Accounting Cycle & Process: Steps, Journal-Ledger-Trial Balance Flow

TAKEAWAYS:

• The accounting cycle is a 9-step process that starts with transactions and ends with financial statements, repeating every accounting period.
• Source documents (invoices, receipts) → Journal entries (debit/credit) → Ledger postings (T-accounts) → Trial balance → Adjustments → Adjusted trial balance → Financial statements (Income Statement, Balance Sheet).
• Double-entry bookkeeping ensures every transaction affects at least two accounts (e.g., Cash increases while Inventory decreases).
• Adjusting entries (accruals, deferrals) correct timing mismatches (e.g., unearned revenue, prepaid expenses).
• Closing entries transfer temporary accounts (Revenue, Expenses) to Retained Earnings and reset them to zero.
• Errors in the cycle (omissions, misclassifications) can be detected via trial balance discrepancies or adjusted entries.

1. What is the Accounting Cycle?

The accounting cycle is the complete process of identifying, recording, summarizing, and communicating financial transactions for a business over a specific period (usually a fiscal year). It ensures financial data is accurate, consistent, and useful for decision-making.

Why is it important?

• Helps businesses track income, expenses, and assets.
• Ensures compliance with accounting standards (e.g., Nepalese Accounting Standards, IFRS).
• Provides financial statements for stakeholders (investors, banks, government).

2. The 9 Steps of the Accounting Cycle

Here’s the step-by-step flow of the accounting cycle, visualized as a Mermaid diagram below:

flowchart TD
    A["1. Identify Transactions"] --> B["2. Journalize Transactions"]
    B --> C["3. Post to Ledger"]
    C --> D["4. Prepare Unadjusted Trial Balance"]
    D --> E["5. Record Adjusting Entries"]
    E --> F["6. Prepare Adjusted Trial Balance"]
    F --> G["7. Prepare Financial Statements"]
    G --> H["8. Record Closing Entries"]
    H --> I["9. Prepare Post-Closing Trial Balance"]
    I -->|"Repeat"| A

Step-by-Step Explanation

3. Key Concepts in the Accounting Cycle

A. Source Documents

These are physical or digital records that prove a transaction occurred. Examples:

• Invoice (from suppliers like Daraz or Nepal Investment Bank).
• Receipt (for cash payments).
• Bank Statement (for bank transactions).
• Cheque (for large payments).

Example of a supplier invoice from a Nepali business (Image: Namira22, CC BY-SA 4.0, via Wikimedia Commons)

B. Journalizing Transactions (Double-Entry System)

Every transaction affects at least two accounts (debit and credit). Example:

• Transaction: Bought inventory for Rs. 50,000 (cash).
  • Debit: Inventory (Asset ↑) Rs. 50,000
  • Credit: Cash (Asset ↓) Rs. 50,000

Journal Entry Table:

C. Posting to Ledger (T-Accounts)

After journalizing, entries are posted to ledger accounts (T-accounts). Example:

D. Trial Balance

A list of all ledger accounts to ensure debit = credit. If not, there’s an error (omission, misclassification).

Example Trial Balance (Unadjusted):

E. Adjusting Entries

Adjustments correct timing differences between cash basis and accrual basis accounting.

Common Adjustments:

1. Accrued Expenses (e.g., unpaid salaries).
2. Prepaid Expenses (e.g., rent paid in advance).
3. Unearned Revenue (e.g., advance payments from customers).
4. Depreciation (e.g., machinery wear and tear).

Example Adjustment:

• Transaction: Rs. 20,000 rent paid in 2079/10/01 for 12 months (adjust for 1 month used).
  • Adjusting Entry:

    Date	Particulars	Dr (Rs.)	Cr (Rs.)
    2079/10/31	Rent Expense A/c	1,667
    	To Prepaid Rent A/c		1,667
    	(Adjustment for rent)

F. Financial Statements

After adjustments, prepare:

1. Income Statement (Revenue – Expenses = Net Profit).
2. Balance Sheet (Assets = Liabilities + Equity).
3. Cash Flow Statement (Cash inflows/outflows).

Example Income Statement (Simplified):

G. Closing Entries

Transfer temporary accounts (Revenue, Expenses) to Retained Earnings and reset them to zero.

Example Closing Entry:

4. Real-World Applications

A. eSewa & Khalti (Digital Payments)

• Concept Used: Cash and Bank Transactions (Step 2 & 3 of the cycle).
• How?
  • When you pay electricity bills via eSewa, the transaction is recorded in:
    1. Journal: Debit Electricity Expense, Credit Cash/Bank.
    2. Ledger: Updated in Expense Account and Bank Account.
  • Adjusting Entry: If eSewa charges a transaction fee, it’s recorded as:

    Date	Particulars	Dr (Rs.)	Cr (Rs.)
    2079/10/05	Electricity Expense A/c	1,500
    	eSewa Fee A/c	20
    	To Bank A/c		1,520

B. Daraz (E-Commerce Order Processing)

• Concept Used: Journalizing Sales & Inventory (Steps 1-4).
• How?
  • When a customer buys a phone for Rs. 20,000:
    1. Journal Entry:

       Date	Particulars	Dr (Rs.)	Cr (Rs.)
       2079/10/01	Cash A/c	20,000
       	To Sales A/c		20,000

    2. Ledger Posting:
       • Cash Account: Debit ↑ Rs. 20,000
       • Sales Account: Credit ↑ Rs. 20,000
       • Inventory Account: Debit ↓ Rs. 20,000 (cost of goods sold)
    3. Adjusting Entry (if COGS not recorded earlier):

       Date	Particulars	Dr (Rs.)	Cr (Rs.)
       2079/10/31	COGS A/c	15,000
       	To Inventory A/c		15,000

C. Nepal Investment Bank (Loan Interest Calculation)

• Concept Used: Adjusting Entries for Accrued Interest (Step 5).
• How?
  • If a customer takes a loan of Rs. 1,000,000 at 10% annual interest, but only pays interest at year-end:
    • Adjusting Entry (monthly):

      Date	Particulars	Dr (Rs.)	Cr (Rs.)
      2079/10/31	Interest Expense A/c	8,333
      	To Accrued Interest A/c		8,333
      (1,000,000 × 10% ÷ 12 months)

5. Worked Example: Kathmandu Retail Shop

Scenario:

• Shop Name: Kathmandu Electronics
• Transactions in October 2079:
  1. Started with Cash: Rs. 500,000, Inventory: Rs. 300,000.
  2. 10/01: Bought additional inventory for Rs. 100,000 (cash).
  3. 10/15: Sold inventory for Rs. 200,000 (cash).
  4. 10/31: Paid rent for November (Rs. 20,000) in advance.
  5. 10/31: Unearned revenue: Received Rs. 50,000 for future services.

Step-by-Step Solution

1. Journal Entries

2. Ledger Postings (T-Accounts)

3. Unadjusted Trial Balance

4. Adjusting Entries

• COGS (Cost of Goods Sold):

  • Assume Rs. 120,000 of inventory was sold.

    Date	Particulars	Dr (Rs.)	Cr (Rs.)
    2079/10/31	COGS A/c	120,000
    	To Inventory A/c		120,000

• Rent Expense (1 month used):

  Date	Particulars	Dr (Rs.)	Cr (Rs.)
  2079/10/31	Rent Expense A/c	20,000
  	To Prepaid Rent A/c		20,000

• Unearned Revenue (1/3 earned in October):

  Date	Particulars	Dr (Rs.)	Cr (Rs.)
  2079/10/31	Unearned Revenue A/c	16,667
  	To Revenue A/c		16,667

5. Adjusted Trial Balance

6. Financial Statements (Simplified)

• Income Statement:

  Particulars	Amount (Rs.)
  Revenue	216,667
  Less: COGS	(120,000)
  Less: Rent Expense	(20,000)
  Net Profit	76,667

• Balance Sheet:

  Assets	Liabilities + Equity
  Cash: 630,000	Unearned Revenue: 33,333
  Inventory: 280,000	Capital: 800,000
  Total Assets	910,000

6. Common Errors & How to Detect Them

7. Exam Tip: How to Score Full Marks

1. Understand the Cycle: Memorize the 9 steps and their order.
2. Practice Journal Entries: Always debit first, credit second.
3. Adjusting Entries: Focus on accruals (unpaid) and deferrals (prepaid).
4. Trial Balance: Ensure debit = credit before proceeding.
5. Real-World Link: Relate examples to Nepali businesses (e.g., Ncell billing, Daraz sales).
6. Diagrams: Draw T-accounts and flowcharts in exams (if allowed).
7. Common Mistakes:
   • Forgetting closing entries.
   • Misclassifying revenue vs. capital.
   • Ignoring adjusting entries for accruals/deferrals.

8. Quick Revision Table

9. Summary

• The accounting cycle is a structured process to ensure financial accuracy.
• Double-entry bookkeeping is non-negotiable (every debit has a credit).
• Adjusting entries bridge the gap between cash and accrual accounting.
• Real-world applications (eSewa, Daraz, banks) rely on this cycle for transparency and compliance.

Final Tip: Practice with real transactions (e.g., your mobile recharge, rent payment) to master the cycle!