Financial Close

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

Related Terms

accounting cycle, nominal and real accounts, financial statements, trial balance