The primary goal of an accounting system is to record a company’s financial transactions and report its financial performance to all concerned parties. The accounting process starts with identifying transactions that a company enters into in the course of its business on a daily basis and ends with the presentation of its financial statements. We briefly describe the main steps in the accounting process in this chapter. We will study each step in more detail in later chapters.

Identifying Transactions

A transaction is any activity that has a financial impact on the company. Examples of transactions include purchasing an asset, selling goods or services, collecting cash from customers, and paying expenses. We are only looking for activities that have a financial impact on the company. This need not be a payment or receipt of cash. A transaction could be creating a current or future financial obligation, such as a payable in the future. An activity that does not have a financial impact, such as the arrival of a visitor, is not a transaction that the accounting system needs to capture.

Analyzing Transactions

Once a transaction is identified, the transaction is analyzed to identify 1) if the transaction creates a benefit (asset) or an obligation (liability) to the company, 2) which specific areas (accounts) are impacted, 3) the quantity of impact, and 4) the direction (up/down) of impact.

Recording Transactions

After a transaction has been analyzed, the transaction must be recorded in the accounting system. Here is where we will deviate from the conventional accounting process. The recording of these transactions is usually done in the company’s accounting books as an entry in the general ledger, journal, and T-accounts. We will record the transactions in the Balance Sheet Equation Template on an Excel spreadsheet or on the accountingtutor.org webpage.

End of period Transactions

Sometimes a benefit (asset or income) or an obligation (liability or expense) may be created with the passage of time (as opposed to an event or transaction). These must be accounted for at the end of the accounting period.

In the traditional accounting system, these end of period transactions are called adjusting entries.

Summarizing Accounts

After the end of period transactions are recorded, all individual accounts are summed up to summarize each account. The sum of each account is often referred to as the account balance. In the traditional accounting system, this process is called preparing the trial balance.

Preparing Financial Statements

You are now ready to prepare the financial statements. The income statement and balance sheet are prepared using the above account balances. The income statement and balance sheet are nothing but the various accounts ordered in a logical manner. This is the last step in an accounting period.

Starting a New Accounting Period

This cycle is then repeated for the next accounting period.