ACCOUNTING FOR THE BUSINESS CYCLE
The business cycle is nothing more than the flow of transactions needed in your business to complete a sale and collect the proceeds. It's important to setting up your accounting system. We want to know what types of transactions are involved and the accounting entries to make along the way. Most companies business cycles progress something like this:
1.Purchase raw materials.
2.Enter goods into raw materials inventory.
3.Begin the manufacturing or assembly process.
4.Enter goods into work in process inventory.
5.Pay suppliers or pay employees (at service companies).
6.Complete the manufacturing or assembly process.
7.Enter goods into finished goods inventory.
8.Sell the inventory.
9.Collect payment for credit sales.
Briefly, here is the way your accounting system interacts at each stage of the business cycle.
Purchase Raw Materials
What happens when you buy the raw materials used to create your company's product? You receive the goods, and you either pay cash for the goods or obligate the company for future payment. Both transactions require these accounting entries:
Increase raw materials inventory Decrease cash (if you paid on the spot) Increase accounts payable (if you didn't)
At this point, we've covered the first two steps of the business cycle listed above.
Begin the Manufacturing Process
When we use raw materials to make our product, the accounting system transfers the inventory from raw materials to an intermediate stage called work in process (WIP for short). This transaction explains the third and fourth steps of the business cycle.
Pay Suppliers
Sometime during the production process we must pay our suppliers if we bought the raw materials on credit. The accounting entry for this transaction does two things:
Reduces accounts payable Reduces cash
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