LO 3.3 Define and Describe the Initial Steps in the Accounting Cycle

First Four Steps in the Accounting Cycle

The first four steps in the accounting cycle are (1) identify and analyze transactions, (2) record transactions to a journal, (3) post journal information to a ledger, and (4) prepare an unadjusted trial balance. We begin by introducing the steps and their related documentation.

These first four steps set the foundation for the recording process.

Step 1. Identifying and analyzing transactions is the first step in the process. This takes information from original sources or activities and translates that information into usable financial data. An original source is a traceable record of information that contributes to the creation of a business transaction. For example, a sales invoice is considered an original source. Activities would include paying an employee, selling products, providing a service, collecting cash, borrowing money, and issuing stock to company owners. Once the original source has been identified, the company will analyze the information to see how it influences financial records.

Let’s say that Mark Summers of Supreme Cleaners (from Why It Matters) provides cleaning services to a customer. He generates an invoice for $200, the amount the customer owes, so he can be paid for the service. This sales receipt contains information such as how much the customer owes, payment terms, and dates. This sales receipt is an original source containing financial information that creates a business transaction for the company.

Step 2. The second step in the process is recording transactions to a journal. This takes analyzed data from step 1 and organizes it into a comprehensive record of every company transaction. A transaction is a business activity or event that has an effect on financial information presented on financial statements. The information to record a transaction comes from an original source. A journal (also known as the book of original entry or general journal) is a record of all transactions.

For example, in the previous transaction, Supreme Cleaners had the invoice for $200. Mark Summers needs to record this $200 in his financial records. He needs to choose what accounts represent this transaction, whether or not this transaction will increase or decreases the accounts, and how that impacts the accounting equation before he can record the transaction in his journal. He needs to do this process for every transaction occurring during the period.

The picture below of a General Journal shows that the journal includes information such as the date of the transaction, the accounts required in the journal entry, and columns for debits and credits.

Important note:  Hundreds of years ago, someone thought it would be a good idea to call left “debit” and right “credit”, instead of calling left “left” and right “right”.  Now you have to translate in your head — every time you see or hear “debit”, think left and every time you see or hear the word “credit”, think right.  That’s all the debit and credit mean — just left and right!

Step 3. The third step in the process is posting journal information to a ledger. Posting takes all transactions from the journal during a period and moves the information to a general ledger, or ledger. As you’ve learned, account balances can be represented visually in the form of T-accounts.

Returning to Supreme Cleaners, Mark identified the accounts needed to represent the $200 sale and recorded them in his journal. He will then take the account information and move it to his general ledger. All of the accounts he used during the period will be shown on the general ledger, not only those accounts impacted by the $200 sale.

Step 4. The fourth step in the process is to prepare an unadjusted trial balance. This step takes information from the general ledger and transfers it onto a document showing all account balances, and ensuring that debits (lefts) and credits (rights) for the period balance [debit (left) and credit (right) totals are equal].

Mark Summers from Supreme Cleaners needs to organize all of his accounts and their balances, including the $200 sale, onto a trial balance. He also needs to ensure his lefts (debits) and rights (credits) are balanced at the culmination of this step.

It is important to note that recording the entire process requires a strong attention to detail. Any mistakes early on in the process can lead to incorrect reporting information on financial statements. If this occurs, accountants may have to go all the way back to the beginning of the process to find their error. Make sure that as you complete each step, you are careful and really take the time to understand how to record information and why you are recording it. In the next section, you will learn how the accounting equation is used to analyze transactions.