The accounting process, also commonly referred to as the accounting cycle, is a sequence of activities that begins with a transaction and ends with the closing of the books. It also involves the recording of how the cash is received and paid out in a company or organization. The accounting process is a cycle where a bookkeeper collects, organize, process and close every financial information that a business engages in.
The first step of the accounting process is the identification of transaction or financial event and finding the source documents for it. Examples are the purchase order, selling products to customers and paying employees. Next, prepare the source documents of the transaction like the invoice, memo, purchase order, receipts, payment slips and more. These source documents are also stored as a record of the transaction history.
Secondly, recorded transaction in the journal entry. A journal is called as “books of original entry” because the transactions are recorded initially in chronological order of dates debiting one account and crediting the other with brief explanation before transferred to the accounts. Also, transactions are recorded in the journal using a double-entry system. An entry occurs in at least two accounts out of which one is debited and the other is credited.
The next step, transferring the journal entries to ledger accounts. It also known as “books of accounts”. This process of transferring journal entries to ledger accounts is known as posting. The purpose if a ledger is to bring together all the transactions for similar activity. These accounts are represented by T-accounts which mark the debits on the left and the credits on the right side.
The fourth step of the accounting process is preparing a trial balance. The trial balance is a listing of the ending balances in every account. The debit amount in the trial balance should equal to the credit amount. If not, there was an error in the posting of the original transactions that must be corrected.
Prepare an adjusted trial balance on the basis of the addition and subtraction of the entries. It is an internal document and is not a financial statement. It helps to create the income statement and balance sheet and doesn’t provide enough information for preparing the cash flow statement.
Prepare the financial statement from the adjusted trial balance. The financial statements are the end-processing of the accounting system. The financial statements will include Cash Flow Statement, Income Statement (Statement of Financial Performance), Balance Sheet (Statement of Financial Position) and Statement of Retained Earnings.
At the end of the accounting process, closing entries are made to transfer data in the temporary accounts to the permanent balance sheet or income statement accounts. Temporary accounts include revenues, expenses, gains, losses, owner’s drawing accounts, etc. These balances are then transferred to the retained earnings account or the income summary account. It is reflected in the appropriate capital account on the balance sheet.
Before the age of computerized financial systems, a business has the option of using a manual accounting system were performed by hand. Manual bookkeeping is the paper-based and traditional way of bookkeeping. Manual bookkeeping is most commonly used by small businesses with the less complex transaction.
Computerized system is a software-based budgeting of accounting process that used of computers to record, store and analyse financial data. The purpose of computerized accounting systems is to have a clear, transparent and reliable system to keep track of financial transactions. Computerized accounting systems allow to set up income and expense accounts, such as salaries, sales or rental income, etc.
Source documents often called as a business paper, is important to the bookkeeping and accounting process because they serve as the first document that exists relating to the financial transaction. This document will always include the date of the transaction, the total amount of the transaction, a description of the transaction and one or more authorizing signatures. Examples of source documents are invoices, receipts, debit note, credit note, cheque counterfoil, memo, etc.
An invoice is a commercial instrument issued by a seller to a buyer that indicates the goods or services, provided, as well as their prices. An original copy is sent to buyer and duplicate is kept by the seller. An invoice indicates the amount of payment required to be paid to the seller. Invoice included name and contact details of the buyer and seller, date of the product and invoice was sent, payment terms, price per units of the products and the total amount charged.
A receipt is a printed statement of the amount of cash that collected from customers in a business transaction. The original copy is giving to the person who makes the payment whereas the duplicate is retained by the receiver for record. Receipts contain the date of transaction, amount of cash received and payment methods such as cash or credit.
A debit note is also known as debit memo or debit memorandum. It is a document issued by a buyer to a seller when returning goods received on credit. Debit note can provide information to the buyer or seller if there is a mistake in sales invoice or purchase invoice. It is positive amount for the purchaser because the buyer would need to pay less amount due to debiting the seller’s account.
A credit note is also known as credit memo or credit memorandum. It is a document sent by a seller to a buyer when returning goods from the buyer. Credit note is issued when there was a mistake in the price on the original invoice or overpaid the original invoice. It is negative amount because the sales account of seller is reduced.
A cheque counterfoil is a part of the cheque which is torn off and kept by the drawer of the cheque as a record of the transaction. The important of cheque counterfoil is it may access the counterfoil when there is a mistake in the amount recorded in books.
A memo is a short message entered into the general journal and also entered into a general ledger account. A memo used for internal transactions which do not involve another business or individual entity. Memo required when capital contributions of non-cash items and drawing of non-cash items.
A payment voucher is a document which can be used to record a payment of cash or cheque. There are two types of payment voucher which is cash payment voucher and bank payment voucher. Cash payment vouchers are used when cash payment while bank payment vouchers are used when the payment by cheque.