The Five Accounting Cycles
Businesses operate through cycles that represent different areas of financial activity. These
cycles are important because they show where money comes in, how it is spent, and how it is
controlled. Understanding these helps prevent fraud, errors, or mismanagement.
The five main cycles are:
1. Sales and Accounts Receivable – Recording sales made to customers, billing them, and
collecting payments.
2. Purchases and Accounts Payable – Tracking what the company buys (supplies, services,
materials) and making sure suppliers get paid.
3. Human Resources and Payroll – Handling employee records, salaries, wages, and
benefits.
4. Inventory and Storage/Warehousing – Monitoring goods stored, received, and sold to
prevent theft or loss.
5. Capital Expenditures – Managing investments in long-term assets (like equipment, land,
or buildings).
Sales and Accounts Receivable
This is often the starting point of business: selling goods or services to customers.
The business must ensure that sales are properly billed and payments are collected.
Accounting treatment:
o Sales → Income Statement (revenue)
o Accounts Receivable → Balance Sheet (asset)
o Collections → Affect the Cash Balance
Steps to minimize risks in this cycle:
Approve new customers and set credit limits.
Record customer orders properly.
Send invoices correctly and on time.
Collect payments.
Adjust accounts for returns, discounts, or write-offs.
The key idea: Businesses need internal controls (like checks and reviews) to prevent theft or
misappropriation at every step of this cycle.
Where It All Begins
The chapter explains why understanding accounting cycles is so important—especially because
of fraud risks.
Despite better corporate governance and awareness, financial fraud is still common.
Examples include Enron, WorldCom, AIG, Madoff, where fraud involved manipulating
financial results.
Fraud often happens through:
o Fraudulent disbursements (false invoices, forged checks)
o Skimming (stealing money before it’s recorded)
o Cash larceny (stealing money after it’s recorded)
👉 This shows why knowing accounting principles is essential—to detect or prevent fraud.
Purpose of Accounting Systems
To track how money moves in an organization.
To record financial transactions accurately.
Helps managers, owners, creditors, and investors make decisions.
For example:
Owners and executives → Need timely info to monitor performance.
Creditors → Want to know if debts can be paid.
Investors/vendors → Want to check company stability before doing business.
Even nonprofits and government organizations use the same principles because they also
handle money and need accountability.
Key Takeaways for Discussion
1. The five accounting cycles are the foundation of how money flows in and out of a
business.
2. Sales and Accounts Receivable is crucial—it starts with getting business from customers
and ends with collecting payments.
3. Fraud risks exist in every cycle (false invoices, skimming, cash larceny), so internal
controls are necessary.
4. Accounting is not just recording numbers—it’s a system for decision-making,
transparency, and trust for all stakeholders.
