The accounting process is three separate types of transactions used to record business transactions in the accounting records. This information is then aggregated into financial statements. The transaction types are:
- The first transaction type is to ensure that reversing entries from the previous period have, in fact, been reversed.
- The second group is comprised of the steps needed to record individual business transactions in the accounting records.
- The third group is the period-end processing required to close the books and produce financial statements.
We will address these three parts of the accounting process below.
Beginning of Period Processing
Verify that all transactions designated as reversing entries in preceding periods have actually been reversed. Doing so ensures that transactions are not recorded twice in the current period. These transactions are usually flagged as being reversing entries in the accounting software, so the reversal should be automatic. Nonetheless, examine the accounts at the beginning of the period to verify the reversals. If a reversing flag was not set, an entry must be reversed manually, using a new journal entry.
The steps required for individual transactions in the accounting process are:
- Identify the transaction. First, determine what kind of transaction it may be. Examples are buying goods from suppliers, selling products to customers, paying employees, and recording the receipt of cash from customers.
- Prepare document. There is frequently a business document to be prepared or recognized to initiate the transaction, such as an invoice to a customer or an invoice from a supplier.
- Identify accounts. Every business transaction is recorded in an account in the accounting database, such as a revenue, expense, asset, liability, or stockholders' equity account. Identify which accounts are to be used to record the transaction.
- Record the transaction. Enter the transaction in the accounting system. This is done either with a journal entry or an on-line standard transaction form (such as is used to record cash receipts against open accounts receivable). In the latter case, the transaction forms record information in a pre-determined set of accounts (which can be overridden).
These four steps are the part of the accounting process used to record individual business transactions in the accounting records.
The remaining steps in the accounting process are used to aggregate all of the information created in the preceding steps, and present it in the format of financial statements. The steps are:
- Prepare trial balance. The trial balance is a listing of the ending balances in every account. The total of all the debits in the trial balance should equal the total of all the credits; if not, there was an error in the entry of the original transactions that must be researched and corrected.
- Adjust the trial balance. It may be necessary to adjust the trial balance, either to correct errors or to create allowances of various kinds, or to accrue for revenues or expenses in the period.
- Prepare adjusted trial balance. This is the original trial balance, plus or minus all adjustments subsequently made.
- Prepare financial statements. Create the financial statements from the adjusted trial balance. The asset, liability, and shareholders' equity line items form the balance sheet, while the revenue expense line items form the income statement.
- Close the period. This involves shifting the balances in the revenue and expense accounts into the retained earnings account, leaving them empty and ready to receive transactions for the next accounting period.
- Prepare a post-closing trial balance. This version of the trial balance should have zero account balances for all revenue and expense accounts.
In reality, any accounting software package will automatically create all versions of the trial balance and the financial statements, so the actual steps in the accounting process may be considerably reduced. Instead, the steps used in a computerized environment are likely to be:
- Prepare financial statements. This information is automatically compiled from the general ledger by the accounting software.
- Close the period. The accounting staff closes the accounting period that has just been completed, and opens the new accounting period. Doing so prevents current-period transactions from being inadvertently entered into the prior accounting period. In a multi-division company, it may be necessary to complete this period closing step in the software for each subsidiary.
The accounting process is also known as the accounting cycle.