The Accounting cycle

Slide 1

Good day. In this short video we will discuss the accounting cycle. You will be
provided with an explanation of what a cycle is and how this relates to accounting
processes before we discuss each part of the accounting cycle in more depth.

Slide 2

A cycle is a series of events that are regularly repeated in the same order. In life we
can find a variety of cycles around us, just think about the sun rising every day,
moving from east to west before setting again and the seasons we experience every
year. Can you think of more examples?

Slide 3

When we think about financial accounting, the process followed for the recording of
transactions also follow a cycle. A transaction takes place and then the details of the
transaction is recorded on a source document. All the source documents are
recorded in subsidiary journals, before it is posted to the general ledger. The general
ledger account balances are used to compile a trial balance before the financial
statements are prepared. The information in the financial statements is then
analysed and used for decision making purposes. Certain processes in this cycle
takes place daily for example the recording of transactions, others monthly for
example posting to the general ledger and some annually for example the
preparation of the financial statements.

Slide 4

The accounting cycle can be divided into three phases, namely the input phase
where transactions take place and the information is recorded on the source
documents. The processing phase, where the data is recorded in the subsidiary
journals and processed until the trial balance is compiled and the output phase
where the information is reported in the financial statements and then analysed for
decision making purposes.

Slide 5

The accounting cycle starts with the input phase when the first transaction for the
financial period takes place.

Slide 6

A transaction is a business event that has a monetary impact on an entity’s

accounting records. Each transaction must be recorded in the accounting records of
the business. A transaction for example took place, when the owner of the business
deposits an amount as opening capital into the business bank account or even if the
owner contributed an asset for example a computer to the business. Earning money
when selling goods or delivering services as well as paying for expenses are also
examples of transactions.

Slide 7

When a transaction takes place, the business will either issue a source document or
receive a source document. This source document tells the story of the transaction.
Some of the information that you will find on a source document is the date of the
transaction, information of the client or supplier, the type of transaction for example
cash or credit, the monetary value and information relating to the purpose of the
transaction for example selling goods. Examples of source documents are invoices,
receipts, cash slips, credit card slips and internet banking notices of payment.

Slide 8

The second phase of the accounting cycle entails the processing of the financial
information. During this phase the information is recorded in the accounting records
of the business
Slide 9

Subsidiary journals are used to record the transactions taking place in a business.
Transactions are grouped together by type and recorded in chronological order.
Cash transactions are recorded in the cash receipts journal and the cash payments
journal. Credit sales and purchases of inventory on the other hand is recorded in the
sales journal and purchases journal and if any inventory items sold or purchased on
credit is returned it is recorded in the sales returns journal and purchases returns
journal. Some businesses keep cash on hand for small expenses for example buying
tea and coffee for the office. These transactions are recorded in the petty cash
journal. Any transaction that does not fit with the purpose of the other journals, are
recorded in the general journal for example when an entity buys a vehicle on credit.
All transactions taking place are recorded in these journals on a daily basis and at
the end of each month the columns of the journals are totalled and the balances are
posted to the general ledger.

Slide 10

One of the principles of accounting is that no entry can be made in the general
ledger if it was not recorded in one of the subsidiary journals. An entry in the general
ledger will therefore always have its origin in a subsidiary journal from where it can
be traced back to a source document that provides evidence of the transactions that
took place. All assets, liabilities and equity accounts are grouped together in a
statement of financial position section and these accounts are sequentially
numbered and referenced with the letter “B” preceding the number. All these
accounts are balanced at the end of the financial year.

All income and expense accounts are grouped together in the nominal account
sections and are also numbered sequentially. These accounts are referenced with
the letter “N” preceding the number. These accounts are totalled at the end of the
financial year and closed off to either the trading account or the profit and loss
account.

The balances and totals of the general ledger accounts are used to draw up the trial
balance.
Slide 11

The trial balance is a list of account balances. All debit balances are written in the
debit column and all credit balances are written in the credit column. Once the trial
balance has been compiled, the total of the debit column should be equal to the total
of the credit column. This is because of the double entry system used to record
accounting transactions. If these columns are not equal, it is an indication that an
error was made during the recording process.

Slide 12

The last phase of the accounting cycle is the output phase. In this phase the financial
information is presented to the users of the information in an understandable format
from where it is analysed and used for decision making purposes.

Slide 13

After the financial year-end the financial statements of the business is compiled. The
statement of comprehensive and other income is used to determine the financial
performance of the entity. Income and expenses are disclosed in this statement and
the profit or loss for the financial period is calculated.

The statement of changes in equity indicates the increase or decrease in owners’

equity for the financial period. This statement therefore reconciles the opening
balance of equity at the beginning of the financial period with the closing balance. It
indicates any capital contributions made by the owner, any withdrawals done by the
owner as well as the movement due to the profit or loss made by the entity.

The statement of financial position indicates the position of the entity, if the entity
should close its doors today. It provides a snapshot of the financial position of the
business on a specific date. What is the value of the assets, how much money does
the entity owe and how much is the owners equity. The statement of financial
position is in fact nothing other than a detailed accounting equation showing that
Equity = Assets – Liabilities.
The cash flow statement indicates all cash inflows and outflows of the business
during the financial period.

Lastly the notes to the financial statements contain important information on the
various items included in the financial statements for example the accounting
policies followed and other explanatory information

Slide 14

The information presented in the financial statements are further analysed by the
management of a business to gain insight for decision making purposes. Return on
investment, return on assets, debt repayment ratios etc can be calculated from
where management can then make strategic decisions regarding the future of the
entity.

Slide 15

The final step of the accounting cycle is decision making. During this step
management uses the financial information to evaluate accounting policies,
products, income streams, suppliers and much more to determine whether the entity
is performing as desired or whether change is needed in certain areas to improve
performance.

Slide 16

This short video briefly discussed each step in the accounting cycle, starting with the
transaction taking place, the issuing of a source document, recording the transaction
in the relevant subsidiary journal, posting to the general ledger, compiling the trial
balance, preparing the financial statements, analysing and interpreting the
information and decision making.