Closing the books is what we accountants live for. For those non-accountants, it is the process where the accounts are checked for accuracy at the end of each period. Closing the books can refer to either the month-end or year-end close. Both are essentially the same process, although the year-end close typically requires greater precision and analysis as the financial reports that are prepared are distributed to a wider audience, often subject to audit. The following discussion focuses on the month-end close.
The purpose of the monthly close is to provide accurate financial reports and key performance indicators to assist management in overseeing the organization. The close helps drive performance, increases accountability and strengthens internal controls. The close involves examining both Balance Sheet and Profit and Loss accounts to ensure that these are correct. Accuracy is ensured through reconciliations, analysis, and comparisons.
The Balance Sheet component of the close typically requires five key processes:
- All cash accounts are reconciled to bank accounts;
- All control accounts are agreed to their subledgers. Control accounts typically include Accounts Receivable, Inventory, Fixed Assets, and Accounts Payable;
- Prepaid balances are reviewed to ensure that amortizations are correct;
- Payroll clearing accounts are cleared; and,
- Sundry debits and credits are analyzed to ensure these are appropriate and necessary accruals are recorded. Accruals can be required for bad debts, severance, claims and other liabilities.
Statement of profit and loss
The Profit and Loss component of the close requires that line items are compared to both prior year and budget with explanations being obtained for significant differences. If the organization is a for-profit entity then changes in Gross Margin or Gross Profit percentages should also be reviewed and understood.
An important part of the close is to review cut-off to ensure that transactions are recorded in the correct period. This also involves matching revenues with expenses.
Roll forwards should be undertaken for changes in Balance Sheet accounts that have Profit and Loss impact. These roll forwards reconcile the changes in accounts with their corresponding Profit and Loss impact. Examples include depreciation, bad debt and severance expenses.
Each controller or finance professional will develop their own best practices through trial and error and their own experience within their organization. Some of these include:
- A month-end checklist should be developed to ensure that all necessary steps are taken are completed. The check list includes the tasks to be performed, when these should be completed, who is to complete and an area for initials to acknowledge completion. This checklist should be maintained for each close.
- Assessment of both financial and non-financial key performance indicators (KPIs). Non-financial indicators could include volume and the number of full time equivalents.
- The month-end close should be completed on a timely basis. Timeliness helps drive performance, identify trends and helps provide for quick resolution of performance issues. To ensure timeliness the month-end close should actually start before month-end. Typically payroll entries can be entered into the accounting system before the end of the month. Preliminary account reviews can identify posting errors and provide for early correction.
The end product of the monthly close is a report to management which includes financial statements, key performance indicators and a narrative explaining significant variances from budget or prior period. The management report is a value add that accountants provide to the organization, assisting other members of the organization to make informed business decisions.