This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year? You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. What are your year-to-date earnings? So far, you have not worked at all in the current year. The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019. You also review the following information: You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. Assume you own a small landscaping business. Let’s look at another example to illustrate the point. For our purposes, assume that we are closing the books at the end of each month unless otherwise noted. However, if the company also wanted to keep year-to-date information from month to month, a separate set of records could be kept as the company progresses through the remaining months in the year. Zeroing January 2019 would then enable the store to calculate the income (profit or loss) for the next month (February 2019), instead of merging it into January’s income and thus providing invalid information solely for the month of February. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019.
The balance sheet accounts, such as inventory, would carry over into the next period, in this case February 2019. on January 31, 2019, then the inventory balance when it reopened at 12:01 a.m. However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period.įor example, a store has an inventory account balance of $100,000. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. It also helps the company keep thorough records of account balances affecting retained earnings. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. Closing, or clearing the balances, means returning the account to a zero balance. However, most companies prepare monthly financial statements and close their books annually, so they have a clear picture of company performance during the year, and give users timely information to make decisions.Ĭlosing entries prepare a company for the next accounting period by clearing any outstanding balances in certain accounts that should not transfer over to the next period. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns.
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