The complete accounting cycle

In depth

The worksheet (optional)

A worksheet is an internal working paper, today usually a spreadsheet, that lays the end-of-period steps side by side. The traditional ten-column worksheet has a debit and a credit column for each of five stages: the unadjusted trial balance, the adjustments, the adjusted trial balance, the income statement and the balance sheet. Each account’s balance is carried across the page to the statement it belongs on. The worksheet is not a financial statement and is never published, and using one is optional. It helps an accountant plan the adjustments and draft the statements before any adjusting entry is journalised.

Adjustments are shown as increases (+) or decreases (−) in each account’s normal balance. A ten-column worksheet has no columns for the statement of changes in equity, so Dividends is carried to the balance sheet columns.

The worksheet also produces net income before any statement is written. Across all of Lantern’s accounts, the income statement columns hold $6,110 of debits (the expenses) and $7,100 of credits (the revenue); the difference, $990, is net income. The balance sheet columns differ by the same amount: $43,000 of debits (assets of $42,700 before accumulated depreciation is deducted, plus dividends of $300) against $42,010 of credits (accumulated depreciation, liabilities and common stock). Adding the $990 to the credit side balances them, because the period’s profit is the one change in equity that has not yet reached the balance sheet accounts. Closing is what puts it there.

Reversing entries (optional)

A reversing entry is made on the first day of a new period and is the exact opposite of an adjusting entry made at the end of the previous one. It is optional and is normally used for accruals (accrued expenses and accrued revenues), which a later payment or receipt will settle. Its purpose is convenience: whoever records that later payment can do it the routine way, without having to know that part of it was accrued last period.

Take Lantern’s accrued wages. At 31 March, adjustment a5 recorded $1,400 of wages that the baristas earned on 16–31 March, to be paid on 5 April: debit Wages Expense, credit Wages Payable. Closing then took Wages Expense to zero. There are two ways to record the 5 April payroll, and they end in the same place.

With the reversal, Wages Expense briefly carries a credit balance of $1,400, an unusual balance that disappears when the payroll is recorded. After 5 April both routes show Wages Payable at zero, no April wages expense from this payroll, and cash $1,400 lower. The reversal changes no result; it only lets the payroll be recorded as an ordinary expense.

To see the rest of the month, suppose (hypothetical figures) that on 20 April Lantern pays $1,500 for wages earned on 1–15 April, and that on 30 April it accrues $1,600 for 16–30 April. The table follows the balance of Wages Expense through April by both routes.

Both routes also leave Wages Payable at $1,600 on 30 April.

Both routes give April wages expense of $1{,}500 + 1{,}600 = 3{,}100$, which is what the baristas earned in April. Reversing entries guard against a specific slip: the payroll clerk who, not knowing about the accrual, records the 5 April payment as Wages Expense when no reversal has been made. April’s wages expense would then be $1{,}400 + 1{,}500 + 1{,}600 = 4{,}500$, and Wages Payable would still include $1,400 that nobody is owed.

Reverse only accruals that a later cash payment or receipt will settle. Reversing depreciation, or the expiry of prepaid insurance, would simply cancel a correct adjustment, because no later transaction will record that expense again.

Correcting entries

Errors are found at every stage: when a trial balance doesn’t balance, when a reconciliation fails, when a reviewer asks why an account looks odd. Once an entry has been posted, it is not erased or overwritten. Instead the accountant records a correcting entry, a new journal entry that brings the accounts to the balances they would have had if the original entry had been right. This preserves the audit trail: anyone can see what was recorded, when it was fixed and why.

One method works for every correction. Write the entry that was made, write the entry that should have been made, and record the difference, account by account. Lines that were right in both drop out. Three errors Lantern could have made in March show the patterns. Each is hypothetical, and each is supposed to be found during the review of the unadjusted trial balance, before the adjusting entries.

• Wrong account. Suppose the $350 for March advertising (10 March) had been debited to Prepaid Advertising instead of Advertising Expense. Cash was right; only the debit was misplaced. The correction moves it: debit Advertising Expense 350, credit Prepaid Advertising 350. Uncorrected, the error would overstate both assets and net income by $350.
• Wrong amount. Suppose the $1,200 rent payment (28 March) had been keyed as $2,100 on both lines. Rent Expense and the cash paid are each $900 too large, so the correction debits Cash 900 and credits Rent Expense 900. The trial balance could not catch this error, because both sides were wrong by the same amount; the bank reconciliation would. Notice that 900 is divisible by 9, the signature of two transposed digits.
• Omitted entry. Suppose the $260 utilities bill (31 March) had never been recorded. Nothing needs undoing: the correction is simply the missing entry, debit Utilities Expense 260, credit Accounts Payable 260, with a memo explaining why it is late.

If the journal entry was right and only the posting went astray, for example a correct amount posted to the wrong ledger account, a manual system fixes the ledger rather than adding a journal entry. In accounting software posting is automatic, so posting errors of that kind don’t arise; errors, and their corrections, are in the entries themselves.

Internal control

The cycle produces reliable numbers only if the entries going into it are genuine, complete and accurate. Internal control is the set of processes an organisation uses to make sure that happens, and more broadly to protect its assets, comply with the law and run its operations well. A widely used framework is published by COSO, the Committee of Sponsoring Organizations of the Treadway Commission. First issued in 1992 and updated in 2013, it defines internal control in one sentence:

Internal control is a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance.

COSO, Internal Control — Integrated Framework: Executive Summary (May 2013)

Three parts of that definition matter. Internal control is a process carried out by people, not a binder of rules on a shelf. It gives reasonable assurance, not a guarantee: two employees who collude, or a manager who overrides a control, can defeat it, and some controls would cost more than the losses they prevent. And it serves three kinds of objective at once: running operations well, reporting reliably and complying with laws and regulations.

COSO organises internal control into five components: the control environment, the tone set by owners and managers and their commitment to integrity; risk assessment, working out what could go wrong; control activities, the specific checks; information and communication, getting the right information to the right people; and monitoring activities, checking that the controls keep working. The 2013 framework sets out seventeen principles under these five components.

In a small business, the control activities are where the framework becomes concrete:

• Segregation of duties. No one person should handle every stage of a transaction: authorising it, recording it and holding the asset involved. If the person who receives customers’ cash also records it and reconciles the bank account, they can take cash and hide the shortfall. Split those tasks and a theft needs two people.
• Authorisation. Transactions are approved by someone with the authority to approve them, within set limits: for example, the owner approves every purchase over $500 before it is ordered.
• Documentation. Every entry is supported by a source document, and documents such as invoices and receipts are prenumbered, so that a missing one is noticed.
• Physical safeguards. Cash, stock and equipment are locked away; computer records are protected by passwords and backed up.
• Reconciliations and independent checks. The records are compared with an independent source: the ledger’s cash with the bank statement, Accounts Payable with suppliers’ statements, the Supplies account with a count. Lantern’s supplies adjustment (a2) began with exactly such a count.

What software automates, and what still needs judgement

Accounting software has absorbed most of the mechanical steps. Posting happens the moment an entry is saved, so the journal and ledger cannot disagree. Trial balances and statements are reports, produced on demand. Year-end closing happens automatically. Bank feeds import transactions and suggest how to record them, and recurring entries such as monthly depreciation can be scheduled. What remains is the part that was always the real work: judgement.

• Classification. Is a $4,000 overhaul of an oven a repair expense, or an improvement that extends its life and belongs in Equipment? Is a payment to the owner a dividend, a salary or a loan? Software records whatever account it is given.
• Estimates. Depreciation needs a useful life and a residual value, and later courses add estimates such as the customers who won’t pay. These are forecasts, made by people and reviewed by auditors.
• Cut-off. Which period does a transaction belong to? A breakfast catered on 31 March but invoiced on 2 April is March revenue (Lantern’s a7). Software uses whatever date it is given; choosing the right period is a judgement.
• Completeness and existence. Is every transaction in the records, and is every recorded transaction real? A balanced ledger can still leave out a bill or include a payment to a supplier who doesn’t exist. Controls, reconciliations and review answer that question; arithmetic can’t.

One month, start to finish

To see the whole cycle at once, follow a much smaller business through one month. Fetchwell Dog Training Co., a fictional company founded by Marta Silva, runs group puppy courses and private sessions. It starts trading on 1 May 2026 and uses only accounts you already know. Steps 1 to 3 cover its eight transactions in May.

Step 4: posted to the ledger, the entries give an unadjusted trial balance of $8,860 on each side (first column of the table below). Step 5: two facts at 31 May need adjusting entries. The equipment has been used for one month of its 36: $3{,}600 \div 36 = 100$. And four of the six puppy classes have been held, so $2{,}160 \times 4 \div 6 = 1{,}440$ of the advance payments has been earned.

Steps 6 and 7: the adjusted trial balance totals $8,960, and the statements come straight from it.

The statement of cash flows (not shown) would explain the $4,160 of cash: $1,960 from operating activities, $3,600 spent on investing and $5,800 from financing. Operating cash exceeds net income of $1,040 because $720 was collected for classes not yet held, $250 of advertising is unpaid and the $100 of depreciation used no cash, while $150 of revenue is still to be collected: $1{,}040 + 720 + 250 + 100 - 150 = 1{,}960$. Profit and cash are different measures, as lesson 8 showed.

Steps 8 and 9: after closing, the post-closing trial balance (last column of the table) lists only permanent accounts and totals $7,910. Debits of $7,910 less the $100 of accumulated depreciation equal total assets of $7,810; credits are liabilities of $970 plus equity of $6,840 plus that same $100. Every lesson in this course has played its part: the equation and the debit and credit rules in the entries, the ledger and trial balances, accrual adjustments, the statements, and closing.