The accounting process is a systematic way to record, organize, and analyze financial transactions of a business. These steps ensures accuracy in financial reporting and helps businesses make informed decisions.
1. Identifying Financial Transactions
The first step in accounting is to identify transactions that need to be recorded. These could include:
- Sales of goods or services
- Purchases of supplies or equipment
- Payments to employees
- Receipt of loan funds
Only transactions that have a monetary value and affect the business’s financial position are recorded.
2. Recording Transactions in Journals
Transactions are recorded chronologically in the journal, also called the book of original entry. Every entry should have the following details:
- Date of the transaction
- Accounts affected
- Debit and credit amounts
- A brief description or reference
- A Reference to the Invoice or material proof of the transaction
For example:
- Date: January 5, 2025
- Description: Purchased office supplies
- Debit: Office Supplies $500
- Credit: Cash $500
- Invoice #: 1532
3. Posting to the Ledger
From the journal, entries are transferred to the ledger, where accounts are organized. Each account has a dedicated page, such as Cash, Accounts Receivable, Internet Expense or Sales Revenue.
4. Preparing a Trial Balance
A trial balance is a list of all ledger accounts and their balances at a specific time. It ensures that:
- Total debits = Total credits
If there’s a mismatch, it indicates an error in recording or posting that must be corrected.
5. Making Adjusting Entries
Adjusting entries are made at the end of an accounting period to account for:
- Accrued expenses (e.g., wages earned but not paid)
- Prepaid expenses (e.g., insurance)
- Depreciation of assets
- Revenue earned but not yet recorded
Example:
- Accrued salary: Debit Salaries Expense $1,000; Credit Salaries Payable $1,000
After the adjustment entries are made, the Adjusted Trail Balance is made to ensure that the debit and credit balances are equal.
6. Preparing Financial Statements
Using the adjusted trial balance, the business prepares the financial statements that give a detailed review of the business’s financial health:
- Income Statement: Shows revenues and expenses used to calculate profit or loss.
- Balance Sheet: Lists assets, liabilities, and equity at a specific time.
- Cash Flow Statement: Tracks cash inflows and outflows.
These statements are essential for stakeholders like investors, creditors, and management to make informed decisions and plan the future direction of the business.
7. Closing Entries
At the end of the accounting period, temporary accounts like revenues, expenses, and dividends are closed to the Retained Earnings account. This resets their balances to zero for the next period. We will learn more about this in another article.
8. Post-Closing Trial Balance
A post-closing trial balance is prepared to ensure that:
- All temporary accounts are closed
- The ledger is ready for the new accounting period
Why Follow the Accounting Process?
- Accuracy: Reduces errors in financial reporting
- Compliance: Meets legal and regulatory requirements
- Decision-Making: Provides reliable data for planning and strategy
By mastering the accounting process, businesses can maintain organized records, ensure compliance, and make informed financial decisions.
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