Simply put, the accounting cycle is the journey from the beginning of a transaction to its inclusion in the financial statements. Your dedicated bookkeeper is the one who will continually execute this cycle for your business like clock work. Let's delve into the details of this process.
Step 1: Collect and analyze transactions
Bookkeepers start by collecting and analyzing the business's transactions and gathering supporting documents.
They also get a list of the business's relevant accounts for recording transactions, called the chart of accounts.
When A Bigger Bottom Line client managers first meets with a new client, we use a checklist to guide our discussion about the business finances. We cover important questions like what are the different types of income generated by the products or services they sell. Additionally, what are the expenses that they pay on a regular basis. We also want to know how many checking accounts, credit card accounts, and loans they have. It may seem simple, but sometimes people forget to provide information on all their accounts or provide all of the bank statements. That's why we make sure to go through our checklist and verify all of the bank and credit card statements. We want to make sure we catch any easy-to-miss accounts, like reserve or savings accounts, that are also under the business.
As bookkeepers, we help our clients understand their finances. When we find mistakes in their books, we take on a teaching role. Since our clients aren't accounting experts, we approach these moments with care. We gently guide them to identify any overlooked information, ensuring accurate records without making them feel overwhelmed. Building trust is an essential part of the process.
Step 2: Record and post transactions
Next, the bookkeepers records transactions for the business. Thanks to new things like ecommerce, online banking, and dedicated accounting software, most of the transactions can be automatically recorded in real-time (if daily services are chosen), which is ideal. However, there are some transactions that need to be manually entered into the system, or edited to include additional line items or splits. The complexity of the bookkeeping and accounting work increases depending on how many of these manual updates are needed.
The bookkeeper ensures the transactions are correctly categorized and assigned to the right accounts. The accounting software automatically reorganizes the journal entries, grouping them based on the different accounts, and the bookkeeper posts the summary entries to the general ledger. Then the bookkeeper reconciles all transactions against source documents, such as bank statements.
At A Bigger Bottom Line, the time we spend on transaction management can vary depending on the client's business, structure, and operations. It's important to accurately categorize and enter transactions to save time in the future when analyzing data. Imagine spending a lot of time analyzing incorrect data due to miscategorization—it's not fun!
Next, we post the entries to the general ledger and reconcile everything. We compare the activity in the journals and ledgers against the source documents to make sure everything was recorded right. After we do this, we know we have accurate information as we move forward in the process, which is really important.
Step 3: Prepare unadjusted trial balance for Review
Your bookkeeper uses a tool called the unadjusted trial balance to verify that credits and debits are balanced. This is basically a review of the Balance Sheet and Profit and Loss statement, all on one page. At this stage, it is an unadjusted trial balance, since no adjusting entries have been made yet. This serves as the initial draft of financial information for the company. This allows the bookkeeper to check for any errors or omissions in the previous steps of the accounting cycle. At this point, at A Bigger Bottom Line, the reviewer accountant may step in to review the bookkeepers numbers for accuracy, depending on the frequency of service the business is signed up for. Draft Financials are posted by the bookkeeper for review. These serve as the unadjusted trail balance as they contain the same if not more information to review.
Step 4: Prepare adjusting entries
Next, the bookkeeper makes the adjusting entries, provided by the accountant reviewer or CPA, to account for depreciation of larger equipment like ovens, refrigerators, and freezers. These entries spread the cost of the items out over the span of the equipment's useful life.
*NOTE: Other adjusting entries may be related to recategorizing certain transactions to a different account, moving transactions from a parent account to a sub-account, merging accounts, closing prior periods, applying payment transactions to open invoice or bill transactions, entering credit memos, adjusting inventory balances or values, job costing certain expenses or time entries to customer projects, and more. There are many types of adjustments that may be needed that a skilled accountant can pick out of the trial balance and draft financial information. These advanced accounting adjustments are based on expert reasoning, and computer systems do not have the ability to point out all these needed updates, as they relate to a certain business. This is why trusting experts to review your data in depth is the only way to ensure accuracy of reporting over time.
Step 5: Prepare adjusted trial balance
With the adjusting entries complete, the bookkeeper prepares the business's adjusted trial balance and completes a final review for accuracy. This provides a summary of the ending balances in the accounts.
The adjusted trial balance is an important step in the accounting cycle, happening right before you prepare the financial reports. At first, we start with an unadjusted trial balance, which summarizes all the work and lists the account balances at the end of the period. Then, an accountant reviewer or CPA steps in and makes adjustments to this trial balance. This may be weekly, monthly, or annually depending on the level of service being provided.
These adjustments could be things like depreciation, which don't involve actual cash transactions and can be done yearly, quarterly, or monthly.
The adjusted trial balance combines the unadjusted one with these adjustments to ensure that the financial statements accurately reflect all the necessary information. Even if we are not directly involved in making adjustments as a bookkeeper, it's important to understand the purpose and significance of the adjusted trial balance. It acts as the final checkpoint before creating those all-important financial reports.
Step 6: Prepare financial statements
The bookkeeper's last step is to create the business's four main financial statements:
Income statement - showing the business revenues and expenses for a specific period (also known as the profit and loss statement or P&L)
Balance sheet - presenting a snapshot of the business assets, liabilities, and equity at a particular moment
Statement of equity - tracking the changes in the business equity, starting from the opening balance to the ending balance for the period
Statement of cash flow - providing information about the sources and uses of cash by the business, offering insights into cash inflows and outflows.
The accounting cycle is a workflow that helps your bookkeepers accurately record and summarize transactions, which reduces mistakes.
Up for deeper information on this process? Keep reading.
The trial balance is a financial report that acts as a built-in check in the accounting cycle to catch errors in financial records. If the trial balance debits and credits don't balance, it's a sign that there are errors that need to be found and fixed.
In the accounting cycle, adjusting entries are made to account for transactions made in advance, asset depreciation, and to show the true financial picture of the business.
Following the standard process in the accounting cycle is like following a cake recipe. Just as each ingredient must be added in the correct order to create a delicious cake, each step in the accounting cycle must be followed accurately to produce error-free financial reports.
Question: Is your bookkeeper completing the accounting cycle as often as your business needs them to? To answer this, the crucial questions we need to ask are:
What time periods do you normally look at?
What information do you need to obtain on a regular basis?
Would it be helpful to see the information month-to-month, quarter-to-quarter, or year-to-year?
Do you need to pay bills weekly?
Do you need to send customer invoices right away?
Do you have staff on payroll tracking their time hourly?
Are their costs that you incur to a particular customer or project?
Do you have inventory that needs to be regularly tracked?
Do you need to calculate and pay estimated taxes?
Are you enrolled in the right bookkeeping program?
It's all about understanding your business needs so that the work can be done at the right frequency to get you the reports you need. This allows you to make better decisions and accomplish whatever you set out to do, which is the ultimate goal. So, take the time to give your bookkeeper the responses to these questions so they can understand your needs and preferences, and provide you with reports that are tailored to your business's specific requirements.
Define the period
Because businesses don't all use the same time periods for reporting their financial data, when putting together financial statements, it's essential to clearly show the date or time period they cover. This helps ensure that the financial information is presented accurately. It's like putting a label on the statements to let everyone know exactly when they're valid for. So, whether it's for a month, a quarter, or a year, make sure to mark it clearly to avoid any confusion.
Foundational principles
When it comes to the accounting cycle, understanding a few basic accounting principles is key. These principles help ensure that transactions are recorded in the correct time frame.
Periodicity Assumption
Revenue recognition principle
Matching principle
Periodicity Assumption
A business can report its financial results within specific time periods. This usually involves reporting results and cash flows regularly, such as monthly, quarterly, or annually.
Think of the accounting cycle like a never-ending loop that happens over and over again. This loop is called periodicity, and it's all about keeping things consistent and organized.
With periodicity, businesses make sure that they report their financial information in a timely and meaningful way. It's like a clock ticking, reminding them to update their records and create accurate financial statements that reflect the specific timeframes of their transactions.
So, by following this repeating pattern, businesses stay on top of their finances and provide a clear picture of their financial health. Revenue recognition principle
A business recognizes its revenues when the goods or services are provided to the customer, regardless of when the payment is received.
The revenue recognition principle helps you figure out when to count revenue. It's the basis of accrual accounting. The key idea is that revenue gets recognized when the work is finished and delivered, not when the payment arrives.
So, even if the business is waiting for a payment, as long as they've completed the work or provided the goods, they can record that revenue in the books. But on the flip side, if the work isn't complete and the money arrives early, that is money owed rather than revenue until the work is finished or the goods are delivered.
It's all about being fair and accurate with the financial reporting! Matching principle
Revenues and their associated expenses should be recognized in the same reporting period.
The matching principle helps you keep everything in sync. It's is all about linking expenses to the revenues they're connected to. It recognizes that there's a cause-and-effect relationship between spending and earning.
So, when you follow the matching principle, you make sure to record expenses in the same period as the revenues they helped generate. This concept is a crucial part of accrual accounting, which gives a more accurate picture of a company's operations on the income statement.
You want the financial statements to tell the whole story, and the matching principle helps you do just that.
*Not sure if accrual accounting is included in the services that your bookkeeper is providing? Be sure to ask them. You may have signed up for a cheaper program that does not include advanced accrual accounting. Make sure that as you grow your business, you are investing in more enhanced services so your bookkeeper and accountants can provide you with the best feedback. Your business coaches and CPA's may start asking you for this information. Before you think your bookkeeper is not "doing their job" to provide this, make sure you ask if you are paying for this level of accounting service. Your bookkeeper may know full well how to provide the service, but may not have been asked to do so due to budgeting constraints.
Dedicated Accounting Software has its Advantages and Disadvantages
ADVANTAGES: Let's start by looking at the advantages of dedicated software.
Basic calculations and sums
Accounting software takes care of basic calculations and sums, so you don't have to worry about making math errors, which saves you time and ensures accuracy.
Crediting and debiting
Accounting software handles proper crediting and debiting based on the transaction type, making sure that all credits and debits are balanced.
Simultaneous updating of accounts
Whenever you enter a transaction, accounting software quickly updates all the relevant accounts at once. That means you don't have to manually calculate balances or transfer data between different accounts, which is a real time saver!
LIMITATIONS:
While accounting software can be pretty amazing, it does have its limitations. Let's look at those now. Data entry accuracy
Accounting software won't stop you from accidentally categorizing transactions the wrong way or typing in the wrong amounts.
No ability to reason
No matter how advanced the software is, it can't replace the expertise and knowledge of a skilled bookkeeper who understands how to organize accounts, how different transactions affect the books, and how to help business owners understand complex financial statements.
The bottom line
The bottom line is that using dedicated accounting software (like QuickBooks Online) results in saved time and reduces the risk of errors, but it can never replace human intuition and judgment.
That's why your bookkeeper is crucial in providing that expertise and personal guidance to your business, ensuring you can navigate your business's financial matters with confidence and clarity.
Software options
There are a lot of accounting software options out there. One popular choice, and our favorite, is QuickBooks Online. It's a comprehensive software that comes packed with features.
With QuickBooks, you'll have a bundle of tools to keep your businesses finances in order and streamline your other business processes. *Not sure which QuickBooks Online software to choose from? Book a free consultation with A Bigger Bottom Line to learn more about your options and what might suit you best.
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