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 the business transactions in the books of accounts of the company so that the financial statements of the entity can be prepared. The profits and the business’s financial position can be known after regular intervals of time.
Table of contents
- What are the Steps in the Accounting Process?
- Steps in Accounting Process
- Recommended Articles
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 are recorded. Also, the transactions that belong to the business are to be recorded, and not the owner’s transactions 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 recording 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 entity’s books 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, the purchases account will be debited (purchases increase), 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 an accounting record that compiles every financial transaction of a firm to provide accurate entries for financial statements. The double-entry bookkeeping requires the balance sheet to ensure that the sum of its debit side is equal to the credit side total. A general ledger helps to achieve this goal by compiling journal entries and allowing accounting calculations. . t helps the owner/accountant know each account’s balance 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. Finally, we can determine the ending bank balance from it.
#4 – Unadjusted Trial Balance
The company’s trial balance is prepared to check whether the debits are equal to the credits or not. The trial balance’s main purpose is to identify any errors made during the above process. The trial balance reflects all the accounts balances at the given time. After the preparation of the trial balanceTrial BalanceTrial Balance is the report of accounting in which ending balances of a different general ledger are presented into the debit/credit column as per their balances where debit amounts are listed on the debit column, and credit amounts are listed on the credit column. The total of both should be equal., it is checked that the total of all credits is equal to the total of all debts, and if the total is not the same, then an error is to be identified and corrected. There can be other reasons for the error, but 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 by preparing the trial balance. 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 StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business. 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 end 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 the 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 equals 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 the 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 –