We are all familiar with accounting but do we know it involves a process called the accounting cycle? The accounting cycle is the process that spans from the point a customer places an order for some goods to the actual preparation of the financial statement. Therefore, as we shop daily in the various outlets we patronize, we are helping them build up their financial database.
But I mentioned it is a cycle, right? Yes, it is. According to the periodicity concept recommended by the International Financial Standards (IFRS), financial statements are reported periodically. These periods can be quarterly, half-yearly, or annually. Therefore, the cycle repeats itself periodically.
Now, let’s talk about the steps:
Source documents: these are documents issued to customers that serve as evidence that a transaction has occurred. It is also a document used for collating and recording all the transactions of a business. Examples include invoices, receipts, payment vouchers, sales/purchase credit memos, etc.
Journal Entries: This is a record that shows the chronological order of transactions. For example, a list of transactions that occurred in a day as recorded by a salesperson, evidenced by the source documents raised. It also specifies cash and credit transactions (payables/receivables).
Ledger: This is the book of account. It groups the various transactions according to their group headings, for example, all cash transactions are recorded in a cash ledger. All credit transactions are recorded in the various receivables and payables accounts. This would facilitate easy tracking of transactions.
Trial Balance: there is also a principle for recording transactions called the double-entry principle. Every transaction involves two or more people hence there is always a giver and a receiver. If I invest in a business, I give you cash in return for shares in the company. Trial balance is the list of all transactions that confirms the accuracy of the various postings in the account. It helps confirm if the principle of double-entry has been adhered to.
Adjustments: To err is human, hence we should not get too excited when our trial balance shows no difference between the total credit and total debit. Some errors do not affect the trial balance, for example, complete omission of a transaction, double recording of transactions, classifying transactions wrongly, etc. As a result, such an account would not result in accurate decision-making. How do we know if there are missing transactions? One way to track this is through bank reconciliation. This is the process of matching transactions in the company books with the bank statement. This would help us identify missing transactions.
At this stage also, I filter the accounts for transactions that do not belong in that period (Prepayments and deferred income). Hence, the matching concept, prescribed by IFRS.
Adjusted trial balance: As a result of this, we then prepare an adjusted trial balance that reflects the accurate position of the business.
Preparation of the financial statement: At this stage, we have all the ingredients necessary for preparing the financial statement that can enhance adequate decision-making.