Accounting Cycle Explained

The accounting cycle is like a factory assembly line - raw transactions go in, polished financial statements come out.

What is the Accounting Cycle?

The systematic sequence of steps followed to record and report business transactions.

Duration: One accounting period (usually 1 year, but can be monthly/quarterly)

The 9 Steps of Accounting Cycle

Transaction Occurs
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1. Identify & Analyze Transaction
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2. Record in Journal (Journalizing)
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3. Post to Ledger (Posting)
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4. Prepare Trial Balance
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5. Make Adjusting Entries
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6. Prepare Adjusted Trial Balance
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7. Prepare Financial Statements
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8. Make Closing Entries
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9. Prepare Post-Closing Trial Balance

Let's understand each step with Ram's Electronics Shop example.

Step 1: Identify & Analyze Transaction

What Happens: A business event occurs that can be measured in money.

Example:

• ❌ "Customer walked into shop" (Can't measure in ₹)
• ✅ "Customer bought TV for ₹30,000 cash" (Measurable!)

Ram's Transaction: Sold goods for ₹10,000 cash

Analysis:

• Which accounts affected? Cash A/c & Sales A/c
• Type of accounts? Real & Nominal
• Debit/Credit? Cash (Real) comes in → Debit, Sales (Nominal - Income) → Credit

Step 2: Journalizing (Recording in Journal)

What Happens: Record transaction in Journal (book of original entry)

Ram's Journal Entry:

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
01-04-2024	Cash A/c ....Dr.		10,000
	To Sales A/c			10,000
	(Being goods sold for cash)

Key Points:

• Date in first column
• Debit account written first (with "Dr.")
• Credit account written below (with "To")
• Narration in brackets
• L.F. = Ledger Folio (page number, filled during posting)

Step 3: Posting to Ledger

What Happens: Transfer journal entries to respective ledger accounts

Ram's Cash Ledger:

Date	Particulars	J.F.	Debit (₹)	Date	Particulars	J.F.	Credit (₹)
01-04	To Sales	1	10,000

Ram's Sales Ledger:

Date	Particulars	J.F.	Debit (₹)	Date	Particulars	J.F.	Credit (₹)
				01-04	By Cash	1	10,000

Process:

• Post debit entry to debit side of Cash A/c
• Post credit entry to credit side of Sales A/c
• Note journal page number in J.F. column

Step 4: Trial Balance

What Happens: List all ledger balances to verify:
Total Debits = Total Credits

Ram's Trial Balance (After multiple transactions):

Account Name	Debit (₹)	Credit (₹)
Cash A/c	50,000
Capital A/c		1,00,000
Purchases A/c	30,000
Sales A/c		10,000
Rent A/c	5,000
Furniture A/c	25,000
Total	1,10,000	1,10,000

✅ Balanced! (Both sides equal)

Step 5: Adjusting Entries

What Happens: Record items not yet recorded (outstanding, prepaid, depreciation)

Examples:

• Salary for March ₹10,000 not paid (Outstanding)
• Rent paid ₹12,000 for April-May also (Prepaid)
• Depreciation on furniture @10%

Ram's Adjusting Entry:

Particulars	Debit (₹)	Credit (₹)
Salary A/c ....Dr.	10,000
To Outstanding Salary A/c		10,000
(Being salary outstanding for March)

Step 6: Adjusted Trial Balance

What Happens: Prepare trial balance again AFTER adjusting entries

Purpose: Ensure all adjustments recorded correctly

Ram's Adjusted Trial Balance:

Account Name	Debit (₹)	Credit (₹)
Cash A/c	50,000
Capital A/c		1,00,000
Purchases A/c	30,000
Sales A/c		10,000
Rent A/c	5,000
Furniture A/c	25,000
Salary A/c	10,000
Outstanding Salary A/c		10,000
Total	1,20,000	1,20,000

Step 7: Financial Statements

What Happens: Prepare final reports:

A. Trading & Profit & Loss Account:

• Shows profit or loss
• Ram's Profit = Sales - Purchases - Expenses = ₹10,000 - ₹30,000 - ₹15,000 = Loss ₹35,000

B. Balance Sheet:

• Shows financial position on last day
• Assets vs Liabilities

Step 8: Closing Entries

What Happens: Transfer all nominal account balances to Profit & Loss A/c

Ram's Closing Entry:

Particulars	Debit (₹)	Credit (₹)
Profit & Loss A/c ....Dr.	35,000
To Purchases A/c		30,000
To Rent A/c		5,000

Effect: All expense accounts become ZERO (ready for next year)

Step 9: Post-Closing Trial Balance

What Happens: Trial balance with ONLY Real & Personal accounts (no Nominal)

Ram's Post-Closing Trial Balance:

Account Name	Debit (₹)	Credit (₹)
Cash A/c	50,000
Furniture A/c	25,000
Capital A/c		65,000
Outstanding Salary A/c		10,000
Total	75,000	75,000

Note: All income/expense accounts removed (closed), only asset/liability remain

Why This Cycle?

Purpose	Benefit
Systematic	No transaction missed
Verifiable	Trial balance checks errors
Complete	From journal to final accounts
Repeatable	Same process every period
Auditable	Clear paper trail

Real Company Example: Reliance

Reliance follows this cycle:

1. Lakhs of transactions daily (sales, purchases, salaries)
2. All journal|ized in ERP system
3. Auto-posted to ledgers
4. Trial balance generated monthly
5. Adjustments for depreciation, provisions
6. Quarterly financial statements prepared
7. Year-end closing entries
8. Cycle repeats next year!

Common Mistakes in the Cycle

❌ Mistake 1: Skipping adjusting entries
✅ Fix: Always account for outstanding/prepaid items

❌ Mistake 2: Not closing nominal accounts
✅ Fix: Transfer all income/expense to P&L

❌ Mistake 3: Trial balance doesn't tally, still proceed
✅ Fix: Find error BEFORE moving ahead

Quiz

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💡 Final Wisdom: "The accounting cycle is your financial GPS - it ensures you never lose track of where your money is going. Follow each step religiously, and your accounts will always be accurate and audit-ready!"