Chapter 7: Closing the Books

“Closing the books” is the process of finalizing all financial activity at the end of an accounting period (often year-end, but it can be monthly or quarterly for internal reporting). This ensures that all income and expenses are properly recorded, and that temporary accounts are reset for the next cycle.

1. Post-Closing Trial Balance

Definition

• After you make all adjusting entries (for accrued revenues, expenses, depreciation, etc.) and close the temporary accounts (revenues, expenses, and drawings/dividends) to the equity account, you prepare a Post-Closing Trial Balance.
• This trial balance includes only the permanent (real) accounts—namely, assets, liabilities, and equity. Temporary (nominal) accounts should have zero balances at this stage.

Purpose

1. Verify Balances: Ensures that debit and credit totals still match after closing entries.
2. Confirm Zero Balances: Validates that all temporary accounts (revenues and expenses) have been closed and reset.
3. Starting Point: Acts as the opening trial balance for the next accounting period.

Format

The Post-Closing Trial Balance typically lists:

• Account Names (Cash, Accounts Receivable, Equipment, Accounts Payable, Equity, etc.)
• Debit Balances
• Credit Balances

The sum of all debits must equal the sum of all credits. If they don’t match, there’s likely an error or omission in the closing process.

2. Year-End Procedures
3. Review and Adjust

• Ensure Adjusting Entries Are Complete: Double-check prepaid expenses, accrued revenues/expenses, and depreciation.
• Finalize Inventory Counts (if applicable): Update the books to reflect correct inventory values.

2. Close Temporary Accounts

1. Revenue and Expense Accounts:
   • Transfer net income (or net loss) to the Retained Earnings (for corporations) or Owner’s Capital (for sole proprietors/partnerships) account.
   • This zeroes out the temporary accounts.
2. Dividends/Owner’s Draws (if applicable):
   • Close these accounts to equity, reducing retained earnings or owner’s capital by the total withdrawals during the period.

3. Prepare Financial Statements

• Income Statement: Summarizes revenues and expenses for the year.
• Balance Sheet: Reflects ending balances of assets, liabilities, and equity after all adjustments.
• Cash Flow Statement: Shows the movement of cash across operations, investing, and financing activities.
• Retained Earnings Statement (or Statement of Owner’s Equity): Displays changes in equity, including net income and dividends/draws.

4. Audit and Compliance Checks

• If required, an audit or review may be conducted by external accountants or regulatory bodies.
• Confirm compliance with relevant accounting standards (GAAP, IFRS) and any local regulations.

5. Tax Preparation

• Gather all necessary reports (profit & loss, balance sheet, payroll records) to ensure accurate tax filings.
• Coordinate with a tax professional if the business has complex transactions or multiple state/country tax obligations.

6. Set Up for the Next Period

• Begin the new year (or new period) with updated balances.
• Adjust or create a new budget based on insights from the closing period.

Key Takeaway

Closing the books involves wrapping up temporary accounts, verifying that adjustments have been made correctly, and producing final financial statements for the period. The Post-Closing Trial Balance confirms that all temporary accounts are reset, ensuring an accurate starting point for the next cycle. Proper year-end procedures help maintain compliance, provide clarity for strategic planning, and facilitate smooth tax filing.