The financial information of your company is the direct measure of the performance of your business. The time-honored method of arriving at the accurate financial information of your business is through accounting. Let’s discuss the importance and nuances of process of accounting for financial information.
The Significance of Accounting
The rationale behind accounting is to meet the following objectives:
• Accounting is essential to determine the current standing of your business in the market.
• The financial information derived through accounting forms the basis for a sound, short or long-term, economic planning for your organization.
• The reports prepared serve as a testimony of your firm’s performance for your clients, investors, creditors and bodies like tax authorities and financial institutions.
The Process of Accounting
The process of accounting is triggered as soon as a monetary transaction occurs. It ends when the accounting books are closed at the end of a particular reporting period. An accounting cycle can be elucidated step by step as discussed below.
The following steps are executed all through the accounting period:
1. Identification of a Transaction
An event is identified as a fiscal deal and the relevant source document like a proof of purchase or a purchase order is generated.
2. Transaction Analysis
The transaction is quantified, the accounts affected are identified and it is determined whether it is a debit or a credit.
3. Journal Entry
The accounting transaction is recorded in an apt journal in a chronological order. It could be sales, purchase, cash receipt, expenditure or a general journal.
4. Ledger Posting
The journal records are transferred to appropriate accounts in a ledger.
The following steps are carried out towards the end of the accounting period:
5. Calculation of Trial balance
A trial balance is calculated to ensure that the debit and credit entries posted in the ledger are accurate; in which case the sum total of debit balances would equal that of credit balances.
6. Adjustment of Entries
Accruals like depreciation expense and interest payable, and pre-payments are recorded as adjusting entries in a journal and then posted to a suitable account in the ledger.
7. Calculation of Adjusted Trial Balance
A new trial balance is arrived at after considering the adjusting entries.
8. Financial Statement Preparation
This is the most crucial aspect of the process of accounting. Financial statements are a representation of the change in the fiscal output of a business over the entire financial period. It is classified into the following components:
a. Income statement – A measure of one or more of revenue, expenditure, profit and loss.
b. Balance Sheet – A statement of assets, liabilities and business equity.
c. Cash flows statement – It is a summary of cash movement related to investments, operations and economic activities of a business during the accounting period.
d. Statement of Equity changes – This is a report tracking movement in equity accounts viz. share capital, dividends paid and retained earnings during the financial year.
9. Closure of Entries
The temporary accounts’ balances are reduced to zero by transferring those to permanent accounts. Journal entries are closed and posted to ledger accounts in order to achieve this.
10. Calculation of the Final Trial Balance
This is calculated to ensure zero discrepancy in permanent account balances.
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