CHAPTER
17

Closing Your Books and Other Accounts

In This Chapter

• Tasks to perform at the end of each month
• Working with the trial balance
• Finding errors in your account balances
• Tasks to perform at the end of each year

Larger businesses have dedicated employees who review and close the books each month, but even the smallest of businesses need to review the books at least monthly. As you’ll see in this chapter, users sometimes try to fix one problem in their books and inadvertently cause another problem. Even the most mindful of users can distractedly enter the same transaction twice, for example. The sooner you catch mistakes in your accounting records, the easier it is to fix the problem and avoid potential financial ramifications such as unrecoverable payments or inflated income tax bills.

Some accounting software requires you to carry out certain actions at the end of a month before you can start entering transactions in a new month. Even if your software doesn’t mandate it, always schedule time to review your books at least monthly. The activities we recommend in this chapter help you keep your business on track and make filing the requisite tax forms much easier. In the following pages, we show you how to make corrections if you find errors while completing your monthly analysis. In addition, we discuss the steps for closing your books at the end of the year.

Monthly Accounting Procedures

Depending on the type of accounting software you use, you might be obligated to perform some monthly procedures, or you may be able to roll along from month to month. Similarly, you might be required to take specific actions to move into a new year, or the year-end might be a nonevent.

There’s a benefit to the formalized closing procedures in an accounting program. If the software puts a fence around a specific accounting period, you’re less likely to post a transaction to an incorrect period. However, even the more informal accounting programs generally allow you to set a closing date for your books so you can prevent inadvertent changes to previous accounting periods.

In this section, we look at the accounting tasks you might need to perform at month end.

Program-Specific Tasks

Depending on whether you use a desktop-based accounting program or a cloud-based version, you might have some specific month-end tasks to complete.

Some desktop-based accounting programs take a regimented approach to accounting periods. For instance, Sage 50 allows you to modify transactions during a 2-fiscal-year period. You typically work in a single accounting period at any given point, although the software allows you to edit or add transactions in other periods without physically changing the accounting period. The desktop versions of QuickBooks, on the other hand, don’t require formal accounting periods.

In Sage 50, each month you need to choose Tasks, System, and Change Accounting Period to advance your accounting program to a new month. You’re limited to a 2-year span of accounting periods in this program, but not every program enforces such limitations.

You still can enter transactions in prior or future months, but the catch in this case is that all transactions default to the first day of the accounting period when the accounting period doesn’t match the calendar month. This increases your odds of posting transactions into the wrong month, or requires you to continually change the date on each transaction you enter. The transaction date automatically defaults to today’s date when the accounting period and calendar month match.

This isn’t a limitation of every desktop program, but rather a peculiarity to be on the lookout for with any other desktop-based accounting program.

Most cloud-based accounting programs tend to be agnostic with regard to accounting periods. You simply post transactions to your accounting software without worrying about which accounting period the transactions post in. This can be liberating for users who have little or no accounting background, as it gives you the freedom to work with few limitations. However, the downside is that your accounting software might not warn you if you inadvertently date a transaction, say, 3 years in the past or 5 years in the future.

Some desktop-based accounting programs, such as Sage 50, require you to switch periods at the end of a month.

Many desktop programs provide a prompt that alerts you if you enter a transaction unreasonably far into the future or the past. The desktop version of QuickBooks provides the warning, for example, but the online version of QuickBooks doesn’t.

Some accounting programs warn you if you attempt to post a transaction too far in the past or the future.

ACCOUNTING HACK

Even if your accounting software doesn’t require a formal closing process for a month or year, you can often set a closing date for your books that locks them so changes cannot be made prior to the closing date without a password. This is an important level of protection for your books, particularly for protecting your documentation for tax returns. Governmental auditors might want to look at your books several years after the fact, and if your books don’t match the amounts you filed on your tax returns, you could be exposed to additional scrutiny.

Bank and Credit Card Reconciliation

One of the most important actions you can carry out each month is reconciling your bank and credit card accounts. (We discuss the specifics of the reconciliation process in Chapter 8.)

Reconciling your bank account ensures that the cash amount on your balance sheet is accurate. Reconciling credit card accounts ensures that you properly report the outstanding liabilities on your balance sheet, and guarantees all expenses for the month appear on your income statement.

Balance Sheet Review

It’s important to run a Balance Sheet report at least once a month so you can keep track of what your business owns, owes to others, and the book value of your ownership stake (see Chapter 14).

Here are some common items you should look for on your balance sheet:

Accounts Receivable should match the total on your Aged Accounts Receivable report (Chapter 13). If you find a discrepancy, use the techniques in Chapter 7 to review your general ledger for your Accounts Receivable account to find the misposted entries. Common errors include crediting revenue to the Accounts Receivable account instead of a revenue account, or using a journal entry to write off bad debt instead of using credit memos within your accounting software as discussed in Chapters 6 and 13.

Accounts Payable should match the total on your Aged Accounts Payable report (Chapter 13). Your Accounts Payable account can be subject to errors similar to those for your Accounts Receivable account.

Payroll tax liability accounts should reflect the unpaid amounts due. Users sometimes inadvertently post tax deposit payments to a Payroll Taxes expense account instead of the corresponding liability account. This can distort your actual expenses, lower your income, and create a liability on your balance sheet that doesn’t actually exist.

Inventory should match the Inventory Valuation report (Chapter 5). Users sometimes incorrectly attempt to write off damaged or spoiled inventory by using journal entries.

Remember, when reviewing your Balance Sheet report on-screen in your accounting software, you often can click on an account balance to view the underlying detail. This displays a report similar to the general ledger (see Chapter 7). You can then click on a line item within that report to drill down to the actual transaction.

RED FLAG

The sum of your Retained Earnings, Capital Distributions, and Net Income on your balance sheet should always be a positive number. If the amount falls below 0, you might have more misposted accounting transactions, or you might be withdrawing too much from your business in the form of distributions. Excess distributions can result in an additional capital gains tax of 10 to 15 percent of the excess amount. Limit distributions to the amount of net income for a given year, or distribute up to the amount of your retained earnings account. You can withdraw shareholder loans without adverse tax affects if they’ve not been used to claim prior losses.

Income Statement Review

The end of each month is a good time to review your income statement for missing and misposted transactions. When reviewing, compare the current income statement to the one from the same period last year so you have something to use as a guide.

Here are some common items you should look for:

Accounts that have a lower balance than usual. Check particularly for expense accounts that should reflect a monthly expense, such as a health insurance premium payment.

Revenue accounts that have negative balances. (Except discount accounts.) Expenses may have been inadvertently posted to a revenue account.

Expense accounts that have negative balances. Revenue activity may have been inadvertently posted to an expense account. Expense accounts can legitimately have a negative account balance if you’ve received a refund for an expense paid in a prior year.

Expense accounts that have unusually high balances. A user might have entered a bill twice or posted a transaction to the wrong account.

Inventory Analysis

As we discuss in Chapter 5, inventory can present an exposure to your business. At least once a month, it’s important to review how much inventory you have on hand. Doing so may help you identify excessive quantities of slow-moving products, or perilously low quantities of fast-moving products.

Your accounting software offers a report along the lines of the Inventory Valuation Report shown in the following figure. If available, the Percent of Inventory Value column can help you identify concentrations in your inventory where you might have excessive amounts of money tied up.

An Inventory Valuation Report gives you a bird’s-eye view of your physical inventory on hand.

Aging Reports Review

In Chapter 13, we show how to run the Aged Accounts Receivable and Aged Accounts Payable reports in your accounting software. In addition to confirming that the overall amounts are reasonable, you should have procedures in place for handling receivables and payables that have aged beyond a reasonable time.

This could include working with a collection service to collect old receivables and working with a debt consolidation service if you’re having trouble keeping your Accounts Payable up to date.

Payroll Liabilities

You should establish separate liability accounts for each payroll tax your business is responsible for (see Chapter 4). As noted in Chapter 12, you might find yourself remitting taxes to multiple levels of government, including federal, state, and local.

At the end of each month, quarter, and year, the amounts in your payroll liability accounts should exactly match the amounts you’re required to remit. For instance, if you submit state withholding taxes monthly, then at the end of the month, your state income tax withholding account should match the amount you’ll remit on the fifteenth of the following month (or whichever date your state requires).

Understanding the Trial Balance

A concise listing of every account balance on your books, your Trial Balance report gives you an at-a-glance look at your business. Even though you may review your balance sheet and income statement carefully, you also should review your trial balance because situations you might not see in other reports can pop out immediately in this report format.

A Trial Balance report summarizes your balance sheet and income statement in a single report.

Despite your best efforts, accounting errors can and will occur within your books.

Adjusted Trial Balance

Your accounting software might offer an Adjusted Trial Balance report (sometimes called the Working Trial Balance). Historically, accountants used this report to mark up transfers that needed to occur between accounts. Increases or decreases to accounts are written in the middle columns, and the balances on the right are updated manually.

This old-school practice might feel out of date, but it does allow you to see the impact of the changes you’re contemplating before you actually make them.

An Adjusted or Working Trial Balance report enables you preview account adjustments before you make them in your books.

This report is designed to be a paper-based tool as opposed to the on-screen modifications you can make in most other reports we mention in this chapter.

Accounts with Opposite Signs

Typically, asset accounts have a debit balance, which means they appear on the left of the two amount columns on your trial balance. As you learned in Chapter 4, certain accounts, known as contra-asset accounts, naturally have a credit (right column) balance.

The following list shows whether certain types of accounts typically have a debit balance or a credit balance. You can refer to this list when reviewing your trial balance to help identify any account that may be out of line:

• Assets: Debit, except for contra-assets
• Liabilities: Credit
• Equity: Debit or credit, depending on the context of the account
• Revenue: Credit, except for accounts that record discounts
• Expenses: Debit

Asset or liability accounts with the wrong type of balance are often indications of an accounting error or missing transaction. A revenue account with a debit balance could be an indication of a mistaken entry or of credits given for prior year sales. An expense account with a credit balance could mean you received a refund or rebate for something you expensed in a prior year.

RED FLAG

Misposted entries in your accounting software are sometimes, but not always, the result of a user making an error when entering a transaction. More often, the errors arise when inventory items are set up incorrectly. As covered in Chapter 5, you’re required to specify revenue, Cost of Goods Sold, and inventory accounts for stock items. If the wrong account numbers are used for any of these settings, when you sell inventory items, the automatic entries your accounting software makes will be incorrect.

Amortizing Prepaid Expenses

Chapter 11 explained that the Internal Revenue Service requires your financial statements to reflect only actual expenses incurred in your business. So if you prepay a 6-month insurance policy on December 1, you’re only entitled to record [1/6] of that amount as an expense in December. The other [5/6] must initially be recorded to a Prepaid Expenses account. Then, for each of the next 5 months, you’ll transfer 1 month of the insurance premium to Insurance Expense from Prepaid Insurance.

You’ll do this by creating a journal entry to move the money between accounts. Your accounting software may offer a Transfer feature, but that’s intended for transferring money between bank accounts, such as between checking and savings, as opposed to transferring amounts between other nonbanking accounts.

ACCOUNTING HACK

You might be able to use your accounting software to automate certain month-end journal entries; look for “memorized” or “recurring transactions” in your program. For instance, you can set up a journal entry that automatically moves $150 from your Prepaid Insurance account to your Insurance Expense account, request it stop after 6 months, and your books will update themselves. Automatically recording monthly depreciation, amortization expenses, and other recurring transactions ensure that ongoing revenue and expense items post to your books automatically, which can simplify your monthly review process.

Checking and Correcting Balances

Beyond accounts that have the wrong type of balance (debit versus credit and vice versa), other types of problems can cause nagging issues in your books. This section helps you identify and correct a couple other account error situations.

When you encounter these amounts, you can use a journal entry to adjust the balances to 0 or to match the exact balance the account should have. If your Federal Withholding Taxes account has a credit balance of 3 cents, for example, you can correct this by creating a journal entry that debits Federal Withholding Taxes for 3 cents and credits Payroll Tax Expense for 3 cents.

Duplicate and Mistaken Transactions

Given the nature of numbers, and depending on the number of transactions you’re juggling, you might inadvertently post the same transaction more than once in your books. Examples include recording an adjusting journal entry twice, invoicing a customer more than once, or recording a duplicate bill from a vendor.

Your accounting software will likely notify you if you enter the same vendor bill with an identical invoice number more than once, but only if you enter the bill before writing the check. There’s no safety net with regard to accidentally recording other types of transactions more than once.

Duplicate transactions may distort an account balance enough to make the mistake noticeable, or you might need to carry out a detailed review of your general ledger, as we discuss in Chapter 7.

When given the option, you should generally void rather than delete duplicate transactions. Voided transactions don’t affect your general ledger or financial statements, but they do provide an audit trail should questions arise about the transaction later. Deleted transactions don’t necessarily vanish forever, however. As mentioned in Chapter 7, most modern accounting programs provide an audit trail report that records every transactional change in your books. So if you discover that a transaction has vanished, you can use the audit trail to determine which user eliminated the transaction.

You sometimes might need to make a correction to a paid invoice or bill. Your accounting software locks these transactions after a payment is applied against them, but you can still make changes by temporarily unapplying the customer or vendor payment. To do so, choose the payment transaction from your list of previous entries, clear the checkbox that relates to the bill or invoice, and save the payment transaction. You can then open the bill or invoice in a similar fashion, make the correction, and save the bill or invoice. Then return to the payment transaction, and reapply the payment.

Double-Checking Your Work

Even experienced accountants sometimes fumble debits and credits when entering journal entries. If you enter a journal entry backward by reversing the debit and credit amounts, you’ll double the impact of the mistake or situation on your books you were trying to fix.

When entering journal entries, always double-check your balance sheet, income statement, or trial balance to ensure the affected account balances changed as you intended. If you find a goof, simply edit the journal entry to swap the amounts between the debit and credit columns.

Year-End Procedures

At year-end, you need to carry out all the month-end procedures discussed throughout this chapter, along with these few extra procedures:

Print your General Ledger and financial reports to PDF documents, and save the files, preferably somewhere other than your main computer hard drive. Also back up your accounting records using the techniques we discuss in Chapter 15.

If you’re using a desktop program such as Sage 50, use the Year-End Wizard to close the fiscal year. Programs that don’t require a formal year-end close should allow you to specify a closing date for your books. By doing this, you can typically choose between a warning or require a password before users can add or edit transactions dated prior to the closing date you set.

Although storage space usually isn’t a consideration in a cloud-based accounting program, the physical size of your books can grow over time in desktop-based programs. This can result in performance issues that make reports take longer to appear on-screen as well as other delays. Your accounting software provides a feature that allows you to eliminate transactions from previous years. Such a command will typically appear on the File menu or sometimes tucked away under a Utilities submenu. Look for something along the lines of Purge.

Always create a backup of your data before performing a purge procedure so you can restore your records if needed.

BOTTOM LINE

Unlike many situations in life, most aspects of your books can be easily fixed, particularly if you catch mistakes in time. Take time each month to carry out the month-end procedures we recommend in this chapter. Doing so can save you money by ensuring that you don’t inadvertently pay more or less taxes than you should. Accurate books result in accurate financial statements, which can help you secure financing, should you need to borrow money to grow your business.

The Least You Need to Know

• Monitoring your account balances monthly helps you ensure your books are correct and current.
• Tools provided in your accounting software make the monthly and annual review go smoothly.
• Reviewing your trial balance can help you find errors subject to correction.
• Save a backup copy of your accounting records at the end of each year so you’ll always have the detailed support for your financial statements.