Various measures need to be taken at the end of an accounting period. Adjustments to income statements and balance sheet accounts are of utmost importance. Although automated accounting systems take care of many processes, businesses need to understand exactly what happens financially at the end of an accounting period. While most tasks might be automated, there are always certain aspects that require manual attention. Here are certain vital elements that every business must look after at the time of closing.
Temporary Accounts – Income Statement
All revenues and expenses that have occurred in the period must be accounted for within that same period and should not be left to be included later. Both the revenues and expenses are recorded in the same period as defined by the matching principle because, otherwise, your closing income statement would contain anomalies. Ask your vendors to provide you with work in progress figures so that you can include them in the income statement. All accounts will be closed at the end of the accounting period, giving them the name temporary accounts.
Knowing how much money you spent to make what you earned will help you make strategic decisions in the future. You will quickly know if you need to cut the costs to lower the expenses or increase the price to bulk up revenue. Whatever the case may be, closing temporary accounts is critical for your business operations.
Permanent Accounts – Balance Sheet
Permanent accounts need to be managed actively throughout the accounting period. It is important so the current capacity of the business can always be determined correctly. No balance in the account will go away unless it is written off. Every transaction must be tracked and adjusted accordingly. While some of these tasks are performed automatically, inventory changes and depreciation need to be adjusted manually. All assets must be reevaluated at the end of an accounting period, and any changes should be adjusted likewise.
Reconciliation of bank statements is another vital task that needs to be performed as you should prepare for filing tax returns, too. Amortizing the prepaid assets to determine the value of future payments needs to be completed for a specific accounting cycle. A well-maintained balance sheet allows you to determine the business’s current standing, which is imperative to its success.
Trial Balances
The remaining trial balance in each account must be determined before the end of an accounting period. It helps to ensure that all debit entries are equivalent to credit entries and any anomalies are updated through the adjusted trial balance. The trial balance reports will help you determine the opening and closing balances of many accounts, which will help you understand the abnormalities in your bookkeeping system and what needs to be addressed.
Closing Entries
Typically, your accounting software will perform the closing entries on the books. However, it is vital to understand how the process works. An income summary account is created by closing off the revenue and expense accounts. This means that your income statement is wiped clean and is ready to be reused for the next accounting period. The income summary accounted is further closed into a retained earnings account, represented as equity on your balance sheet. After the tax deductions and other expenses, the retained earnings are then transferred into the net income account, distributed among the shareholders as equity.
Conclusion
The closing of an accounting period is indispensable because you never know where the business stands financially without these closing adjustments. You have all of the information, but it is scattered, and you cannot make sense out of it unless all of the closing entries are performed for the accounting period. Because the results are significant, businesses should use the help of a professional if they are unable to perform these steps on their own.
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