The Accounting Cycle and the Fiscal Year
The accounting cycle and the fiscal year are the plain meat and potatoes of the accounting system, and the manner in which it operates. The reasons for an accounting, the control of the accounting system, and the successful operation of a business all come down to this thing known as the accounting cycle and the boundary of operation known as the fiscal year.
The accounting cycle, explained means that there are seven basic steps involved in the accounting process, or cycle. They are constants, regardless of your business type, the number of employees you have, or even your unique business needs associated with the accounting system. The seven basic steps must be performed each and every time data is manipulated, reported, and used in a business.
The first step is to analyze and record transactions in a journal. This means that every time a transaction of financial value occurs, it must be recorded in a journal. There are several different journal types, but there is a type to accommodate any transaction. The next step in the cycle is to post transactions to the ledger. The ledger is a book containing all the accounts that a business uses. The third step, and this one takes some time to complete, is the preparation of a trial balance with a work sheet.
Now if all this seems really confusing, stop and think compare it to washing your clothes: everything must be washed; it is then sorted according to classification such as shirts in one stack, pants in another, and then socks in still another. The trial balance is our review of the entire stack of wash, to make sure that we have accounted for every piece. Much simpler from that point of view, right?
The next few steps are simply a check and balance of the already entered transactions. Since the invention and greatly incorporated use of the computer, trial balances and adjusting entries have taken on a new face. Quite often, any mistakes we would have made in manual systems are caught and corrected upon entry with a computerized system. However, should you have mistakes; adjusting entries are necessary and are posted to the ledger. Closing entries are then journalized and posted to the ledger and a post-closing trial balance sheet is prepared.
The final phase begins with the preparation of the financial statements. We know from an earlier article what the financial statements comprise, but let's cover once again just to be sure. The financial statements are comprised of the income statement, the owner equity statement, the balance sheet and the statement of cash flows. All the information contained in the financial statements is an accumulation of transactions from the journals and ledgers. Can you begin to see, now, how important it is to get the information right from the beginning? A home build on shaky ground won't last, and is faulty from the beginning. So are the accounting cycle and the information produced therein.
The fiscal year for businesses, can vary from the actual physical year that runs from January to December, if a business so chooses. Many corporate entities choose an accounting cycle that is different from the traditional January to December year simply to accommodate the masses of information that must be produced for each event. Employee information, such as payroll, is based on the January to December year. W-2's, 1099's and all the reporting that accompanies these documents must be performed within a specific time frame. It would be almost impossible to also accommodate a business year end, at the same time. Thus, the fiscal year was born and generally will run from September to August for most corporate entities. Hopefully, the accounting cycle and the fiscal year concept are a little easier now for you to understand.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.