Accounting Cycle Questions and Answers [With PDF]

The accounting cycle is the full journey of a transaction, from the moment it happens to the final financial statements, and then back to the start for the next period. Knowing the steps in the right order is one of the most common exam questions. Here are 20 important questions with clear answers.

This is Chapter 5 of our Accounting course. It builds on Double Entry System.

Meaning and Steps

Q1. What is the accounting cycle?

The accounting cycle is the series of steps an organization follows in each accounting period, from identifying and recording transactions to preparing financial statements and closing the books. When the period ends, the cycle starts again for the next period.

Q2. What is the purpose of the accounting cycle?

Its purpose is to record, classify and summarize transactions in an orderly way, to produce financial statements for each period, and to keep the accounts continuous from one period to the next.

Q3. What are the steps of the accounting cycle?

Note: Some textbooks give 9 or 10 steps. They usually leave out analysis and interpretation, or treat reversing entries as optional. The order of the remaining steps is the same. Follow the version in your syllabus.

The Steps Explained

Q4. What is the first step?

Identifying and measuring transactions. Not every activity is recorded, so each event is checked to see whether it is financial and measurable in money. Then the accounts affected are identified. If goods worth 2,000 are bought for cash, the Purchases account and the Cash account are involved.

Q5. What is the second step?

Recording (journalizing). Each transaction is written in the journal with its debit and credit, based on a source document. If a transaction is not recorded here, every later step will be wrong.

Q6. What is the third step?

Classifying, also called ledger posting. Journal entries are transferred to the ledger, so that all transactions of one account, such as Cash or Sales, appear in one place.

Q7. What is the fourth step?

Summarizing by preparing a trial balance. It lists all ledger balances on one sheet. If the books are arithmetically correct, total debits equal total credits.

Q8. What is the fifth step?

Adjusting and rectifying entries. Items such as outstanding expenses, prepaid expenses, accrued income, income received in advance and depreciation are adjusted so that the correct income and expense of the period is shown. Errors found are also corrected.

Q9. What is the sixth step?

Preparing the adjusted trial balance. After the adjusting entries are posted, the account balances are recalculated and listed again. This list is the adjusted trial balance.

Q10. What is the seventh step?

Preparing financial statements from the adjusted figures. The main statements are the income statement (profit or loss), the statement of changes in equity, the balance sheet (financial position) and, in many cases, the cash flow statement. A manufacturing business also prepares a manufacturing account.

Q11. What is the eighth step?

Analysis and interpretation. Owners, managers, lenders, tax authorities and others need to understand the statements. Techniques such as ratio analysis, trend analysis, common-size statements and cash flow analysis are used to turn the figures into useful information.

Q12. What is the ninth step, closing entries?

Nominal accounts (income and expenses) only measure one period, so at the end they are closed. Their balances are moved to an Income Summary (or Profit and Loss) account, and the net profit or loss is then transferred to the capital account. Example with sales of 100,000, expenses of 70,000 and profit of 30,000:

Q13. What is the tenth step, the post-closing trial balance?

After closing, only assets, liabilities and capital accounts still have balances. A post-closing trial balance lists them to confirm they are in balance. These balances become the opening balances of the next period.

Q14. What is the last step, reversing entries?

Reversing entries are made on the first day of the new period. They cancel certain year-end adjusting entries, such as accrued expenses or accrued revenue, so that the later payment or receipt can be recorded in the normal way without double counting. This step is optional.

Continuity and Key Concepts

Q15. How does the accounting cycle maintain continuity of accounts?

Under the going concern concept, a business is expected to continue. At the year-end, outstanding and prepaid items are adjusted. Nominal accounts are closed, while assets, liabilities and capital are carried forward as opening balances. This links one period to the next.

Q16. Which four entries help maintain continuity?

1. Adjusting entries
2. Closing entries
3. Reversing entries
4. Opening entries

Q17. How long does the accounting cycle continue?

As long as the business continues to operate. A new cycle begins whenever one accounting period ends.

Q18. Why is it called a cycle?

Because the steps are repeated in the same order every period. When the last step is finished, the work returns to the first step for the next period.

Q19. Which step of the accounting cycle is optional?

Reversing entries. They only make later bookkeeping easier and are not needed to prepare the statements.

Q20. For which items are reversing entries made?

• Accrued (outstanding) expenses
• Accrued revenue
• Prepaid expenses (when first recorded as an expense)
• Unearned (advance) revenue (when first recorded as income)

Quick Revision Points

• Order: record, post, trial balance, adjust, adjusted trial balance, statements, close, post-closing trial balance.
• Nominal accounts are closed. Real accounts are carried forward.
• Closing entries move profit or loss into capital.
• Reversing entries are optional.
• Adjusting, closing, reversing and opening entries maintain continuity.

Take the chapter quiz below, then continue to Journal.