Closing of books of account is last step in accounting cycle. In this post, we learn step by step how to close books in accounting without doing any errors.
Meaning of books are closed:
Closing of books means act of transferring balance of temporary accounts to income summary accounts. Finally, profit or loss determined in income summary account is transferred to capital or retained earning account.
7 important steps to close books of accounts without doing errors:
Doing closing entry is easy process but you also remember following points.
Check for unbilled invoices:
Sometimes income accrues but invoices are not raised. To follow accrual accounting method and find out correct profit or loss, we need to check at year end for any unbilled invoices, raise invoice and consider income in accounting.
Check for accrued expenses:
All the outstanding expense should be considered at the time of closing. Generally, most of the payable are related to the month of march. Consider them in your accounts.
Verify physical inventory with stock in hand:
Verification of physical inventory with balance in account reflects true pictures of profit and asset.Over valuation of inventory value leads to higher profit. Other side, undervalue of inventory leads to lower profit.
Correct the errors:
70% to 80% accounting is automated today. Still there may be some omission in recording the transaction. Some transaction may be transferred to wrong account. Revenue and capital transactions should be categorized correctly. Personal expense of owner of business should be transfer to capital account. Check twice for this kind of errors.
close the all the temporary account ( Income accounts and Expense accounts):
After considering all the adjustments, accruals and omissions, next move should be transfer all the income and expense account to income summary account / profit and loss account. To close all the income account, debit the income account and credit the income summary account and to close all the expense account, credit all the expense account and debit income summary account.
How to close net income/ income summary to retain earning?
Close profit to Capital account or retained earning: Finally, you need to transfer profit to capital account if you have proprietary status of business or to retained earning account if your business status is corporate.
Do following entry –
To transfer profit to capital account / retained earning account,
Profit account Debit
To Capital account/ retained earning account.
To transfer loss to capital account / retained earning account,
Capital account / retained earning account Debit
To Loss account
Prepare post closing trial balance:
After doing all the necessary entry, last step is preparation of closing trial balance. Closing trial balance is snapshot of balance sheet presented in trial balance format. If you are not familiar with account cycle, read our post – accounting cycle steps with example.
Closing the books of accounts example:
Let’s understand closing of books concept with example.
Mr.Zen has Following expenses and income during the year 2015. He needs to close the temporary accounts.
To close the books, we transfer all the income and expense account to Profit and loss account / Income summary account and Net profit should be transfer to Mr.Zen a/c ( Capital a/c).
|Profit and loss a/c Dr||74,350|
|To salary a/c||12,000|
|To rent a/c||60,000|
|To Mobile bill exp a/c||1,000|
|To Printing exp a/c||200|
|To depreciation a/c||1,000|
|To bad debt a/c||150|
|Consultancy a/c Dr||6,20,000|
|Interest income a/c Dr||2,000|
|To Profit and loss a/c||6,22,000|
|Profit and loss a/c Dr||5,74,650|
|To Mr. Zen a/c||5,74,650|
Accounting is easy task if your basic is clear and you give attention to small details. Remember above simple steps to close books. It will prevent you to do mistakes. You can purchase my accounting video course to sharp your knowledge.