What does it mean to ‘close the books’ in accounting
Closing your books a year-end activity where business reports are finalised. “Books” refer to a company’s transaction records that are used to generate financial statements. These transactions inform the business owner about the money flowing in and out of their business.
What is the importance of closing the books?
- Closed books indicate that your finances are in order. Doing it properly will prevent inconsistency in your data as the income and expenses from the previous year will not get carried to the next.
- Closing out your transactions also allows your accounting software to generate annual financial reports, which inform you about your business performance.
- Closing your books on time is crucial if you are a small business owner as it signals that the books are in order. It also helps you file your tax returns on time.
How to close the books in 9 simple steps
1. Update the general ledger: Many small scale businesses maintain account totals in different journals. For example, there may be separate accounting journals for cash inflow and outflow. These figures have to be updated on your general ledger accounts.
2. Calculate general ledger totals: Work out the total for each account by adding up all your entries. This will give you preliminary ending balances.
3. Get your preliminary trial balance: In the previous step, you calculated the preliminary ending balance for all accounts. In this step, add all those ending balances to arrive at a preliminary trial balance. A trial balance is the total of all debits and credits, such that total debits is equal to total credits. If there is a mismatch between the two, then it’s likely that there was a mistake made in one of the previous steps.
4. Add adjustments: Transactions that are added as adjusting entries aren’t usually the ones that take place day to day. Some examples would be depreciation or real estate taxes. Once you have added these adjustments into your journal entries, add the entries from all accounts again to arrive at your adjusted account balance.
5. Prepare a new trial balance: The next step is to add all your adjusted account balances to arrive at your new trial balance. Check whether your debits and credits are equal. If not, revisit your calculations.
6. Perform variance analysis: Many firms track their monthly expenses against their planned budget. Analyzing these results plays a key role in tracking a company’s financial health. Variance analysis is a common method for doing this. It helps you correct mistakes and prepare necessary adjustments to your expenses by comparing your plans with the reports gathered after implementation. Accountants play a key role in preparing variance reports.
7. Generate financial statements: If your debits and credits are equal, you can proceed and prepare your three year-end financial statements: the balance sheet, cash flow statement, and profit and loss statement. These will help you understand your business financials.
8. Finalize closing entries: Get your general ledger ready for the next financial year by setting revenues and expenses to zero. In this step, the values of temporary accounts are shifted to a permanent account.
9. Prepare a final trial balance: Once all revenue and expense accounts have been marked as zero, the trial balance will contain only numbers from the balance sheet. Check if your total debits equal your total credits.
What is audit trail and how does it accelerate your year-end accounting?
An audit trail is a collection of records that show a financial transaction’s details and helps confirm its accuracy and authenticity. The audit trail feature is crucial for accounting professionals and business during year-end accounting, as it gives thorough insight into every transaction that happened throughout the year within the system. It spots any inaccuracies in the financial accounts that need to be fixed and reduces human hours. Here are a few advantages of audit trail that you might want to know to keep your books clean.
Better security: Having your audit trail enabled helps detect security breaches and unofficial access. It also helps companies track the entire user activity within the system.
Increased accountability: With a record of all transactions, audit trail makes individual responsibilities transparent for all activities. In this way, it encourages everyone to be liable.
Regulatory compliance: With the new audit trail mandate effective from April 1, 2023, companies can show compliance and avoid potential penalties or legal issues.
Error correction: Since audit trail identifies errors, inconsistencies, or discrepancies in accounting data, companies can use this information to improve the integrity of their records.
Closing your books can be done during the month end or year-end depending on your business strategy. Experts in the field, especially accountants, advise reconciling your accounts and generating reports every month to help you track your business performance efficiently while keeping your finances updated. You can do all of this and more, with ease, when a cloud accounting software is in place.