Closing the accounts
| Closing the accounts |
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Closing the accounts is the process of establishing the final balance of an account and then booking the entries in order to balancing the balance (The Entrepreneur's Dictionary of Business and Financial Terms (2014))
The closing process gives temporary accounts zero balances, so they are ready to collect new information for the subsequent accounting period. In regards with permanent account, their balances are brought forward for every new accounting period.
Permanent accounts contain the results of all transactions from the beginning of the business. Their balances are move forward to each new accounting period. Examples : all accounts reported on the balance sheet
Temporary accounts contain information for one accounting period. Mentioned accounts are closed at the end of every accounting period. Examples: revenue, expense drawing accounts
College Accounting, 19th edition, Chapters 1-9, (2008)
Purposes of closing accounts
Purposes of closing accounts:
- Closing accounts clear the balances of all temporary accounts. Mentioned accounts have zero balances at the beginning of the next accounting period.
- Closing accounts summarize a period's revenues and expenses in the Income Summary account, thanks to that the net income or loss for the closing period can be transferred as a total to Retained Earnings.
(Financial Accounting 9TH EDITION (2007))
How to close the accounts?
The steps involved in making closing entries are as follows:
- Close the credit balances
To close the account which has credit balance, there must be a debiting journal entry made on the account in the amount of its balance.
- Close the debit balances
To close the account which has debit balance, there must be a crediting journal entry made on the account in the amount of its balance.
- Close Income Summary account
If the entries closing have been posted, it could be deduced that:
- the balance of the Income Summary account represents a net income and
- a debit balance represents a net loss.
4. Close the Dividends account balance The dividends account presents the amount by which cash dividends reduce profits retained during an accounting period. The debit balance of the Dividend account is closed to the Retained Earnings account.
Not all of the revenue accounts have credit balances and also not all of the expense accounts have debit balances. It means that, when referring to closing accounts instead of revenue accounts there often is uses the term credit balances and instead of expense account the term debit balances.
It is not necessary to use the Income Summary account during the preparing closing entries. Income Summary does simplify the procedure.
(Financial Accounting 9TH EDITION (2007))
After closing the accounts
Closing entries are post to the general ledger to make the accounts ready for the next accounting period. Not all accounts are closed. Permanent accounts (=balance sheet accounts) like assets, liabilities and capital accounts are not closed, because their balance is moved for the next accounting period. The nominal accounts are closing due to not moving the balance for the next accounting period.
(Fundamentals of Accounting: Basic Accounting Principles Simplified for Accounting Students (2007))
Everything is ready for the opening new accounting period, when all steps has been completed and all closing entries have been posted.
(Financial Accounting 9TH EDITION (2007))
Examples of Closing the accounts
- Closing the Accounts Receivable: At the end of the accounting period, the Accounts Receivable account must be closed to show the final balance of what customers owe the company. This is done by entering a debit to the Accounts Receivable account to reduce the balance to zero, and a credit to the Income Summary account to show the total of all receivables.
- Closing the Accounts Payable: At the end of the accounting period, the Accounts Payable account must be closed to show the final balance of what the company owes its suppliers. This is done by entering a credit to the Accounts Payable account to reduce the balance to zero, and a debit to the Income Summary account to show the total of all payables.
- Closing the Retained Earnings: At the end of the accounting period, the Retained Earnings account must be closed to show the final balance of the company's retained earnings. This is done by entering a debit to the Retained Earnings account to reduce its balance to zero, and a credit to the Income Summary account to show the total of all retained earnings.
- Closing the Income Summary: At the end of the accounting period, the Income Summary account must be closed to show the final balance of the company's income. This is done by entering a credit to the Income Summary account to reduce its balance to zero, and a debit to the Retained Earnings account to show the total of all income.
- Closing the Equity Accounts: At the end of the accounting period, the Equity accounts must be closed to show the final balance of the company's equity. This is done by entering a debit to the Equity accounts to reduce their balances to zero, and a credit to the Income Summary account to show the total of all equity.
Advantages of Closing the accounts
Closing the accounts is a crucial step in the financial year-end closing process. It has several advantages, such as:
- It ensures that all transactions are accurately recorded and reconciled with the general ledger. This helps to prevent any discrepancies in the accounts, as well as to provide a reliable source of financial data which can be used for financial reporting.
- It allows for the accurate assessment of any profits or losses that have been incurred during the financial year. This can be used to inform strategic decisions and ensure that the business is operating in a financially sound manner.
- It helps to ensure that all taxes and other liabilities are paid on time and that the business is compliant with legal requirements.
- It also provides a clear picture of the financial position of the business at the end of the financial year, which can be used to inform future business decisions.
Limitations of Closing the accounts
Closing the accounts has several limitations, including:
- Difficulty in identifying and recording all the transactions for the period: Closing the accounts requires an accurate and complete record of all transactions that took place during the period, which can be difficult if there are missing records or incomplete information.
- Incorrect entries and calculations: Closing the accounts involves making several calculations and entries, which can lead to errors if the calculations are incorrect or the entries are wrong.
- Inability to make changes: Once the accounts are closed, it can be difficult to make any changes to the records as the accounts are considered to be final.
- Time constraints: Closing the accounts can be a time-consuming process and may need to be completed within a certain period of time in order to meet deadlines.
Closing the accounts is an important process for any business to ensure their accounts are balanced and all income and expenses are accounted for. Other approaches related to closing the accounts include:
- Reconciliation: Reconciling the books involves comparing the records of a company's income and expenses to ensure that all transactions are accurately reported. This includes verifying that all transactions have been posted to the proper accounts, and that the amounts match the supporting documents.
- Adjusting Entries: Adjusting entries are journal entries made at the end of an accounting period to correct errors or to record transactions that have occurred but have not yet been recorded. These entries are necessary to ensure that the financial statements accurately reflect the current state of the business.
- Closing Entries: Closing entries are journal entries made at the end of an accounting period to transfer the balances of temporary accounts to permanent accounts. This allows the temporary accounts to be reset to zero, and the permanent accounts to reflect the net effect of all transactions that occurred during the accounting period.
Overall, closing the accounts is an essential component of the accounting process, and requires an accurate and thorough review of the organization’s financial records. Reconciliation, adjusting entries, and closing entries are all important steps in this process that help ensure that the financial statements are accurate and up-to-date.
References
- Agtarap-San Juan D., (2007), Fundamentals of Accounting: Basic Accounting Principles Simplified for Accounting Students, AuthorHouse, Bloomington
- Heintz J., Parry R., Jr., (2008), College Accounting, 19th edition, Chapters 1-9, Cengage Learning, Boston
- Masoom K., (2014), The Entrepreneur's Dictionary of Business and Financial Terms, PartridgeIndia, Gurgaon
- Needles B., Powers M., (2007), Financial Accounting 9TH EDITION, Cengage Learning, Boston
Author: Kinga
