When we talk about the accounting cycle, we refer to the set of phases that are repeated in each fiscal year during the existence of the company. It is the record of all the economic-financial operations that have been carried out in said period.
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The operations can be of two types:
- Real operations: they involve a transaction of the company with its environment. They are done throughout the year and also usually have documentary support.
- Formal operations: they are carried out by the application of an accounting standard or principle. They are done at the end of the exercise.
Its main purpose is to have the accounting information about the results obtained and the economic-financial and patrimonial situation.
The reason why economic activity is divided into annual cycles is due to:
Tax legislation: we must settle the annual taxes corresponding to the benefits obtained.
Commercial legislation: we are required to write and present the annual accounts of the company in the Commercial Registry.
Informative interest: this way we will avoid mistakes and possible deviations by having the economic-financial situation of the company. Having all the accounting information will help us in making decisions.
Duration of the accounting cycle
As a general rule, the duration of the accounting cycle usually coincides with the calendar year (from January 1 to December 31). When the company is created, the duration is usually shorter since it is counted from the beginning of its activity until the end of the year. The same happens in the dissolution of the company since it will be counted from the beginning of the fiscal year until the end.
The start and end date of the fiscal year other than the calendar year must be set in the Bylaws. Otherwise, the exercise will begin on January 1 and end on December 31.
It is important to decide the beginning and the end of the year, especially in cases where economic activity is seasonal. It is also relevant to take into account the formal obligations (formulation of accounts and presentation in the Registry, audits …) and fiscal obligations (presentation of Corporate Tax).
Stages of the accounting cycle
The phases that make up the accounting cycle are as follows:
- Initial balance sheet: at the beginning of the fiscal year, the company will have a certain equity, which will be reflected in the balance sheet.
- Opening of accounting: the elements that the company has are recorded in both the Daily Book and the Ledger. The opening entry will consist of making a charge to the asset accounts and a credit to the liability and net accounts.
- Record of the operations of the year: increases in assets (rights and assets) will be recorded in the debit and decreases in the credit. Variations in liabilities (obligations and debts) work just the opposite. An increase represents an entry in the credit and a decrease in the debit.
- Periodification: we attribute the corresponding expenses and income to the year by applying the accrual principle. With special attention on:
- The expenses and income accounted for in the year corresponding to a subsequent one.
- The expenses and income accrued in the year and pending accounting.
- Adjustments prior to the determination of the benefit – or loss – generated in the year: we will make any changes that help to reflect the faithful image of the company. For example, we make a provision for unpaid accounts, we consider depreciation …
- Balance of checks of sums and balances: it helps us to verify that we have not made mistakes in the annotations made. If the total figures do not match, it is because we have made a mistake.
- Calculation of the result: it is done by subtracting the expenses incurred from the income. It is the settlement of the accounts of groups 6 and 7. If the balance of the result is:
- DEBTOR (Should> Have) a loss occurs.
- CREDITOR (Must <Have) a benefit occurs.
- Accounting closing: we must charge the credit accounts and pay the debtor accounts to the books. With this management will be all accounts with zero balance. All accounts of group 8 and 9 are settled.
- Annual accounts: the balance sheet, the profit and loss account, the statement of cash flow, the statement of changes in equity and memory are formulated.
- Distribution of the result: is the benefit obtained by the company after paying the Corporation Tax. It can be distributed among the owners of the entity or set aside as a reserve.
Importance of the accounting cycle
The financial information that gives us to know the results of our company enables us to make strategic decisions. The constant changes in the market, technology, globalisation and current competitiveness mean that we have to be constantly improving.
The key is to rigorously design the most profitable strategies and minimise the risk as much as possible.
Knowing the economic stability, solvency of the organization, the trend of expenses and income allows us to make estimates of the results that we will obtain in the future. We can identify and eliminate activities that do not give us enough benefits and take advantage of those that generate added value.
At present, due to accounting automation we can obtain graphs and statistics that visually show us the financial evolution.
In conclusion, we must strictly apply accounting principles to show the true image of our company. If our accounts are falsified, in addition to committing a crime, we are doomed to fail.
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