The accounting cycle, end to end — Accounting Module 10

Modules 1-9 covered each piece of accounting in isolation. This module ties them together into the cycle every accountant runs, monthly or quarterly. The cycle is mechanical and repetitive — but it's also the place where most accounting fraud and error gets caught, because each step is a defensible audit trail.

The eight-step cycle

1. Identify transactions: receipts, invoices, contracts, bank statements — anything that creates a recordable economic event.
2. Record in the journal: write the journal entry with date, accounts, debits, credits, narration.
3. Post to the ledger: copy each entry to the relevant ledger accounts.
4. Prepare unadjusted trial balance: list every account's balance; debits must equal credits.
5. Record adjusting entries: accruals, deferrals, depreciation, allowances (Module 9).
6. Prepare adjusted trial balance: re-check that debits still equal credits after adjustments.
7. Prepare financial statements: income statement first; then balance sheet (with net income flowing into retained earnings); then cash flow statement; finally statement of changes in equity.
8. Close temporary accounts: zero-out revenues, expenses, and drawings into retained earnings so the next period starts at zero on the P&L accounts.

Closing entries

Revenue and expense accounts are 'temporary' — they accumulate within a period, then close to retained earnings. If you didn't close them, the Sales Revenue account would grow forever, mixing this year's sales with last year's. Closing entries reset them.

text

Close revenue (temporary credit balance) into Income Summary:
   DR Sales Revenue        500,000
   DR Interest Income       20,000
   CR Income Summary       520,000

Close expenses (temporary debit balances) into Income Summary:
   DR Income Summary       350,000
   CR COGS                 200,000
   CR Rent Expense         100,000
   CR Salaries Expense      50,000

Close Income Summary (now showing 520k credit − 350k debit = 170k net income)
into Retained Earnings:
   DR Income Summary       170,000
   CR Retained Earnings    170,000

Close Drawings (if any) into Retained Earnings:
   DR Retained Earnings     50,000
   CR Owner's Drawings      50,000

After all closing entries, all P&L accounts and Drawings are zero, ready for the next period.
Retained earnings carries forward the cumulative profit.

Closing entries roll the period's revenues, expenses, and distributions into retained earnings.

Why the cycle matters even with software

Quickbooks does most of these mechanically. But understanding the cycle matters because: (1) you can spot when the software is doing something wrong; (2) you can explain a number to a stakeholder or auditor; (3) you can build a manual close process when software fails or for a side project; (4) when the books need to be 're-opened' to correct a prior-period error, you know exactly where in the cycle the correction belongs.

The closing-the-books rhythm

In most businesses: bookkeeping happens daily; the trial balance is prepared monthly; adjusting entries and financial statements are run quarterly; full closing entries (resetting P&L accounts) run annually. Some businesses (banks especially) close monthly or even weekly for regulatory reporting.

Exercise

Walk through what would happen if you skipped step 5 (adjusting entries) and went straight from unadjusted trial balance to financial statements. Pick three specific items that would be wrong. Now: what if you skipped step 8 (closing entries) at year-end — what's the consequence for next year's reporting?