Full cycle Accounting - understaning the basics
Full cycle accounting is taking all business activities to produce accurate financial statements. It is a way to ‘keep score’ on how the business is doing with the results displayed on a ‘score board’.
The process involves many steps. Those steps range from an initial recording of transactions to presenting final financial statements.
In this post we will go over the overall framework of the accounting cycle. This framework can be applied to small and medium businesses.
The first aspect to consider when looking at full cycle accounting is the key word ‘cycle’. Per Merriam Webster–cycle is “a series of events that are regularly repeated in the same order.” This definition fits the accounting process perfectly. Every month, quarter, or year will have the same transaction processed similarly.
The basic areas in the cycle are:
- Initial recording
- Adjusting journal entries
- Producing financial statements
- Closing of the books for the period
- Cash receipt cycle. This sub-cycle primarily focuses on the recording of revenue. The revenue can be recorded by either cash or through credit sales. This cycle also includes the respective internal controls necessary to monitor revenue.
- Cash disbursement cycle. This sub-cycle primarily focuses on the recording of expenses. The expenses can be recorded either by immediate payment or products and services purchased on credit. This cycle also includes internal controls necessary to prevent unauthorized disbursement of cash.
Adjusting Journal Entries
Adjusting journal entries (AJE) are common for any size of business. These entries usually fall outside of the standard receipts and disbursement cycles yet are necessary for accurate financial statements. These entries usually entail non-cash entries or accrual entries.
An example would be recording the monthly depreciation on equipment. Depreciation expense is a non-cash entry. Depreciation expense would never hit the disbursement cycle. The crucial aspect in AJEs is to help present a true financial picture of a company as of a point in time.
Producing Financial Statements
The financial statements are the culmination of activity for the period. The core financial statements include:
- Balance sheet
- Income statement
- Statement of cash flows
The balance sheet gives a picture as of a point in time of the business’s equity. The income statement gives a picture of the activity for the period. The cash flow statement shows how much cash the business provided or used for operations.
Combined, all the core financial statements provide management with a clear picture of the business ‘score board.’
The last aspect of the accounting cycle is the closing of the books for the period. This step is necessary as it will segregate the accounting transactions in the proper period.
For example, April transactions should be kept in the April period or 2021 transactions should be kept in the 2021 period. The segregation of these entries provides a picture of activity for month to month and year to year.
The closing of the books closes the circle, or cycle, on the accounting process for the period. This cycle then will start again with the new period.
Understanding the basics of the full accounting cycle is foundational for businesses. The continual process can be refined to maximize efficiency.
This can then build more sophisticated cycles and ultimately forecasts and budgets.