Closing the Books: Learn the Basics and How to Close the Books

For one, closing the books at the end of the year is necessary for proper tax reporting and filing—but the process is also imperative for maintaining and growing the business. Annual statements not only provide a look back at the past year but also assist in making informed decisions about the business’s future. And, if anything seems “off” related to the business’s accounting or financials, closing the books is an opportunity to find and remedy those issues. When the books are closed, all debits and credits should add up to zero. A number of mechanisms are used to ensure that the final balance is accurate.

These forms of organization serve to place limits on accountants’ liability. You can also find the phone numbers and mailing addresses of State Boards of accountancy and State Societies of CPAs. Browse around this site to investigate anything else that is of interest. The next section briefly the closing process is sometimes referred to as closing the books describes the evolution of accounting systems from the one-journal, one-ledger manual system you have been studying to computerized systems. It’s becoming more and more rare to use actual books for your accounting – almost everyone has gone digital (it’s a lot easier that way).

Why is it important to close the books?

List all the account balances in the debit and credit columns and total them to make sure debits and credits are equal. The Income Summary account is a clearing account used only at the end of an accounting period to summarize revenues and expenses for the period. After transferring all revenue and expense account balances to Income Summary, the balance in the Income Summary account represents the net income or net loss for the period. Closing or transferring the balance in the Income Summary account to the Retained Earnings account results in a zero balance in Income Summary. The Income Summary account is a clearing account used only at the end of an accounting period to summarize revenues and expenses for the period. In essence, by zeroing out these accounts, they are reset to begin the next accounting period.

• • Closing the Dividends account—transferring the balance of the Dividends account to the Retained Earnings account.
• This process helps owners stay on track with business goals and prepare for filing their income tax returns.
• Because revenue accounts have credit balances, you must debit them for an amount equal to their balance to bring them to a zero balance.
• 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.

We want income statements to start every year from zero, but for accounts like equipment, debt, and cash accounts—reported on the balance sheet—we want to keep a running balance from the beginning of the business. The post closing trial balance reveals the balance of accounts after the closing process, and consists of balance sheet accounts only. The post-closing trial balance is a tool to demonstrate that accounts are in balance; it is not a formal financial statement. All of the revenue, expense, and dividend accounts were zeroed away via closing, and do not appear in the post-closing trial balance. However, there is still a closing process that prevents the accountants and bookkeepers from accidentally posting entries to the prior period.

Practice Question: Preparing a Closing Entry

We have completed the first 7 steps, and now we come to the final steps that are all part of the closing process. You will find information about the CPA exam, about becoming a CPA, hot accounting topics, and various other topics, such as the US states that have passed a 150-hour requirement to sit for the CPA exam. You can also learn such things as the states that have approved limited liability companies (LLCs) and limited liability partnerships (LLPs).

If this is the case, the corporation’s accounting department makes a compound entry to close each dividend account to the retained earnings account. The four-step method described above works well because it provides a clear audit trail. For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account. The closing entries are also recorded so that the company’s retained earnings account shows any actual increase in revenues from the prior year and also shows any decreases from dividend payments and expenses. This chapter will explain the steps required to complete the accounting
cycle. This includes understanding the full accounting information
cycle, and what is used to create the financial statements that will be
provided to required and interested stakeholders.