The Accounting Cycle, Debits and Credits, and Double Entry Accounting

The accounting cycle is a ten step process, starting with collecting data about the original economic event that affects the financial statements, to the final production of the financial statements for the period.

This online accounting section goes through each step in the accounting cycle, from collecting data to producing the final financial statements.

Although the best small business accounting software packages handle much of the accounting cycle automatically, such as posting to the general ledger, a thorough grasp of these accounting principles gives business stakeholders and analysts valuable information about the composition of the business financial statements and the underlying story behind them.

The Accounting Cycle

1). Collecting and Analyzing Data about an Economic Event

2). Recording the transaction in the Accounting Journal

3). Posting from the Accounting Journal to the General Ledger

4). Preparing the Unadjusted Trial Balance

5). Recording Adjusting Entries

6). Preparing the Adjusted Trial Balance

7). Preparing Financial Statements

8). Recording Closing Entries

9). Preparing a Final Trial Balance

10). Recording Reversing Entries

1). Collecting and Analyzing Data about an Economic Event

A source document provides evidence that an economic event has actually occurred. Examples of source documents include a receipt, an invoice, a depreciation schedule, and a bank statement.

Because the financial statements and the accounting cycle center on the accounting equation, the accounting cycle is set up to ensure that any transaction entered keeps the accounting equation in balance. This concept is known as double entry accounting.

Learning Accounting: The Accounting Equation and Double Entry Bookkeeping

Assets = Liabilities + Owner’s Equity

For example, an entry to increase an asset account must also increase liabilities, owners equity, or reduce another asset by the same amount to keep the accounting equation in balance.

Every account has a left side and a right side to enter a transaction. In accounting terms, a debit simply means an entry on the left side of an account, and a credit simply means an entry on the right side of an account.

General Ledger Account

Debit Side

Credit Side

Debits and Credits

Debits are entries made on the left side of an account column, and a credit is an entry made on the right side of an account column.

The concept of debits and credits simply allows us to keep the accounting equation in balance without memorizing the process. Debits to the left of the equation, assets, increase the balance, and credits to the right side of the equation, liabilities and owners equity, increase the balance. Similarly, credits to assets decrease the balance, and debits to the right side of the equation also reduce the balance.

By analyzing the economic event, we determine what effect the transaction has on the accounting equation.

Debits and Credits and Double Entry Accounting

Debits Indicate	Credits Indicate
Asset Increases	Asset Decreases
Liability Decreases	Liability Increases
Owners Equity Decreases	Owners Equity Increases
Expenses	Revenue

For example, when Sunny invested $50,000 to start his business, $50,000 increased the cash balance of the business, an asset, and also increased owners equity.