How to Close Accounts at the End of the Fiscal Year

What is Account Closing?

Account closing (or closing entries) is an accounting process that takes place at the end of the accounting period (usually at the end of the fiscal year on December 31) to zero out temporary accounts (such as revenues and expenses), and transfer net profit or loss to permanent accounts (such as capital or retained earnings). The main objectives are:

• Accurately determine net profit or loss.
• Prepare financial statements (income statement, balance sheet).
• Ensure that current year data does not mix with new year data.
• Comply with accounting and tax standards.

Types of Accounts in the Closing Process

Before starting the closing process, you must distinguish between two types of accounts:

1. Temporary Accounts (Nominal)

These are closed and zeroed at the end of the year, and include:

• Revenues (sales, services, etc.).
• Expenses (salaries, rent, depreciation, etc.).
• Income summary account (or profit and loss).

2. Permanent Accounts (Real)

These are not closed, but their balances are carried forward to the new year, and include:

• Assets (cash, inventory, fixed assets).
• Liabilities (debts, loans).
• Equity (capital, retained earnings).

Steps to Close Accounts at the End of the Fiscal Year

The accounting closing process requires executing a series of interconnected procedures with precision and organization. Here are the detailed practical steps:

1. Review and Complete Accounting Records

Start by ensuring that all financial transactions that occurred during the year are fully recorded. This review includes:

• Issue pending invoices: Make sure to issue invoices for all sales or services provided before year-end, even if payment has not been collected yet.
• Record additional income sources: Document any side revenues such as investment returns or referral commissions.
• Document expenses: Collect all receipts and invoices and record them in the accounting system.
• Complete payroll statements: Include the last payroll payment of the year along with any year-end bonuses.
• Reconcile bank accounts: Perform a final reconciliation between your accounting records and bank statements.

2. Separate Personal and Business Transactions

Review all financial transactions and ensure they are properly classified. You may find cases where you paid business expenses from your personal account or vice versa. Document these cases and record the necessary adjustment entries to correct the classification and ensure data accuracy.

3. Reconcile Loan Balances and Interest Expenses

If you have loans or credit facilities, you must analyze their payments accurately. Each monthly payment is usually divided into two parts: a portion that is deducted from the principal loan amount, and a portion that represents interest expense. Make sure to record each part in the correct account, and match your balances with loan statements from the lender.

4. Calculate Accrued Revenues Not Yet Invoiced

For long-term projects that have not yet been completed, determine the value of work completed by year-end and record it as accrued revenue, even if you have not issued an invoice for it yet. This ensures that revenues are recognized in the correct accounting period according to the accrual accounting principle.

5. Record Revenues Received in Advance

If you have received payments from customers for services or products not yet delivered, they should be recorded as a liability (unearned revenue) rather than earned revenue. This reflects the actual reality that the company is obligated to provide value to the customer in the future.

6. Record Accrued Expenses Not Yet Paid

Record all expenses that relate to the current accounting period even if you have not received invoices for them or have not paid them yet. For example, if you received a service on the last day of the year and have not received the invoice yet, estimate the amount and record it as an accrued expense.

7. Adjust Prepaid Expenses

Some expenses are paid in advance for periods extending beyond one fiscal year (such as annual insurance or quarterly rent). Determine the portion that relates to the current year and the portion that relates to future periods, and record the latter as an asset (prepaid expenses) to be carried forward to the next year.

8. Inventory Count and Adjustment

If your company maintains inventory, conduct an actual physical count to determine the quantities on hand and their value. Compare the results with your accounting records and record any discrepancies. Calculate the cost of goods sold based on the valuation method adopted (FIFO, weighted average, etc.).

9. Close Revenue Accounts

After ensuring the accuracy of all balances, begin the actual closing process. First, zero out all revenue accounts by transferring them to the income summary account:

Dr. Revenue Accounts (all types)
Cr. Income Summary

10. Close Expense Accounts

Zero out all expense accounts by transferring them to the income summary account:

Dr. Income Summary
Cr. Expense Accounts (all types)

11. Determine and Transfer Net Results

Calculate the difference between total revenues and expenses in the income summary account. If the balance is a credit, it represents profit; if it is a debit, it represents a loss. Transfer this balance to the retained earnings account or capital account depending on the type of company.

12. Prepare Final Financial Statements

Use the final data to prepare the closing financial statements, which include the income statement, statement of financial position, statement of cash flows, and statement of changes in equity.

Important Tips to Avoid Errors When Closing Accounts

• Start preparation early: Don't wait until the last moment; begin reviewing your records at least a month before year-end to be able to discover and correct any errors.

• Don't mix personal funds with company funds: Maintain completely separate bank accounts, and record any overlap between them immediately as a loan or advance to ensure the accuracy of your financial reports.

• Apply the accrual accounting principle: Record revenues when earned and expenses when incurred, not just when collected or paid, to obtain a true financial picture.

• Conduct an actual physical inventory count: Don't rely solely on computerized records; conduct a physical count and compare results to discover any discrepancies due to damage, theft, or errors.

• Use reliable accounting software: Relying on manual records increases the likelihood of errors; invest in professional accounting software like Mezan to facilitate the closing process and reduce errors.

Frequently Asked Questions

1. Must accounts be closed on December 31 only?

No, the fiscal year can be different from the calendar year. Some companies choose a fiscal year ending at the end of March, June, or September depending on the nature of their business. What matters is adhering to the same date every year and disclosing it in the financial statements.

2. What is the difference between monthly closing and annual closing?

Monthly closing is an administrative procedure to review performance and prepare periodic reports, but temporary accounts are not zeroed out; they continue to accumulate. Annual closing, however, is a final official closing in which all revenue and expense accounts are zeroed out and the net result is transferred to equity.

3. Can closing entries be modified after approval?

Technically yes, but this is not recommended and should be avoided. If you discover errors after closing, it is preferable to address them in the new fiscal year through corrective entries, with disclosure in the notes accompanying the financial statements if the errors are material.

4. How do I handle Zakat and tax when closing?

You must calculate the Zakat or income tax due on the year's profits and record it as an expense or liability before final closing. In Saudi Arabia, Zakat is calculated at 2.5% of the Zakat base, while income tax for foreign companies is 20%. Consult a specialized accountant to ensure full compliance.

5. What is the importance of the post-closing trial balance?

The post-closing trial balance shows only permanent accounts (assets, liabilities, and equity) and all temporary accounts should have zero balances. This balance represents the starting point for the new fiscal year and helps ensure that the closing process was completed correctly.

Conclusion

Closing accounts at the end of the fiscal year is not merely a routine accounting procedure, but rather a pivotal process that determines the accuracy of your financial results and ensures compliance with accounting and tax standards. By following the systematic steps we have reviewed and adhering to the essential tips to avoid errors, you can complete the closing process with confidence and professionalism.

Remember that early preparation, clear separation between personal and business transactions, application of the accrual accounting principle, physical inventory count, and using reliable accounting software like Mezan are all essential factors for successful closing and minimizing errors.