Key Concepts
Before tracing the accounting cycle, here are the tools it uses. You'll learn to prepare each one in Chapters 3–5 — for now, just get familiar with the names and the order.
| Tool | What it is |
|---|---|
| Source document | Evidence that a transaction took place (e.g. invoice, receipt) |
| Journal | The book where a transaction is first recorded |
| Ledger | Where all the entries for each account are gathered together |
| Trial balance | A list of all the closing balances taken from the ledger |
| Statement of Financial Performance | Shows the profit or loss for the period |
| Statement of Financial Position | Shows what the business owns and owes at a point in time |
The accounting cycle is the processing of accounting transactions through the accounting information system. It has 4 stages (sequence is tested):
| Stage | What happens | Frequency |
|---|---|---|
| 1. Identify and record | Source documents are used to record transactions in the journal; journal entries are posted to the ledger | Daily |
| 2. Adjust | Ending balances in ledgers are listed in the trial balance; adjusting entries are recorded in journals and posted to ledgers | At least once a year |
| 3. Report | Based on the adjusted trial balance, financial statements are prepared (Statement of Financial Performance & Statement of Financial Position) | At least once a year |
| 4. Close | Income, expenses, drawings and dividends accounts are closed via journal entries posted to the ledger | End of the year |
The accounting information system (AIS) is the flow of tools that supports the cycle (sequence is tested):
Source documents → Journals → Ledger → Trial balance → Statement of Financial Performance / Statement of Financial Position
The first 4 (Source documents → Trial balance) relate to the identifying and recording of transactions; the last 2 relate to the preparation of financial statements.
C2 focuses on the first stage: identifying source documents and understanding their purpose. The remaining stages are covered in Chapters 3–5.
4 stages — "I Always Report Clearly":
- I — Identify and record (daily)
- A — Adjust (end of accounting period)
- R — Report (end of accounting period)
- C — Close (end of accounting period)
AIS flow — always left to right, never skip a step:
Source documents → Journals → Ledger → Trial balance → Statement of Financial Performance → Statement of Financial Position
Getting the AIS order wrong. The most common error is placing Journals before Source documents, or Financial Statements before the Trial balance. The correct order is always: Source documents → Journals → Ledger → Trial balance → Statement of Financial Performance → Statement of Financial Position.
Confusing the AIS flow with the 4-stage accounting cycle. They are related but answer different questions.
- The AIS is the sequence of tools (documents, books, statements).
- The accounting cycle is the overall process (identify, adjust, report, close).