13 September 2011

Accounting Cycle

Accounting cycle define as stages in the process of recording accounting transaction. It started from recognition of a valid document or transaction evidence and finished when accounting period is closed.

The stages of transaction recording process are as follow:
  1. Recognition of a valid document or transaction evidence. 
  2. Record the transaction to journal entry 
  3. Post to general ledger 
  4. Make unadjusted trial balance 
  5. Record adjustment journal entry 
  6. Make adjusted trial balance 
  7. Make closing journal entry 
The accounting system always adheres this cycle. Therefore, understanding accounting cycle is very important in preparing computer-based accounting system.

The first stage, recognition of a valid document or transaction evidence, is easy to be carried out. Usually, a valid document is characterized as follow:
  1. The document should be original, not a copy one. If it was a copy, there should be an authorized party who is responsible for the validity of the document such as original signature or stamp. A copied document that is considered to be valid are certificate of vehicle ownership (proof of vehicle ownership), housing ownership certificate, land certificate, notarial deed of incorporation, letter of contract agreement. For safety and secured reason, these documents should be kept separately. Original documents that can be used as a basis for recording transaction are monthly bill of telephone, electricity, toll road, equipment repair or maintenance such as air conditioner, computer, vehicle, and house. 
  2. There should an authority who is responsible for the validity of document. It is indicated with the original signature of an employee who is currently working, at the time the document was made. 
  3. For the bill, usually, in addition to signature/stamp, there is also a stamp duty, which indicates that the document is legally valid. 
  4. Sometimes legal documents are accompanied with supporting documents, to confirm the validity of the document. The supporting documents usually contain details of the transaction. 
Second stage, record the transaction to journal entry is the most important thing. This is where an accountant's accuracy is tested. Accountants should be able to identify, to the account where a transaction must be recorded in a journal. An error in recording transactions into the journal will result an error in the financial statements (whether the income statement, balance sheet or cash flow). Further result, decision-making could be wrong.

For the third, fourth, and sixth, using the current computer technology, these stages are easy to be done. Post to general ledger and make trial balance can be executed any time we need so that information can be generated in a real time basis. However, practically, posting to general ledger and making trial balance are executed monthly, at the end of the month.

Fifth stage, adjustment journal entry to be recorded to correct the wrong journal made in stage 2, or to add necessary journal such as accrual journal or deferral journal. The objective of this accrual or deferral journal is to make financial statement, mainly income statement, become smooth (un-fluctuated). Exception should be made if there is extra ordinary transaction that force accountant to record it in the current period.

Finally, make closing journal entry, to transfer net income/loss resulted from income statement to retained earning account. Using the computer technology, closing journal entry can be made both manually or automatically.

If done manually, we should calculate first, how much net profit/loss for the current period, and then made the journal. The trick is to transfer the balance (re-set the balance to be zero) for each expense and revenue accounts to an account called "income summary account". Income summary account is then transferred to retained earnings account. If done automatically, computer will calculate and transfer automatically to retained earning account. The principle works the same as the manual. There is a statement of "re-set the balance to be zero ", why should we do that? Per definition, a statement of income which consists of revenue and expense is a report showing the results of operations during a particular accounting period (the period ending on the date specified). Once past a certain time period, the revenue and expense accounts should start from zero again, of course, to meet the definition of income statement.

This differs from the definition of balance sheet. Balance sheet is a report showing the company's financial position at the time/date specified, i.e. at the end of particular accounting period. Thus, the account balance of zero is not to be re-set. Even if the account has zero balance at a particular specified it was declared, it was not because of "re-set to be zero". It was at that time, the account has zero balance.

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