behalf of a firm, reporting the firm’s performance and issuing financial statements. Thus, an accountant plays an important role whether it is a small domestic entity or a large multinational company. tries to locate the error from prepare preparing the trial balance, and also trial balance helps to know the balances of all accounts in a summarized form.
#5 – Adjusting Journal Entries
When the accrual basis of accounting is followed, some of the entries are to be made at the end of the accounting year, such as entries of expenses that may have been incurred but are not booked in the Journal and entries of some income that may be earned by the business but are not yet recorded in the books. For example, the interest amount on a fixed deposit is earned each year, but it is accumulated in the fixed deposit amount. This interest income is to be recorded in the books of accounts yearly because the interest is earned yearly, no matter the amount will be received together after the maturity of the fixed deposit.
#6 – Adjusted Trial Balance
After all the adjusting entriesAdjusting EntriesAdjusting Entries in Journal is a journal entry made by a company at the end of any accounting period on the basis of the accrual concept of accounting. Companies are required to adjust the balances of their various ledger accounts at the end of the accounting period in order to meet the requirements of the various authorities' standards. are made, again, a trial balance is to be prepared before preparing the financial statements to check that all the credits are equal to the debits after the adjustment entries are made.
#7 – Preparation of Financial Statements
After all the above steps are completed, the financial statements of the company are prepared to know the actual financial position, the profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. position, and the cash flow position of the business. The statements that are prepared for knowing the above positions are a statement of profit and loss for knowing the profitability position, the balance sheet for getting the financial position, and the cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities. to know the changes in cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. from the three activities of the business (operating, investing and financing activities).
#8 – Closing Entries
Finally, the accounting cycle ends with this step. These entries transfer the temporary accountTemporary AccountTemporary accounts are nominal accounts that start with zero balance at the beginning of the financial year. The balance is visible in the income statement at the year-end and then transferred to the permanent as reserves and surplus. balances to a permanent account. The temporary accounts are the accounts whose balances ends in a single accounting year such as sales, purchases, expenses, etc. These balances are first transferred to the income statement and then to the permanent account, i.e., the profit/loss is transferred to retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. account. It should be cleared that only temporary accounts are closed not the permanent ones (accounts that are balance sheet accounts such as fixed assets, debtors, inventory, etc.)
After closing entries are made, the trial balance is again prepared to check that the debit is equal to the credit, and the accounting cycleAccounting CycleAccounting Cycle refers to the process of recording transactions and summarizing them for the preparation of financial statements. The objective is to generate useful information in the form of three financial statements namely Income Statement, Balance Sheet and Cash Flows. starts again with the beginning of another accounting year.
Thus, the accounting process includes the steps that are to be followed for recording, classifying, summarizing, etc. the financial transaction of the business where the process starts with identifying the transaction and ends mainly with the preparation of financial statements that are finally used and evaluated by the users of the business.
This has been a guide to Steps in Accounting Process and its definition. Here we discuss the eight important steps of the accounting process. You may learn more about financing from the following articles –