Three Phases of the Financial Accounting Process

The financial accounting process primarily includes identifying, recording and adjusting business transactions, with the resulting data presented in the financial statements. Thus, the accounting process involves a sequence of logical steps that helps turn the data for several separate transactions into systematically arranged financial records. The three phases of the financial accounting process can also be divided into several sub-steps that each focus on different accounting tasks.

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The financial accounting process – also is known as the accounting cycle – starts with sorting through initial financial statements, proceeds to recording and posting them in journals and ledgers, further goes into adjusting and closing certain journal entries and ledger accounts, and finishes with trial balance testing and compiling financial statements.

Some accounting steps repeat themselves throughout the accounting cycle, such as data entry and posting, while others take place once at certain phases of the accounting process, such as entry adjusting and closing, as well as compiling financial statements.

The first phase in the financial accounting process relates to the recording and posting of journal entries for future uses. Once business transactions are identified, each transaction is journalized into a pair of debit and credit accounts and date-marked using the transaction dates. As more transactions take place throughout an accounting period, they are continually journalized in the journal book.

Transaction items entered in the general journal must be later transferred to another accounting book called the general ledger, which is a complete list of all transaction accounts of assets, liabilities, equity, revenues and expenses.

​Read More​: How Does a Ledger Account Work?

The second phase of the financial accounting process involves the adjusting and closing of certain previously entered journal entries. These entries often involve adjusting prepaid expenses as assets and unearned revenues as liabilities.

The purpose of adjusting a prepaid expense or unearned revenue entry is to reduce the outstanding amount of the initially recorded prepaid expense or unearned revenue to reflect that a portion of it has been incurred or earned during the current accounting period. Entry closing refers to the close of the temporary revenue and expense accounts into an equity account, namely the retained earnings account.

Without adjusting and closing certain entries and accounts, data as originally entered and posted may not reflect the business reality, and as a result can covey incorrect financial information. To further ensure data integrity, the third phase of the financial accounting process conducts a trial balance test of all accounts, in addition to compiling the financial statements.

Recording errors can happen sometimes, and the purpose of a trial balance is to add up all debit accounts against the sum of all credit accounts and see if there are any imbalances. After a trial balance test has produced a balance among all accounts, various account data can be plugged into their corresponding accounts in different financial statements.

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