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Definition
The accounting term financial close refers to the process of reducing the balance in nominal accounts, such as revenues and expenses, to zero. The close is part of the accounting cycle, and is necessary to prepare these temporary accounts for the next period's transactions and events.
Explanation
A financial close is typically conducted once the company has prepared financial statements for the current accounting period. Prior to the close, the information contained in these accounts is first transferred to an Income Summary, which holds this data for each accounting period. Once transferred, the revenue and expense accounts are closed through a series of entries posted to the company's general ledger. The Income Summary account is subsequently closed through a transfer to owner's equity.
Once the financial close is complete, a post-closing trial balance is performed to verify that all debits and credits have been posted to the Income Summary.
Example
Company A has two sources of revenue; the first being from sales of $500,000 and the second being interest income of $10,000 in the current accounting period. The closing entries recorded in the general ledger for the revenue account would be:
Sales Revenues | $500,000 | |
Interest Income | $10,000 | |
Transfer to Income Summary | $510,000 |
In this example, Company A followed the same process to close out their expense accounts, which included the cost of goods sold ($250,000), selling general and administrative expenses ($100,000) as well as income taxes ($50,000) for a total of $400,000.
Cost of Goods Sold | $250,000 | |
SG&A | $100,000 | |
Income Tax Expense | $50,000 | |
Transfer to Income Summary | $400,000 |
The final step in the process is to close out the Income Summary account to Retained Earnings.
Income Summary Account | $90,000 | |
Retained Earnings | $90,000 |
