The accounting closing process enables businesses to verify the accuracy of performance data and ensure conformity with specific regulatory guidelines. These include generally accepted accounting principles, or GAAP, and international financial reporting standards, or IFRS. U.S. Securities and Exchange Commission directives also dictate how companies must go about closing their books and preparing financial statements.
The financial statement closing process includes a hodgepodge of activities a company undertakes to close its books, correct potential errors, make specific adjustments and prepare accurate financial statements in accordance with GAAP and IFRS. Various personnel participate in the closing process, making sure the business meets its end goal of error-free, law-abiding financial reporting. These professionals include bookkeepers, accountants and financial managers. They generally work under the guidance of senior professionals, such as corporate controllers, accounting directors and the chief financial officer.
Posting Adjusting Entries
Accountants post adjusting entries to ensure data accuracy, matching how much a company made over a period with how much it spent. The period may be a month, quarter or fiscal year, but a monthly closing process is the most common. Accounting adjustments include changes to unearned revenues and prepaid expenses. An unearned revenue is money a company receives in advance, promising to send goods or provides services at later date. A prepaid expense is cash the business pays to a vendor or service provider with the understanding that the vendor will perform specific tasks in the future. For example, a company pays insurance premiums for a full year. The business records the payment as a prepaid expense, which is a short-term asset, in the corporate balance sheet. At the end of the month, a bookkeeper must make an adjustment entry to reflect the fact that the company only incurs one month of insurance expense.
Error correction is integral to the financial statement closing process. It enables financial managers to weed mathematical inaccuracies out of the book-closing mechanism. These errors may come from poor application of accounting rules, numerical incorrectness and changes in GAAP and IFRS.
Preparing a Trial Balance
After posting adjustment entries and correcting errors, financial managers prepare a trial balance. This step is a prelude to the preparation of full-scope accounting reports, because trial-balance information directly flows into final data summaries. A trial balance enables a company to check that total credits equal total debits. It is an outgrowth of the basic accounting equation that mandates that assets equal liabilities plus equity.
Preparing Financial Statements
A correct trial balance clears the way for accurate, complete financial statements. These include a statement of financial position, a statement of profit and loss, a statement of shareholders' equity and a statement of cash flows.