Accounting activities generally fall into one of several natural accounting processes (or cycles). Accounting personnel may be responsible for all or only a part of a cycle. In either case, it is important that they have at least a basic understanding of the complete cycle. Primary cycles include:
Sales, accounts receivable, and cash receipts.
Purchasing, accounts payable, and cash disbursements.
Inventory and cost of sales.
Fixed assets and depreciation.
General ledger and financial statements.
Each cycle is briefly discussed below.
Sales, Accounts Receivable, and Cash Receipts
This process or cycle consists of selling goods or services and receiving payment from customers. The accounting department’s role in this process generally consists of the following activities:
Data entry (invoices). Entering the sales invoices (including any debit or credit memos) into the accounting system to produce the sales journal.
General ledger posting (invoices). Posting the sales journal to the aged trial balance and the applicable general ledger accounts (debit to accounts receivable and credit to sales).
Data entry (customer remittances). Applying customer payments against applicable open sales invoices to produce the cash receipts journal.
General ledger posting (remittances). Posting the cash receipts journal to the aged trial balance and the appropriate general ledger accounts (debit cash and credit accounts receivable).
Reconciliation. Keeping the aged trial balance in balance with the ending general ledger balance.
Account maintenance. Setting up new customer accounts and credit limits and deleting/changing existing accounts.
The Accounting Procedures and Procedures Guide Chapter 3, Processing Sales and Receipts, discusses this process in more detail.
A crucial part of this process is ensuring that invoices, remittances, and any adjustments are posted accurately and on a timely basis. If the timing is delayed or transactions are posted inaccurately, the aged trial balance will become unreliable for managing receivables, customer complaints will become common place, and financial statement accuracy could diminish.
Purchasing, Accounts Payable, and Cash Disbursements
This process or cycle consists of the purchase of goods or services and the subsequent payment of those goods or services. The accounting department’s role in this process generally consists of:
Account coding. Ensuring that vendor invoices have been coded with the appropriate general ledger account numbers based on the approved chart of accounts. Proper account coding requires accounting personnel to have a strong understanding of the company’s chart of accounts.
Data entry (invoices). Entering the vendor invoice amounts (including any debit or credit memos) into the accounting system to produce the purchases journal.
General ledger posting (invoices). Posting the purchases journal to the accounts payable subsidiary ledger and the various general ledger accounts. For instance, recording a debit to the appropriate asset (inventory or fixed asset) or expense accounts and a credit to accounts payable.
Check preparation. Selecting invoices to pay and preparing checks for paying specific vendor purchases to produce the cash disbursements journal.
General ledger posting (checks). Posting the cash disbursements journal to the accounts payable subsidiary ledger and the general ledger (debit to accounts payable and credit to cash).
Reconciliation. Keeping the accounts payable subsidiary ledger in balance with the ending general ledger balance.
Account maintenance. Setting up new vendor accounts and deleting old accounts.
The Accounting Procedures and Procedures Guide Chapter 4, Processing Purchases and Payments, provides in-depth discussion of this process.
Ensuring that vendor invoices have been recorded accurately and coded with the appropriate general ledger account numbers are crucial steps in this process. Any undetected errors at this stage could affect vendor payments, financial statement accuracy, and tax return amounts. Thus, accounting personnel should exercise great care at this stage and follow established internal controls.
The payroll process consists of processing payrolls and remitting amounts due to employees, government, and others (health insurers, retirement plan trustees, etc. ). The accounting department’s role in this process generally consists of the following activities:
Time cards processing. Checking mathematical accuracy of time cards.
Data entry. Entering time distribution by employee, including hours worked, time off, and overtime hours into the accounting system to produce the payroll journal.
General ledger posting (payroll). Posting the payroll journal to the general ledger. For example, debit compensation expense and credit liability accounts for net payroll and payroll taxes.
Check preparation. Preparing and distributing employee payroll checks to produce the payroll check register.
General ledger posting. Posting the payroll check register to the general ledger. For example, debit liability accounts and credit cash.
Tax reports preparation and deposits. Preparing payroll tax reports and making required tax deposits to state and federal agencies.
Account maintenance. Setting up new employees, deleting terminated employees, changing pay rates and tax rates, revising employee withholding amounts, etc.
The Accounting Procedures and Procedures Guide Chapter 5, Processing Payrolls, covers all aspects of this process in great detail.
Preparing timely and accurate paychecks is obviously important to accounting personnel, since to do otherwise will often bring an immediate response from affected employees. Also, failing to file accurate and timely payroll tax reports subjects the company and key employees (possibly even some supervisory accounting personnel) to tax penalties.
Inventories and Cost of Sales
The inventory and cost of sales process consists of properly accounting for incoming and outgoing inventory. The extent of the accounting department’s involvement in this area varies greatly with the nature of the company’s business (retailer, wholesaler, or manufacturer) and the type of inventory accounting system. In many small businesses, CPAs (both internal and external) are heavily involved in this area because of its complexity and importance to the business’s success.
The accounting department’s role in this process generally includes:
Data entry (purchases). Entering inventory purchases is typically done as part of the purchasing process. In addition, posting the purchases journal typically updates the inventory subsidiary ledger if one is maintained.
Cost of sales. As mentioned above, the method used to record cost of sales varies greatly among small businesses. If a separate inventory subsidiary ledger is maintained, cost of sales is often automatically recorded by the accounting system (as part of the sales and accounts receivable process) when customer sales are posted. If a separate subsidiary ledger is not maintained, cost of sales is often recorded with a manual journal entry at month end by applying an estimated cost of sales percentage to sales for that month. In any event, accounting personnel should ensure that all recorded sales have a matching recorded cost in the same period.
Inventory transfers. Adjusting the detailed inventory records (if any) and the general ledger for transfers of inventory between locations or the disposal of excess, obsolete, or damaged inventory.
Reconciliation. Keeping the inventory subsidiary ledger in balance with the ending general ledger balance.
Account maintenance. Setting up new inventory parts in the system and changing part numbers of existing inventory items.
Accounting for inventories and cost of sales is a complex area that varies greatly from one company to the next.
Fixed Assets and Depreciation
The fixed assets and depreciation process consists of recording fixed asset additions and deletions and related depreciation. The accounting department’s role in this process generally includes:
Purchases. Recording fixed asset purchases in the general ledger is typically done as part of the purchasing and cash disbursement cycle. Purchases are usually posted to the general ledger by debiting the appropriate fixed asset account and crediting accounts payable.
Subsidiary fixed assets ledger. If the company’s fixed asset system is integrated with the company’s accounting system, the fixed asset subsidiary ledger is generally updated at the same time fixed asset purchases are posted to the general ledger. Otherwise, additions and retirements typically must be reentered into a separate stand-alone fixed asset/depreciation system.
Depreciation. Calculating and recording depreciation for each asset is typically done by using an automated fixed assets/depreciation system. However, companies with relatively few fixed assets sometimes use manual or automated spreadsheets to track fixed assets and related depreciation. In addition, those companies make a manual journal entry to record the depreciation provision. Companies generally must make separate depreciation calculations for tax purposes.
Retirements. Recording fixed asset retirements (sales, trade-ins, or disposals) is typically posted to the general ledger via a manual journal entry.
Accounting personnel have two primary challenges in the fixed assets and depreciation area. They must ensure that the subsidiary fixed assets ledger stays in balance with the general ledger control account and that depreciation calculations comply with financial statement rules and ever-changing tax requirements.
General Ledger and Financial Statements
The general ledger process consists of posting the period’s transactions to the general ledger and preparing financial statements. The accounting department’s role in this process generally includes the following activities:
Posting summary journal entries. Entries from summary journals (purchases, sales, cash receipts, cash disbursements, payroll, etc. ) are typically posted by the system throughout the month as batches of transactions are processed.
Preparing manual Journal entries. Preparing and posting manual journal entries varies depending on the type of entry. The entries may be either recurring journal entries that must be made each month or adjusting journal entries that are made as needed to correct any errors that are detected.
Generating the trial balance. The trial balance is simply a numerical listing of all general ledger accounts in account number order. Accounting personnel generate the general ledger trial balance to ensure total debits equal total credits.
Reconciling subsidiary ledgers and supporting workpapers. As discussed previously, comparing general ledger control accounts with subsidiary ledgers (accounts receivable, inventory, property and equipment, and accounts payable) and any supporting workpapers (bank reconciliation, investment schedule, prepaid expense schedule, etc.) is crucial to ensuring the accuracy of the general ledger. Accounting persons should investigate out-of-balance situations and prepare adjusting journal entries when needed.
Closing out. Closing out the general ledger involves making an entry to zero out all income statement accounts for the period (month or year) and posting the offsetting entry to the balance sheet’s retained earnings account. After making this entry, the balance sheet should be in balance (in other words, assets should equal liabilities plus equity).
Producing the financial statements. Producing the financial statements is done after the general ledger has been prepared and is in balance. Computer-generated financial statements typically include a balance sheet and an income statement.
The Accounting Procedures and Procedures Guide Chapter 7, Maintaining the General Ledger, and Chapter 8, Preparing Financial Reports, provide in-depth discussion of the general ledger and financial statement process.
Accounting personnel’s main concern in preparing the general ledger and financial statements is ensuring that all entries have been accurately posted. A careful review of the trial balance and preliminary general ledger and a comparison to subsidiary ledgers and supporting work papers will often reveal additional adjusting journal entries that are needed to correct errors.