The Accounting Cycle
Step #1: Analyzing transactions
Step #2: Recording transactions
Step #3: Posting transactions
Step #4: Prepare a trial balance (T.B.)
Step #5: Make adjusting entries
Step #6: Prepare an adjusted T.B.
Step #7: Prepare financial statements
Step #8: Close the books
Step #9: Reversing entries (optional)
Step #1: Analyzing Transactions Using the “Accounting Equation”
 The Accounting Equation: A = L + S.E.
 Determine how each transaction affects the company’s financial position using the accounting
equation.
 At least two items of the equation must be affected by each transaction in order to maintain
the equality (i.e., an increase on one side must be accompanied either by a decrease on the
same side or by an increase on the other side of the equation)
 To start, you may ask the question of “Did the company get anything? And How?/From
whom?” or “Did the company give up anything? And Why?/To whom?”
Step #2: Recording Transactions
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Record the complete effects of each and every transaction chronologically.
The place to record the transactions called journal
The Double-Entry Bookkeeping language: Dr. and Cr.
Temporary versus permanent accounts
Step #3: Posting transactions from journals to ledger accounts
 An account is a place to summarize the changes in one specific asset, liability, or S/E.
 All the accounts collectively are referred to as the Ledger.
Step #4: Prepare a trial balance (T.B.)
 A list of all accounts and their balances
 The total of the debits must equal the total of the credits
 Purpose is to check the accuracy of the recording and have all accounts in one convenient
place.
 Prepared before financial statements are prepared.
Step #5: Adjusting entries
 When: before F/S are prepared
 Why: to record unrecorded revenues and expenses to ensure proper measurement of income
 How: depend on the type of adjustments and how some of the transactions were recorded
initially.
 Five types of adjustments:
(1) Prepaid expense: expenses that were paid for in advance and were unused are
used/expired at the end of the period; (there are two ways to record the transactions initially
and two ways to adjust them accordingly)
(2) Unearned revenue: revenues that were collected in advance and were unearned are
earned by the end of the period; (there are two ways to record the transactions initially and
two ways to adjust them accordingly)
(3) accrued expense: expenses already incurred, but have not been paid for and are not
recorded;
(4) accrued revenue: revenues already earned, but have not been collected and are not
recorded; and
(5) other adjustments: e.g., bad debt expense related to accounts receivables; cost of goods
sold.
Step #6: Prepare an adjusted T.B.
 An adjusted T.B. is the T.B. after adjusting entries are posted
 Use of worksheet
Step #7: Prepare F/S
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Income Statement
Statement of S/E or R/E
Balance Sheet
Statement of Cash Flows (will be dealt with later)
Step#8: Close the books (closing entries)
 When: After F/S are prepared and only at the end of the fiscal year
 Purpose: to close all temporary accounts (all revenues, expenses, and dividends) to R/E
account.
 Don’t close prepaid expense (which is an asset) and unearned revenue (which is a liability)
accounts
 The four entries to close the books:
o Close the revenues to income summary
o Close the expenses (and contra revenue accounts) to income summary
o Close income summary to R/E
o Close dividends to R/E
Step #9: Reversing entries (optional)
 When: after the closing entry
 What: reverse some adjusting entries, specifically,
o Prepaid expense adjustment (only if the pre-payment was recorded as an expense
initially)
o Unearned revenue adjustments (only if advance collection was recorded as a revenue
initially)
o All accrued expense adjustments
o All accrued revenue adjustments
 The reversing entries are dated the first day of the next period (therefore becomes part of next
year’s accounting records).