Any business that provides services or sells products has an accounting cycle. However, there is a slight difference between the accounting cycles of service companies and trading companies.
Accounting is the way a business keeps track of its finances. Although service companies and trading companies offer very different goods to their customers, they are both required to comply with accounting principles. This means that the accounting equation for both types of business is the same, namely: Assets = Liabilities + Owner’s Equity applies to both.
However, the types of goods and services provided determine how the business is responsible for its operating expenses and revenues, and so the accounting cycle for service and merchandising companies is slightly different.
Table Of Contents
1 Difference Between These Two Types Of Business
2 Differences in the Accounting Cycle of Service and Trade Companies
2.1 Both Have Assets
2.2 Both Have Obligations
2.3 Cost and Owner’s Equity
2.4 Types of Financial Statements
3 Stages of Service Company Accounting Cycle
3.1 Data Analysis
3.2 Journaling
3.3 Posting in the Ledger
3.4 Trial Balance
3.5 Adjusting Journal
3.6 Financial Report
3.7 Closing Journal
3.8 Turning Journal
3.9 Preparation for the New Accounting Period
The Difference Between These Two Types Of Business
A service company is a business that provides services to consumers or other companies. For example, an accounting firm provides accounting services to other individuals or businesses, while a hair salon offers its customers haircuts, styling and other hair care services.
Merchandising companies buy inventory in bulk and then sell these products to their customers, usually smaller businesses or end consumers. A clothing boutique may purchase its jewelry and accessories from a dealer who specializes in clothing accessories.
While service companies may have some inventory (salons selling shampoo and other hair care products for example), for the most part, goods companies always have stock because they are in the business of selling goods to other people.
Differences in the Accounting Cycle of Service and Trade Companies
Both types of companies have almost the same accounting cycle. Transactions are posted in the general journal, and then the amounts are posted to the relevant general ledger accounts. At the end of the accounting cycle, whether it is monthly, quarterly, or annually, the accounts in the general ledger that require adjustments are adjusted and financial statements are prepared.
Once the accounts are closed for the period, they are reopened with an adjusted amount and a new accounting period begins.
Both Have Assets
Service companies and trading companies own assets. Cash, accounts receivable, office equipment, office supplies, and accumulated depreciation all have a place in both types of company charts of accounts. As with any other business, other assets may be different.
For example, a service business may own the building, and therefore the building is an asset. Alternatively, a merchandising company may not own the building but may own the equipment used to package and ship goods to customers.
Both Have Obligations
Both companies have obligations, the person or company to whom they owe capital or money. If a company purchases inventory on credit, then they have an account payable, whether it’s an unpaid purchase order or a balance on the company’s credit card.
If one of the businesses has employees and wages that have been earned but not yet paid, that is also considered a liability. And if there are monthly installments or fees on the building or equipment, the note payable is also listed as a liability.
Cost and Owner’s Equity
Herein lies the difference between a service company and a trading company. Both have the usual costs, such as the cost of office supplies, insurance costs and depreciation costs, for some assets.
And both have income, private and equity accounts for owners. But because a merchandising company owns inventory, it has a special cost associated with buying and selling inventory called Cost of Goods Sold or COGS.
This is a cost calculation related to how much product has been made, will be sold, and is stored in the warehouse. Most service companies don’t deal with COGS, because they don’t deal with physical stock.
Types of Financial Statements
Service and trading companies produce Trial Balances for the beginning of the period, adjusting entries at the end of the period, income statements, balance sheets and changes in capital reports as well as a post-closing trial balance after closing entries are completed. This information is drawn from the general journal and general ledger entries that are posted regularly during the accounting cycle.
Data analysis
The first stage in the service company’s accounting cycle is the collection of valid, accurate, and accountable financial data.
Examples such as purchase receipts, purchase receipts, and so on. Then record all financial transactions in detail in a general journal based on the data collected to make it easier for you in the next stages.
Journaling
After analyzing all transactions, record all the data in the general journal.
Post in Ledger
Journal entries are posted in the general ledger. The general ledger accounts are represented by T accounts.
Trial Balance
To make sure the data from the general journal to the general ledger is correct, you make a trial balance or trial balance to ensure that the data you have inputted is free of errors. For example, the number of debits and credits is not balanced.
Adjusting journal entry
After making a trial balance and if you feel something is wrong, the next step is to make an adjusting journal to adjust for new transactions and accounts that will have an impact on the general ledger later.
Financial statements
Make financial reports such as income statements, balance sheets and reports of changes in capital.
Closing Journal
The next step is to make closing entries for asset, liability, and owner’s equity accounts.
Turning Journal
This step is actually optional. Reversing journal is the stage of reversing several closed accounts to restore their balances. The related accounts in this journal are usually those that relate to payments that are prepaid and not yet due.
Preparation for the New Accounting Period
The final step is to create a new balance sheet for the next accounting cycle period.