What Is The Accounting Process? Steps Explained

Running a business means dealing with money every day. A shop owner may buy goods in the morning, make sales during the day, pay expenses and receive payments from customers. But how can all these transactions be kept in order?

When there are many transactions to deal with, it can become difficult to keep track of what happened, when it happened and how each transaction affects the business. A proper method is needed to keep this information clear and organised.

So, how does a business record and organize all these financial transactions? Let us understand the accounting process, its main steps and how each step works with simple examples.

What Is The Accounting Process?

The accounting process is a systematic series of steps used to record, classify, summarize and analyse a business’s financial transactions. It starts when a financial transaction is identified and recorded and continues through the preparation and analysis of financial statements. 

For example, when a shop buys goods for ₹10,000, the purchase is first identified and recorded. Later when the sale is made, the transaction is classified and included in the accounting record. As more transactions are recorded and processed, the business can prepare financial statements and understand its financial position and performance.

Read: Functions Of Accounting

Steps In The Accounting Process

The accounting process follows a series of steps to record and organize a business’s financial activities. Each step has a specific purpose and helps move the financial information from one stage to the next.

1. Identify Financial Transactions

A financial transaction is a business event that can be measured in monetary terms and has a financial effect on the business. Therefore, in the accounting process, the first step is to identify which business activities need to be recorded in the accounting records. Not every activity of a business is an accounting transaction. 

This step helps the business separate financial transactions from other business activities and identify the transactions that need to be recorded.

Example: A shop buys goods worth ₹10,000 from a supplier. Since the purchase involves money and affects the business, it is identified as a financial transaction.

2. Collect Source Documents

Once a financial transaction is identified, the business collects the documents related to it. These documents provide details about the transaction and act as evidence that it took place.

Source documents can contain information such as the date of the transaction, the amount involved and the goods or services purchased. They help the business record the transaction correctly.

Example: If a shop buys goods from a supplier, the supplier may provide an invoice showing the items purchased and their total cost. The shop can use this invoice while recording the purchase.

3. Record Transactions In The Journal

After collecting the necessary information, the transaction is recorded in a journal. A journal is a book or record where financial transactions are entered in the order in which they occur. Recording transactions in the journal creates a clear record of the business activities. The entry includes important details about what happened and the accounts affected by the transaction.

Example: If a shop purchases goods for ₹10,000, the purchase is entered into the journal with the relevant details.

Read: Top 15 Basic Accounting Terms

4. Post Entries To The Ledger

The information recorded in the journal is then transferred to the ledger. A ledger keeps transactions related to the same account together. This makes it easier to find and review all transactions related to a particular account. Instead of looking through every journal entry, the business can check the relevant ledger account.

Example: If the shop records several purchases during the month, these transactions can be collected under the purchases account in the ledger.

5. Prepare A Trial Balance

After the transactions are posted to the ledger, the business prepares a trial balance. It is a list of the balances of the different accounts in the ledger. The trial balance is mainly used to check whether the debit and credit amounts are equal. If the totals do not match, the accounting records may contain an error that needs to be identified and corrected. However, a balanced trial balance does not necessarily mean that all accounting errors have been detected. 

Example: If the total debit balance is ₹50,000 and the total credit balance is also ₹50,000, the trial balance is mathematically balanced.

6. Make Adjusting Entries

Before preparing the final financial statements, some account balances may need to be updated. These updates are called adjusting entries. They help ensure that income and expenses are recorded in the correct accounting period. This is important because some amounts may be due or earned even when the actual payment has not yet taken place.

Example: A business uses electricity during March but receives the bill in April. The electricity expense for March may need to be recorded in March even though the payment is made later.

7. Prepare Financial Statements

After the required adjustments are made, the business prepares financial statements. These are reports that present the business’s financial information in an organised form. Financial statements provide information about items such as income, expenses, assets, liabilities and the financial position of the business. Different statements provide different types of financial information.

Example: An income statement can show the business’s income and expenses for a particular period. A balance sheet can show what the business owns and owes.

Read: What Is Financial Accounting? 

8. Analyse The Financial Information

After preparing the financial statements, the business can study the information to understand its financial position and performance. This analysis helps the business see important changes in its income, expenses, assets, liabilities and cash. It can also help identify areas that may need attention.

Example: If a shop’s expenses have increased while its sales have remained the same, the owner can review the expenses to understand why this happened.

9. Communicate The Results

The financial information is then shared with the people who need it. Different people may use the information for different purposes. Business owners and managers may use it to understand business performance and make decisions. Investors, lenders and government authorities may also need financial information for their respective purposes.

Example: A business owner may review the financial statements to decide whether the business can afford to open another shop.

Importance Of The Accounting Process

The accounting process helps a business manage its financial information in an organised way. It is important because it:

• Keeps financial records organised: It puts business transactions into a proper system, making financial information easier to find and review.
• Tracks income and expenses: It helps the business keep a record of the money it receives and the expenses it pays.
• Helps identify errors: Checking records at different stages can help find mistakes or missing entries in the accounts.
• Helps prepare financial reports: The information recorded during the process is used to prepare financial statements.
• Supports business decisions: Clear financial information helps business owners and managers understand the business and make informed decisions.

Conclusion

The accounting process is a step-by-step way of turning everyday business transactions into organised financial information. From recording a transaction to preparing financial statements, each stage helps keep the records clear and useful. Understanding these steps makes it easier to understand how a business keeps track of its financial activities.

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