Back to: Financial Accounting
Hello again, everyone!
This week, we’re diving into the accounting cycle—the step-by-step process businesses follow to record and report financial information. Think of it as the “life cycle” of a transaction, from when it first occurs to when it appears in the financial statements.
Accounting Cycle and Source Documents
Steps in the Accounting Cycle
The accounting cycle typically includes the following stages:
Identifying transactions
Every accounting process starts by identifying transactions that need to be recorded. These must be both measurable and financial in nature.
Source documents
These are the original records of business transactions—like receipts, invoices, bank statements, and credit notes. They provide evidence of transactions.
Journal entries
Transactions are recorded in the general journal in date order, using the double-entry system.
Posting to the ledger
Entries are transferred (posted) to the general ledger, where transactions are grouped by account (e.g. cash, sales, expenses).
Trial balance
After all entries are posted, a trial balance is prepared to ensure that total debits equal total credits.
Adjusting entries
At the end of the period, adjustments are made for items like depreciation, accruals, and prepayments.
Financial statements
From the adjusted trial balance, we prepare the financial statements: income statement, balance sheet, and cash flow.
Closing entries
Temporary accounts (like revenue and expenses) are closed to retained earnings.
Post-closing trial balance
A final check to confirm the books are balanced before the new period begins.
Source Documents – Why They Matter
In accounting, accuracy is everything. That’s why source documents are crucial. They support the figures in your books and are used as evidence during audits.
Common examples:
Sales invoice – confirms a credit sale
Purchase invoice – used when buying goods/services
Receipts – proof of cash transactions
Bank statements – confirms payments and deposits
Credit notes – issued for returns or errors in invoices
In this digital age, many of these are now electronic, but their role hasn’t changed—they serve as proof.
Journals and Ledgers – A Quick Refresher
Journal: Often called the “book of original entry”. Every transaction is first recorded here.
Ledger: This is where transactions are sorted by account. It gives a clear picture of how each account (like rent, cash, or revenue) changes over time.