The Accounting Cycle (Grade 10 NSC Matric Accounting): Revision Notes
The Accounting Cycle
Introduction to the accounting cycle
The accounting cycle is a systematic process that businesses follow to record and report their financial information. This cycle begins when a business transaction occurs and continues through to the preparation of financial statements at the end of a financial period. Think of it as a journey that financial information takes from the moment money changes hands to when it appears in formal reports.
For a sole trader (a business owned by one person), the accounting cycle is repeated every month throughout the financial year. This means the business goes through the same steps twelve times annually to maintain accurate and up-to-date financial records.
The Journey of Financial Information
The accounting cycle can be thought of as a complete journey:
- It starts with a business transaction (the beginning of the journey)
- It continues through documentation and recording (the middle stages)
- It ends with financial statements (the destination)
- Then the cycle begins again for the next period
Understanding the complete accounting cycle
The accounting cycle can be visualised as a continuous loop that includes several key stages:
Monthly activities (Steps 1-5):
- Recording transactions
- Collecting source documents
- Posting to subsidiary journals
- Transferring to ledgers
- Preparing a trial balance
Year-end activities (after 12 months):
- Preparing a pre-adjustment trial balance
- Recording adjustments
- Creating a post-adjustment trial balance
- Performing closing transfers
- Preparing a post-closing trial balance
- Compiling financial statements (income statement and balance sheet)
- Analysing and interpreting the financial statements
The first five steps happen every single month and form the foundation of good bookkeeping practice. The remaining steps occur once at the end of the financial year.
Think of the monthly steps as your routine maintenance, while the year-end steps are like your annual service – both are essential for keeping the business's financial records in good working order.
Step 1: Transactions
What is a transaction?
A transaction is any business activity that involves money or monetary value. Whenever the business exchanges money, goods, or services with another person or business, a transaction has occurred. Every transaction must be recorded in the accounting records, no matter how small.
Why transactions matter
Recording transactions is essential because it creates a complete picture of all the business's financial activities. Without proper transaction records, the business owner wouldn't know how much money is coming in, going out, or what the business owes or is owed.
Common Business Transactions
Here are typical transactions that occur in most businesses:
- Selling products to customers – generates income for the business
- Buying stock from suppliers – necessary for having goods to sell
- Paying employee salaries – compensation for work performed
- Receiving money from customers who bought on credit – collecting outstanding debts
- Paying rent for business premises – operating expense for the business location
Step 2: Documents
The importance of source documents
Every transaction needs proof that it actually happened. This proof comes in the form of source documents, which serve as evidence of business transactions.
Why Source Documents Are Critical
Source documents provide:
- Legal evidence of the transaction – can be used in court if disputes arise
- Details needed for accurate record-keeping – ensures all information is captured correctly
- Information for tax purposes – required by tax authorities as proof of business activities
- Protection against disputes – helps resolve disagreements about what was agreed or paid
Without proper source documents, the business cannot prove its financial activities and may face legal or tax problems.
Types of source documents
Businesses use various source documents depending on the type of transaction:
- Receipts: Proof that payment was received
- Cheques: Written instructions to pay money from a bank account
- Invoices: Documents requesting payment for goods or services sold on credit
- Petty cash vouchers: Records of small cash payments
- Debit notes: Documents showing that one party owes money to another
- Credit notes: Documents showing a reduction in the amount owed
- Bank statements: Records of all bank transactions
- Deposit slips: Proof that money was deposited into the bank
All information from these source documents must be accurately recorded in the business's books.
Step 3: Subsidiary books (journals)
What are journals?
Because businesses have many transactions, it would be confusing to record everything in one place. Instead, businesses use different journals (also called subsidiary books) to group similar types of transactions together.
A journal is known as the book of first entry because it's the first place where information from a source document is recorded. Think of journals as the first checkpoint in the accounting cycle where raw transaction data gets organized into categories.
The eight main journals
Cash receipts journal (CRJ)
Purpose: Records all money received by the business.
The cash receipts journal captures every rand that comes into the business, whether through cash sales, bank deposits, or payments from customers who bought on credit.
Typical Cash Receipts Journal Entries
- Cash sales of merchandise – immediate payment received for goods sold
- Rental income received – money earned from renting out property
- Capital contributions from the owner – additional investment by the business owner
- Payments received from debtors – customers settling their credit accounts
Cash payments journal (CPJ)
Purpose: Records all money paid out by the business.
Every time the business writes a cheque or makes a payment, it gets recorded in the cash payments journal. This helps track where the business's money is going.
Typical Cash Payments Journal Entries
- Employee salaries and wages – compensation for work performed
- Water and electricity bills – utility costs for operating the business
- Stationery purchases – office supplies and materials
- Payments to creditors (suppliers) – settling amounts owed for credit purchases
- Trading licence fees – regulatory costs for operating legally
- Bank charges – fees for banking services
Debtors journal (DJ)
Purpose: Records all credit sales to customers.
To increase sales, many businesses allow customers to buy goods and pay later. These customers are called debtors because they owe the business money. When a business sells goods on credit, it issues an invoice to the customer. The original invoice goes to the customer, while the duplicate (copy) is used to record the transaction in the debtors journal.
Important Considerations for Credit Sales
Before granting credit to a customer, the business must check if they are creditworthy. A creditworthy person is someone likely to pay their debt on time. The business should set a credit limit (maximum amount) that each customer can owe.
Common mistakes to avoid:
- Granting credit without checking creditworthiness – can lead to bad debts
- Not setting credit limits – customers may accumulate unmanageable debts
- Failing to follow up on overdue payments – reduces cash flow
Tracking debtors:
- Each customer who buys on credit has their own account in the debtors' ledger
- At month-end, a schedule of debtors is prepared
- This schedule lists all amounts owed by individual customers
- The total on the schedule should match the balance in the Debtors control account in the general ledger
Debtors' allowances journal (DAJ)
Purpose: Records returns and discounts related to credit sales.
Sometimes customers who bought goods on credit want to return them or request a discount (allowance) on the amount they owe. The business must investigate why this is happening.
Two scenarios:
- Goods are returned: The customer sends the goods back to the business
- Allowance is granted: The customer keeps the goods but pays less (this doesn't affect the cost of goods sold)
When an allowance is granted, the business issues a credit note. The duplicate copy of the credit note is used to record the transaction in the debtors' allowances journal.
A credit note reduces the amount the customer owes, which is why it's recorded in this special journal rather than the main debtors journal.
Creditors journal (CJ)
Purpose: Records all credit purchases from suppliers.
Just as businesses sell on credit, they also buy on credit from suppliers. Buying on credit has benefits:
- Keeps cash in the bank (can earn interest)
- Allows the business to take advantage of good deals
- Provides time to pay while selling the goods
When the business buys on credit, it receives an invoice from the supplier. Because different suppliers use different invoice numbers, the business should re-number these invoices in date order for easier reference. The original invoices are used to record transactions in the creditors journal.
Tracking creditors:
- Each supplier has their own account in the creditors' ledger
- At month-end, a schedule of creditors is prepared
- This schedule lists all amounts owed to individual suppliers
- The total should match the balance in the Creditors control account in the general ledger
This tracking system ensures the business always knows exactly how much it owes to each supplier and can manage its cash flow effectively.
Creditors' allowances journal (CAJ)
Purpose: Records returns and discounts related to credit purchases.
If the business receives faulty goods or doesn't receive the trade discount promised, it can return goods or request an allowance from the supplier.
Reasons for returns or allowances:
- Wrong trading stock was delivered
- The trader didn't give the trade discount shown on the invoice
When goods are returned or an allowance is requested, the business issues a debit note to the supplier. The original debit note goes to the supplier, and the duplicate is used to record the transaction in the creditors' allowances journal. In response, the supplier will send a credit note confirming they've adjusted the business's account.
Petty cash journal (PCJ)
Purpose: Records small cash payments made from petty cash.
Many businesses keep a small amount of cash on hand (called petty cash) to pay for minor expenses like tea, coffee, or emergency supplies. Each payment is recorded on a petty cash voucher, which must be authorised by the petty cash cashier and a senior manager.
All external source documents (like receipts from shops) should be attached to the petty cash voucher as proof of the expense.
Without proper documentation, petty cash can easily be misused or "disappear" without explanation. Always ensure every petty cash payment has proper authorization and supporting documents.
General journal (GJ)
Purpose: Records all other transactions that don't fit into the specific journals above.
The general journal is used for transactions that can't be recorded in any of the other seven journals. It acts as a "catch-all" journal for miscellaneous transactions.
Think of the general journal as the "everything else" journal. If a transaction doesn't fit neatly into one of the seven specialized journals, it goes into the general journal. This might include corrections of errors, opening entries, or other non-routine transactions.
Step 4: Ledgers
What are ledgers?
Once transactions are recorded in journals, the information needs to be organised by account. This is where ledgers come in. A ledger is a collection of individual accounts that show the complete history of transactions affecting each account.
Types of ledgers
Subsidiary ledgers: These contain detailed information about specific groups of accounts:
- Debtors' ledger: Individual accounts for each customer who owes money
- Creditors' ledger: Individual accounts for each supplier the business owes money to
General ledger: This is the main ledger that contains all other accounts, including:
- Asset accounts (like equipment, vehicles)
- Income accounts (like sales, rent income)
- Expense accounts (like salaries, electricity)
- Control accounts for debtors and creditors
Understanding Posting
The information from journals is posted (transferred) to the appropriate ledger accounts, creating a summarised record for each account.
Think of posting as moving information from the chronological record (journals) to the account-based record (ledgers). This allows the business to see all transactions affecting a particular account in one place, making it easier to track balances and prepare reports.
Step 5: Trial balance
What is a trial balance?
A trial balance is a list showing all the debit and credit balances from the ledger accounts. It's prepared at the end of each month to check that the accounting records are mathematically accurate.
Purpose of the trial balance
The trial balance serves several important purposes:
- Checks that total debits equal total credits
- Identifies potential errors in recording or posting
- Provides a summary of all account balances
- Forms the basis for preparing financial statements (at year-end)
What If the Trial Balance Doesn't Balance?
If the trial balance doesn't balance (debits don't equal credits), it means an error has occurred somewhere in the recording or posting process, and the error must be found and corrected.
Common errors include:
- Transposition errors (writing R54 instead of R45)
- Omission errors (forgetting to record a transaction)
- Double posting (recording the same transaction twice)
- Posting to the wrong side (debit instead of credit, or vice versa)
Never proceed with financial statement preparation until the trial balance balances correctly!
The accounting cycle in practice
Monthly routine
The accounting cycle's first five steps create a monthly rhythm for the business:
The Monthly Accounting Routine
- Throughout the month: Transactions occur and source documents are collected
- Daily or weekly: Transactions are recorded in appropriate journals
- End of month: Journals are totalled and posted to ledgers
- End of month: Trial balance is prepared to check accuracy
- Next month: The cycle starts again
This routine ensures the business maintains current, accurate financial records throughout the year.
Year-end procedures
After completing twelve months of the monthly cycle, the business performs additional year-end procedures to finalise the accounts and prepare financial statements. These procedures include making adjustments for items like depreciation and stock, closing off temporary accounts, and preparing the income statement and balance sheet.
Year-end procedures are more extensive than monthly procedures because they involve:
- Making adjusting entries for items like depreciation, accruals, and prepayments
- Closing off temporary accounts (income and expenses) to determine profit or loss
- Preparing formal financial statements for presentation to stakeholders
- Conducting analysis to evaluate the business's financial performance and position
Remember!
Key Points to Remember:
- The accounting cycle is a continuous process that repeats monthly and includes year-end procedures
- Transactions are the starting point – they must all be recorded with proper source documents as evidence
- Different journals are used for different types of transactions to keep records organised and manageable
- The eight main journals are: Cash Receipts (CRJ), Cash Payments (CPJ), Debtors (DJ), Debtors' Allowances (DAJ), Creditors (CJ), Creditors' Allowances (CAJ), Petty Cash (PCJ), and General Journal (GJ)
- Ledgers organise information by account – subsidiary ledgers track individual debtors and creditors, while the general ledger contains all other accounts
- A trial balance is prepared monthly to verify that debits equal credits and that no mathematical errors have occurred
- Following the accounting cycle systematically ensures accurate financial records and reliable financial statements