Best Practices in Closing the Books for Year-End

Closing entries are journal entries you make at the end of an accounting cycle that movie temporary account balances to permanent entries on your company’s balance sheet. In some cases, accounting software might automatically handle the transfer of balances to an income summary account, once the user closes the accounting period. The entries take place «behind the scenes,» often with no income summary account showing in the chart of accounts or the closing process is sometimes referred to as closing the books other transaction records. The end result is equally accurate, with temporary accounts closed to the retained earnings account for presentation in the company’s balance sheet. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries.

• The closing process reduces revenue, expense, and Dividends account balances to zero so they are ready to receive data for the next accounting period.
• With the stakes so high, closing the books at year-end can certainly be daunting.
• In other words, it contains net income or the earnings figure that remains after subtracting all business expenses, depreciation, debt service expense, and taxes.
• Recall that beginning retained earnings, plus income, less dividends, equals ending retained earnings; likewise, the closing process updates the beginning retained earnings to move forward to the end-of-period balance.
• You can also find the phone numbers and mailing addresses of State Boards of accountancy and State Societies of CPAs.
• This chapter will explain the steps required to complete the accounting
  cycle.

If it’s not, the book cannot be closed, and your accountant or bookkeeper will try to figure out why there’s a discrepancy. A post-closing trial balance is a list of all accounts and their balances after we have updated account balances for adjusting entries. The expense accounts could be closed before the revenue accounts; the end result is the same. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view.

Why is it important to close the books?

But closing the books for the financial year is more important for reflecting the correct retained earnings numbers on the balance sheet, which allows the start of a fresh financial year for profit and loss reporting. Before creating your final report, generate a trial balance, and if things are not adding up, check your work and enter adjusting entries until you are ready to create the final financial statement. Closing is a mechanism to update the Retained Earnings account in the ledger to equal the end-of-period balance. Keep in mind that the recording of revenues, expenses, and dividends do not automatically produce an updating debit or credit to Retained Earnings. As such, the beginning- of-period retained earnings amount remains in the ledger until the closing process “updates” the Retained Earnings account for the impact of the period’s operations.

This makes it easier to do monthly tasks like bank reconciliation, sending sales tax reports to the state, paying your suppliers, and generating customer statements. Regularly closing your books will prevent unwanted changes from occurring to your accounting data after you generate important financial reports for your accountant or tax professional. In a partnership, separate entries are made to close each partner’s drawing account to his or her own capital account. If a corporation has more than one class of stock and uses dividend accounts to record dividend payments to investors, it usually uses a separate dividend account for each class.

The Purpose of Closing Entries

A trial balance is a report that adds up all the credits and debits in your business. You want your total credits to be the same number as your total debits—if they aren’t, go back and check your work. If the credits and debits are equal, your accounts balance, and you’re ready to go to the next step.

On a quartery and annual basis, financial statements are
created for outside stakeholders as well. A net loss would decrease owner’s capital, so we would do the opposite in this journal entry by debiting the capital account and crediting Income Summary. Sum your general ledger accounts again to take into account the adjusted entries from the last step, and then add them all together to make a new trial balance, making sure your debits and credits are again equal. Sum up the preliminary ending balances from the last step to make a trial balance.

Summary Closing the Books

If the total debits and credits in your trial balance are the same, you’re ready to produce a balance sheet and income statement (also known as a “profit and loss report” or “P&L”). These reports can be generated automatically in your accounting software. They offer an overview of a business’s financial position at the end of the applicable accounting period, whether that’s the previous month or year. A post-closing trial balance is a trial balance taken after the closing entries have been posted. The only accounts that should be open are assets, liabilities, capital stock, and Retained Earnings accounts.

The account has a credit balance, which is the net income for the period. Let’s move on to learn about how to record closing those temporary accounts. Even if you ask your accountant to close your books for you, it’s important to understand the basic steps involved so you know what to expect.