The basis for existence of accounting is the presence of financial transactions in the entity; the entity's purchase or sale of goods, as well as the paying salaries transaction, etc. are all called financial transactions, which the company performs when conducting its activity.
Types of financial transactions
Financial transactions carried out by the company, and which are recorded in the books, are categorized into the following types:
- Revenue Transactions
- These include the transactions that occur as a result of the company's practice of its basic activity, the purpose of which is to make profits, e.g. the transactions involving the purchase or sale of goods, expenses paid as salaries, wages, electricity bills…etc.
- Capital Transactions
- These transactions include the company's purchase of fixed assets, the purpose of such purchase is to assist the company practice its activity. They are not acquisition with the intent of resale and making profit from them, such as purchasing land and buildings, production lines, office furniture, computers and others. They also include the transactions that occur as a result of disposing of these assets before or after the expiry of their useful life.
- Financing Transactions
- They include the transactions that occur for financing the company with cash and in-kind assets, so as to be able to carry on its business. This financing is obtained either from internal sources represented by the owners of the company, which is called the capital, or from external sources in the form of loans.
Accounting Cycle Steps
Once a financial transaction occurs, it go through a set of stages and steps to be processed within a particular period of time, and subsequently obtaining the appropriate financial information for the decision-makers. These stages and steps are called the accounting cycle, which are as follows:
1 Preparing the document and analyzing the financial transaction
When the financial transaction occurs, the document that proves the validity of the financial transaction is prepared, so that the accountant then analyzes the financial transaction and identifies the debit and the credit.
2 Recording the Entries in the Journal
After the accountant analyzes the financial transaction and identifies the debit and the credit, he then records the financial transaction in the journal in the form of accounting entries sequential and ordered by date.
3 Posting entries from Journal to the general Ledger and balancing the ledger accounts
After the transaction is recorded in the journal, the accounts debit and credit amounts are then Posted from the Journal to the accounts that are affected by the financial transaction in the Ledger, in order to identify the balance of each account at the end of the period.
4 Preparing the Trial Balance
After financial transactions are posting to the ledger and balancing the ledger accounts, then these accounts are combined by preparing a statement called the trial balance, this statement contains all the balances of debit and credit accounts that were transferred from the ledger.
5 Recording and Posting the Adjusting Entries
After the trial balance is prepared, the accountant makes reviews and check of the accounts. Depending on the result of check, it may appear that the balances of some accounts need to be adjusted by preparing adjusting entries for those accounts, recording them in the Journal
, and posting and balancing them again.
6 Preparing the Adjusted Trial Balance (after the Adjusting Entries)
After the adjustment entries are prepared, the balances of some accounts will change, and then an adjusted trial balance is prepared.
7 Preparing the Financial Statements
After the complete preparation of the adjusted trial balance, which contains all the accounts and their balances, the account balances are then used to prepare the financial statements of the company in order to know the result of the company's performance whether profit or loss, and to determine the company’s financial position at the end of the fiscal period. Financial statements that are prepared at the end of the period are the Income Statement, Statement of Owner's Equity, the Statement of Financial Position (balance sheet) and Cash Flow Statement.
8 Closing the Accounts
After the Income Statement is prepared, the revenues and expenses accounts are closed in the profit and loss account (income summary), as well as closing the Owner Withdrawals account in the capital account or in one of the equity accounts as explained later.