What is the accounting process?
The accounting process is a series of steps that businesses follow to record, classify, summarize, and report their financial transactions.
It is a cyclical process that typically takes place over an accounting period, which is usually a month, quarter, or year.
Accounting helps keep systematic records to ascertain the financial position and financial position of an entity. These records form the fundamentals of accounting for decision purposes.
Transactions and events are recorded by suitable account headings and analysed regarding debit and credit and assets become equities and liabilities. Accounts are classified into three categories of accounts.
- Personal accounts
- Real accounts
- Nominal accounts
Transactions and events first are journalised, which are posted to the ledger and then all accounts are balanced at the end of each accounting period. Balances of nominal accounts are transferred to profit and loss accounts, and balances of real accounts are carried to the balance sheet.
The process of accounting reflects how information flows from the source documents up to the stage where final accounts are prepared and books are closed as follows:
Source Document – Initiating Accounting Process
It represents all documents in the business which contain financial records and act as evidence of the transactions which have taken place. Ex: sale invoices, purchase bills, bank pay-in-slips etc.
Book of original entry [Journal]
Once a transaction has been identified, it is recorded in a journal. A journal is a chronological record of all financial transactions. Each journal entry includes a date, a description of the transaction, and the accounts that are affected by the transaction.
Posting to Ledgers
After a transaction has been recorded in the journal, it is posted to the general ledger. The general ledger is a collection of accounts that are used to record all financial transactions. Each account in the general ledger has a debit and credit side, and the amount of each transaction is recorded on the appropriate side of the account.
Trial Balance
These form part of the double-entry system and are used to record the transactions for the period. These are accounts where information relating to particular assets, liabilities, capital, income and expenditure are recorded. It contains the totals from various ledger accounts and acts as a preliminary check on accounts before producing final accounts.
Also Read: Classification of Accounts in Bookkeeping
Passing Adjustment Entries
Adjusting journal entries are used to adjust the accounts in the general ledger to reflect events that have occurred but have not yet been recorded, such as depreciation, accrued interest, or prepaid expenses.
Once the adjusting journal entries have been made, an adjusted trial balance is prepared. The adjusted trial balance should show a balance of zero, which indicates that the accounts in the general ledger are in balance.
Final Accounts
Final accounts are essentially the culmination of the accounting cycle, providing a comprehensive overview of a business’s financial health and performance at a specific point in time, typically the end of an accounting year. They paint a picture of the company’s profitability and financial position, serving as valuable information for various stakeholders like investors, creditors, and management.
The financial statements typically consist of:
Income statement (Profit and Loss account): Summarizes the company’s revenues and expenses for the period, ultimately determining the net income or loss.
Balance sheet: Provides a snapshot of the company’s assets (what it owns), liabilities (what it owes), and shareholder equity (owner’s investment) at a specific date.
Statement of cash flows: Analyzes the movement of cash in and out of the business during the period, categorized into operating, investing, and financing activities.
Notes to the financial statements: Offer additional explanations and details to clarify the financial statements and address any complexities.
Close the books
The final step in the accounting process is to close the books. This involves transferring the balances of the income and expense accounts to the capital account. The balances of the asset and liability accounts are not closed, and they will be carried forward to the next accounting period.
All the steps mentioned earlier in the accounting process have been discussed in detail in the subsequent posts. We shall understand the process with logic.