Xavier Lightfoot
Intermediate Accounting
Essay 1
There are about ten steps to the accounting cycle and I will be discussing them all
in my essay while using JCPenney as an example. The first objective in financial
reporting is to obtain information about external transactions and this is accomplished by
source documents. All source documents are just a way to relay the necessary
information for each transaction to the accountant. Source documents could be sales
invoices, bills from suppliers, and cash register tapes. The documents will have the date,
participating parties, nature of each transaction, and the monetary terms. For instance,
JCPenney source documents could be a checks, receipts, or invoices from their suppliers.
JCPenney would then use that information from the source documents to perform the
next step in the accounting cycle, which is transaction analysis.
For transaction analysis JCPenney would go over the different source documents
to determine how it effected the accounting equation and what accounts were specifically
involved. For example, JCPenney has many different transactions to occur in one
business day such as supplies purchased on account costing $1000, salaries of $9,000
were paid to employees, or credit sales that totaled $10,000 that day. All of these are real
examples of some transactions that JCPenney would have to deal with on a daily or
weekly basis.
The third step in the process after transaction analysis would be to record the
transaction in a journal. All journals do is provide a chronological record of all the
economic events that will affect the company or business. Any kind of transaction can be
recorded in the journal because it has a place for the account titles, date of the transaction,
account numbers, and explanations of why something is what it is. Therefore if JCPenney
wanted to record their credit sales of $10,000 that day then they would do that by
recording a debit to accounts receivable and a credit to sales revenue in the journal with
the associated dollar amount which in this case would be the $10,000. They also could
record the supplies they purchased on account by recording a debit to assets and credit to
accounts payable for the $1,000.
The fourth step of the process is at the end of the period to post or transfer the
debit and credit information used in the journal to the general ledger accounts. Posting is
just transferring all the information such as debits and credits recorded in journal entries
to the specific accounts affected. The ledger usually has a posting reference such as the
page number of the journal that the journal entry was recorded so that it is easy to
maneuver between the journal and the ledger. Using JCPenney as an example if we use
the same three transactions in the above paragraphs then their ledger would consist of
cash, accounts receivable, sales revenue, supplies, and accounts payable.
The fifth step of the process is to prepare an unadjusted trial balance.
The trial balance is just a list of the general ledger accounts usually listed in the order
they appear in the ledger with the date and ending summed balance to go along with it.
The purpose of the trial balance is to check to make sure the summed debits of each
account equal the summed credits of each account making sure that both sides are equally
balanced so that the accounting equation is still correct that assets equal liabilities plus
stockholders equity. For JCPenney their unadjusted trial balance would include the
ending summed accounts with the proper debits and credits for cash, accounts receivable,
sales revenue, supplies, and accounts payable.
The sixth step in the process is to record adjusting entries and post them to the
general ledger account. Adjusting entries are not transactions that have source documents
or an exchange transaction with another entity. All they do is help with accrual
accounting and satisfying the matching principle where we recognize revenues earned in
that period regardless of when we get the cash. They also recognize expenses incurred no
matter when the cash payment is made. So if JCPenney takes in credit sales of $120,000
in the month of January but did not receive $50,000 of those sales till February we would
still recognize that revenue in January because that is the period in which it was incurred
and vice versa for expenses.
The seventh step is very simple we now have to prepare an adjusted trial balance.
We do this because the adjusting entries have now been posted to the general ledger
accounts and so we must go back and reflect any changes so that we will have an
accurate or correct trial balance.
The eighth step in the process is what we have been building up to it is the reason
we have all the other steps because now it is time to prepare the financial statements. The
first statement is the income statement and it basically summarizes the revenues,
expenses, gains, and losses of the business. For example, JCPenney’s income statement
would include their sales revenue, their costs of goods sold, and all of their expenses such
as salaries, supplies, rent, and depreciation. After calculating these numbers you should
get the net income, which essentially is the profit of your business or company. The next
statement is the balance sheet, which is used to present the financial position of the
company on a particular date. The balance sheet presents the assets, liabilities, and
stockholders’ equity at a point in time. Balance Sheet items are grouped together in
categories or common characteristics. The next statement is the statement of cash flows,
which is used to summarize the transactions that caused cash to change during the period.
The statement classifies all transactions as an operating activity, investing activity, or
financing activity. The last statement is the statement of shareholders’ equity, which is set
up to disclose the sources of changes in the various permanent shareholder’s equity
accounts that occurred during the period.
The ninth step of the process is to close the temporary accounts to retained
earnings. The temporary accounts include revenues, expenses, gains, and losses. All of
which are reduced to zero balances and closed at the end of the year only. In closing the
last and final step of the process is to prepare a post closing trial balance and the purpose
of this is to make sure all closing entries were prepared and posted accurately and the
accounts are ready for the next year’s transactions.