The accounting cycle defines the sequence of the stages to be followed in financial accounting. It starts from identifying the financial transactions and ends with the preparation of financial statements. Thereafter, the statements are analyzed and interpreted by different users to meet their requirements.
The stages of the accounting cycle are :
- Identifying financial transactions : The actual business transactions take place and the supporting source documents are created at this stage. Supporting documents primarily include vouchers. Vouchers have information about the accounts affected by the transaction, the amount of transaction in money terms, the date of transaction and voucher number.
- Recording transactions : This stage pertains to the recording of transactions. Transactions are recorded in the book of accounts. In other words, the information in the vouchers is recorded in the accounting books by creating journal entries.
- Classifying transactions under various accounting heads : In this stage, the journal entries are transferred to different accounts. In simple terms, every transaction will affect at least two parties and therefore, two accounts are created. The financial record in the journal entry created is transferred to these accounts.
- Summarizing and presenting financial statements : Many transactions take place in a business for which various accounts are created. These accounts do not give information in a summarized manner. In financial accounting, the accounting information is summarized in the form of a Trial Balance. The Trial Balance is used to prepare and present the Trading account, Profit and Loss account and Balance sheet. With this, the accounting cycle comes to an end.