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CHAPTER 3 THE ACCOUNTING CYCLE Financial accounting provides information about the firm through the balance sheet, the income statement, the statement of changes in stockholders’ equity, and the cash flow statement. In the last chapter we examined the first three statements, and in chapter 5 we shall describe the cash flow statement. The accounting information system must capture the relevant data about the firm’s transactions, categorize them, and store them in such a way that one can retrieve the information and prepare the financial statements of the entity. This process is referred to as the accounting cycle. Chapter 3 discusses journal entries, posting entries to a ledger, trial balances, adjusting entries, and closing entries. Chapter 4 describes subsidiary ledgers, worksheets, special journals, reversing entries, and correcting entries. Throughout these two chapters, the reader should not overlook the purpose of financial reporting—to help readers of the financial statements make better economic decisions. Journals and ledgers and so on are merely tools to achieve this end. At this stage of the book, we shall also assume that the accountant already has the relevant data to prepare the journal entries. Chapters 6-11 will indicate how the data are captured. Chapter 12 will focus on measurement and disclosure of these items. After reading and studying this chapter, you should be able to: Describe the accounting cycle; Prepare journal entries; Describe the general journal; Post journal entries; Describe the general ledger; Construct a trial balance;
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Ketz--Accounting Cycle Page 3-2 Make adjusting entries; and Make closing entries. OVERVIEW OF THE ACCOUNTING CYCLE Accountants gather data as transactions occur so they can process the data and convert the data into financial statements. The periodicity principle states that accounting reports should be prepared on a periodic basis such as once per year, or quarter, or month. Unless stated otherwise, assume that the report is annual. Also assume, unless otherwise stated, that the fiscal year is the calendar year; that is, the last day of the fiscal year is December 31. These assumptions will be held in the text and in the exercises and problems. The purpose of the accounting cycle is to publish the financial statements for the period. As explained in chapter 1, a transaction is an exchange (the giving up of something of value to receive something of value), a nonreciprocal transfer (the giving up of something of value or the receiving of something of value, but not both), an event (the occurrence of something that has a financial consequence to the firm), or an allocation of the entity (the distribution of some cost to various departments, assets, expenses, or time periods). In a sense, these transactions are the activities of the business enterprise, and the financial reports are historical narratives of what took place during a particular period. Sometimes transactions are classified as either internal or external.
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