22 de November de 2022
What is the Accounting Process?
When we talk about the accounting process, we must know that we are referring to a series of steps that every business entity carries out in order to record the financial transactions of the company.
For this, all commercial transactions are collected, identified, summarized, and recorded in the company’s accounting books, to later prepare the entity’s financial statements. It is through the accounting process that we know both the benefits and the financial situation of the company, at regular intervals of time.
Accounting process steps
Next, we will analyze each of the different steps of the accounting process:
Step 1: Identify the transaction
The identification of the commercial transaction is the initial step in any accounting process. This is where the business entity must identify financial and monetary transactions. In addition, the transactions that are related to the company’s operations must be recorded verifying that those entries have not be registered twice.
Step 2: Recording of transactions
Once we have identified the transactions, we will move on to the second step of the accounting process, which is to create a record for each of the accounting transactions carried out.
This recording of transactions is based on the accounting policy followed by the entity, which may be the accrual principle or cash accounting.
In accrual accounting, both income and expenses are recorded in the entity’s books in the period in which they are earned and incurred, respectively, regardless of the actual income and payment.
In the case of cash accounting, on the other hand, they are transactions that are recorded only when actual cash is received or paid.
In a double entry system, each transaction affects at least two accounts, or what is the same, one account is debited, and another is credited. For example, if purchases are made in cash, the purchase account will be debited (which means that purchases increase), while the cash account will be credited (causing cash to decrease).
Step 3 – Posting to the General Ledger
Once we have made the registration of the transactions, it will be time to move on to the individual accounts, which are recorded in the general ledger.
Regardless of whether you are an owner or an accountant, thanks to this step you will be able to know the balance of each account individually. For example, all debits and credits from the bank account are transferred to the general ledger account, which helps to know the increase and decrease of the bank balance during a period. As if that were not enough, you can also determine the final bank balance from it.
Step 4: Unadjusted trial balance
The trial balance of the company is prepared in order to check if the debits are equal to the credits or if, on the contrary, they are not.
The main purpose of the trial balance is to identify any errors made during the previous accounting process. Through it we can see the balance of sums and balances to see all the balances of the accounts at a given time.
After preparing the balance of sums and balances, it is verified that the total of all credits is equal to the total of all debits, and if the total is not the same, the error must be identified and corrected. To locate this error, a trial balance is made, which helps to know the balances of all the accounts in a summarized way, facilitating its search.
Step 5: Adjusting entries
It is important to know that when the accrual principle is followed, some of the entries must be made at the end of the accounting year, such as the entries for expenses that may have been incurred but are not recorded in the journal of accounts, as well as the entries of some income that the company can obtain but that are not yet registered in the books.
As a practical case we have that the amount of interest on a fixed deposit is earned each year, however it accumulates in the amount of the fixed deposit. This interest income must be recorded at all costs in the books on an annual basis since interest is received annually, regardless of whether the amount is received jointly after the maturity of the fixed deposit.
Step 6: Adjusted trial balance
Once all the corresponding adjusting entries have been made, it is necessary to prepare a trial balance before preparing the financial statements, in order to verify if indeed all the credits are equal to the debits, as they should be after making the adjustment entries.
Step 7: Preparation of the financial statements
Once all the previous steps have been completed, it is time to prepare the financial statements of the company in order to know first-hand both the real financial position, as well as the position of profitability and the cash position of the company.
Financial statements are generally prepared on the basis that the entity is in business and will continue to be in business for the foreseeable future. Its purpose is to know the profitability position of the company through the profit and loss statements, thus obtaining the balance of the financial position, in addition to knowing the evolution of the cash flow, which comes from the three activities of the company such as exploitation, investment and financing.
Step 8: Closing Entries
The cycle of our accounting process ends with the closing entries, which transfer the balances of the temporary accounts to a permanent account.
These temporary accounts are those whose balances end in a single accounting year, such as sales, purchases, expenses, and a long etcetera. These balances are first transferred to the income statement, to then go to the permanent account, or in other words, the profits and/or losses are transferred to the retained earnings account.
It is important to clarify that only temporary accounts are closed, not permanent ones. We are clearly referring to balance sheet accounts, such as fixed assets, debtors, inventories, etc.
Once the closing entries have been made, it is time to prepare the trial balance again in order to verify that the accounts do balance. If so, we will have completed our accounting process and it will be time to restart the cycle with the start of another accounting year.
So far today’s article where we have analyzed what an accounting process is, and how to carry it out in 8 simple steps.
In short, the accounting process includes the steps that must be followed when registering, classifying, and summarizing the financial transaction of the company, whose accounting process begins with the identification of the transaction and ends with the preparation of the financial statements, which are used and evaluated by the users of the company to have a clear control of the accounts.