The accounting cycle is the process that accounts go through to turn all of the recorded data that a company keeps on hand into the four basic financial statements for a given period. This process begins with the raw data that is held by the company. The accountant categorizes this data into specific accounts. These accounts are then used to produce the financial statements.

In order to prepare the financial statements an accountant must make journal entries to post information into its proper accounts. One such entry that would have to be made is when a company purchases something. The journal entry will be different depending on how the company pays for the goods. If it pays cash then the cash account is credited while the appropriate account is debited. Examples of purchase accounts that could be debited are: general inventory, supplies, equipment, land, furniture and buildings. If the company buys on credit then the accounts payable account is credited. The company eventually has to pay cash for its purchases. When this happens cash is credited and the accounts payable account is debited.

The opposite happens when a company sells a good or service. If a service is provided then the service revenue is credited and the cash or accounts receivable are debited, depending on how the customer pays for it. If a good is sold then inventory is credited and either cash or accounts receivable are debited.

Another entry is made for the payment of a company’s expenses. The company has three options to pay for their expenses. They can either pay in advance, pay cash, or pay on credit. Each of these options would give a different journal entry. If the expense was paid in advance then it becomes an asset to the company. The accountant would debit the prepaid expense account and credit its cash or accounts receivable account. If the company paid cash then they would credit the cash account and debit the expense account. The same goes for if they pay on credit, except that they would credit the accounts payable account instead of cash.

The Accounting Cycle continued....