Closing the Books
Closing the books is a critical accounting function to ensure accurate and timely records. Let’s walk through why the books need to be closed, the steps involved, and Finance’s role in the process.
Why Do The Books Need To Be Closed?
The primary goal of closing the books is to make sure that activity from one accounting period doesn’t roll over to the next period.
Impacts On General Ledger Accounts
At some point in the close process, journal entires will impact every account.
Specifically, though, the point of closing the books is to zero out the Revenue and Expense balances. Journal entires move balances to the balance sheet and net them against Retained Earnings. This allows the next period to start fresh and prevents any activity from crossing accounting periods.
Steps In the Closing Process
Step 1: Finalize Journal Entries
First, you need to ensure that any Revenue and Expense entries for the month are complete. This includes accruals for invoices that haven’t been received (accounts receivable) and deferrals for services that haven’t been rendered. Within all of your general ledger accounts, balances must be complete and accurate.
Step 2: Preliminary Trial Balance
Sum all of the preliminary ending balances from the last step to make a trial balance. 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 this isn’t the case, go back to step 1 and check your entries. It the credits and debits are equal, your accounts balance and you’re ready to go to the next step.
Step 3: Enter Adjusting Entries
Adjusting entries include items that are booked only at the period end, and not managed as part of day to day transactions. This can include things like Depreciation, Amortization, Tax Liability, Interest, or other below the line items.
While not part of the day to day operation, these are critical entries to finish the Income Statement and the Balance Sheet.
Step 4: Update Trial Balance and Generate Reports
After the adjusting entries are in, its time to generate a trial balance again. If the credits and debits are equal, its time to generate the preliminary Balance Sheet and Income Statement.
Step 5: Closing Entries and Final Trial Balance
Lastly, zero out your revenue and expense accounts by using journal entries called closing entries. Closing entries transfer the balances of these temporary accounts to permanent accounts. For example, a closing entry empties the Revenue account into the Retained Earnings account.
After that, run the final trial balance. After you transfer them to a permanent account, the Income Statement accounts should have a zero balance. And once again, your debits and credits should balance.
Your books are ready for the next accounting period!
What Role Does Finance Play?
Finance is first and foremost and end user of accounting results. While accounting is responsible for GAAP reporting and external reporting schedules, Finance generates most management accounting. Finance often produces management reporting at the same time as the accounting close.
In some companies, finance has a role in journal entries. This is especially true when it comes to accruals for invoices, since finance has a better line of sight into Purchase Orders and expected spend.
Companies design ledger systems for data entry and G/L management. They aren’t always the best for reviewing entries. Accounting often refers to Finance’s forecasts to look for missed entries, or unexpected swings in the results. In addition, Finance often has access to databases and dashboards that can help accounting research changes in the business and confirm entries.
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