The Bookkeeping Cycle
The bookkeeping cycle is the complete process of recording and processing all financial transactions for an accounting period. Understanding this cycle helps you maintain organized, accurate books.
Overview of the Cycle
The bookkeeping cycle consists of 8 main steps that repeat each accounting period.
Step-by-Step Breakdown
Step 1: Identify and Analyze Transactions
Review source documents and determine the accounting impact.
Source Documents:
- Sales invoices
- Purchase receipts
- Bank statements
- Payroll records
- Contracts
Analysis Questions:
- What accounts are affected?
- Are they assets, liabilities, equity, revenue, or expenses?
- Should they be debited or credited?
Step 2: Record Transactions in the Journal
Create journal entries for each transaction.
Example:
Date: Jan 15, 2024
Description: Purchased office supplies on credit
Account Debit Credit
Office Supplies $500
Accounts Payable $500
Step 3: Post to the General Ledger
Transfer journal entries to individual account ledgers.
Office Supplies Ledger:
| Date | Description | Debit | Credit | Balance |
|---|---|---|---|---|
| Jan 15 | Purchase | $500 | $500 |
Step 4: Prepare Unadjusted Trial Balance
List all accounts and their balances to verify debits equal credits.
Trial Balance (January 31, 2024):
| Account | Debit | Credit |
|---|---|---|
| Cash | $10,000 | |
| Accounts Receivable | $5,000 | |
| Office Supplies | $500 | |
| Accounts Payable | $3,000 | |
| Owner's Equity | $12,500 | |
| Totals | $15,500 | $15,500 |
Step 5: Make Adjusting Entries
Record accruals, deferrals, and other adjustments at period end.
Common Adjustments:
- Prepaid expenses
- Unearned revenue
- Accrued expenses
- Accrued revenue
- Depreciation
Example:
Date: Jan 31, 2024
Description: Record supplies used during month
Account Debit Credit
Supplies Expense $200
Office Supplies $200
Step 6: Prepare Adjusted Trial Balance
Create a new trial balance reflecting all adjustments.
Step 7: Generate Financial Statements
Prepare reports from adjusted balances:
- Income Statement (Revenue - Expenses = Net Income)
- Statement of Owner's Equity
- Balance Sheet (Assets = Liabilities + Equity)
- Cash Flow Statement
Step 8: Close Temporary Accounts
Transfer revenue and expense balances to retained earnings/owner's equity.
Closing Entries:
Close Revenue:
Revenue $50,000
Income Summary $50,000
Close Expenses:
Income Summary $35,000
Various Expenses $35,000
Close Income Summary:
Income Summary $15,000
Retained Earnings $15,000
Cycle Frequency
Daily Tasks
- Record transactions
- Post to ledgers
- Reconcile cash
Monthly Tasks
- Prepare trial balance
- Make adjusting entries
- Generate financial statements
- Reconcile bank accounts
Yearly Tasks
- Make closing entries
- Prepare tax returns
- Create annual reports
- Archive records
Temporary vs. Permanent Accounts
Temporary Accounts (Closed Annually)
- Revenue accounts
- Expense accounts
- Dividend/distribution accounts
Permanent Accounts (Never Closed)
- Asset accounts
- Liability accounts
- Equity accounts
Common Mistakes to Avoid
- ❌ Skipping steps: Each step verifies the previous one
- ❌ Delaying entries: Record transactions promptly
- ❌ Ignoring adjustments: Critical for accurate reporting
- ❌ Not reconciling: Catch errors early
- ❌ Poor documentation: Keep all source documents
Software Automation
Modern accounting software automates much of this cycle:
| Manual Step | Software Automation |
|---|---|
| Journal entries | Auto-generated from transactions |
| Posting | Instant and automatic |
| Trial balance | Real-time reports |
| Adjusting entries | Recurring entry templates |
| Financial statements | One-click generation |
| Closing entries | Automated year-end process |
Even with software automation, understanding the manual cycle helps you:
- Troubleshoot errors
- Verify software accuracy
- Make informed decisions
- Communicate with accountants
Practical Example: Full Cycle
Scenario: Small business, January transactions
- Identify: Made $5,000 sale on credit
- Record: Debit A/R $5,000, Credit Revenue $5,000
- Post: Update A/R and Revenue ledgers
- Trial Balance: Verify all accounts balance
- Adjust: Record supplies used ($200)
- Adjusted Trial Balance: Verify adjusted balances
- Statements: Generate P&L and Balance Sheet
- Close (if year-end): Close revenue and expenses
Next Steps
Now that you understand the bookkeeping cycle, you're ready to dive into Part 2: Keeping a Paper Trail to learn about essential documentation practices.
Quick Reference: The 8 Steps
- ✅ Identify and analyze transactions
- ✅ Record in journal
- ✅ Post to ledger
- ✅ Prepare unadjusted trial balance
- ✅ Make adjusting entries
- ✅ Prepare adjusted trial balance
- ✅ Generate financial statements
- ✅ Close temporary accounts