Financial Accounting | The Accounting Cycle and Transaction Analysis

Financial Accounting

The Accounting Cycle and Transaction Analysis

Overview

This topic walks through the steps of the accounting cycle, from the recording of transactions to the preparation of financial statements. You'll also learn how to analyze business transactions and apply the double-entry system using debits and credits.

Key Concepts and Steps

Source Documents: Invoices, receipts, and other original records used to identify transactions.
Journal Entry: Initial recording of a transaction in the general journal.
Ledger: Collection of accounts that shows changes and balances.
Trial Balance: List of all ledger accounts and balances to check if debits equal credits.
Adjusting Entries: Made at the end of a period to update account balances before financial statements.
Financial Statements: Income statement, balance sheet, and statement of cash flows are prepared from adjusted balances.
Closing Entries: Reset temporary accounts (revenues, expenses, dividends) to zero at the end of the period.
Post-Closing Trial Balance: Final check to confirm that debits and credits are still balanced.

Step-by-Step Example

Problem: On April 1, a company pays $1,200 for 12 months of insurance in advance. What is the journal entry?

Step 1: Identify the accounts affected:

Increase in Prepaid Insurance (Asset) → Debit $1,200
Decrease in Cash (Asset) → Credit $1,200

Journal Entry:

  Date       Account                     Debit      Credit
  Apr 1      Prepaid Insurance           1,200
             Cash                                   1,200

Quick Tip

Always start with the source document and ask: What accounts are affected? What increases or decreases? Should I debit or credit each?