Also, cash might not be paid or earned in the same period as the expenses or incomes are incurred. To deal with the mismatches between cash and transactions, deferred or accrued accounts are created to record the cash payments or actual transactions. The month-end close process includes reviewing the company’s balance sheet, intercompany trades, month end journal entries, and other documents (like bank statements, income, and expenses) and reconciling them. Accountants also use the term «accrual» or state that they must «accrue» when discussing revenues that fit the first scenario. Further the company has the right to the interest earned and will need to list that as an asset on its balance sheet.

The financial close doesn’t have to be a headache for the accounting team. Following the right set of steps when dealing with financial records at the end of each month will result in a positive impact on the organization as a whole. You can be sure at the end of each month that any transactions have fully occurred either before or after the closing and that your month-end balance is accurate and up-to-date.

Step 9 – Review

The entries in your financial statements must match the entries from bankers, vendors, and other entities. Now you need a checklist that ensures you have all the data you need to complete those steps. This month end checklist helps you gather the information you need before your monthly close date. As such, it’s a good idea to ask somebody who didn’t prepare your accounts to take a look at them. Have this person check all financial statements, as well as your general ledger.

Accruals and deferrals are the basis of the accrual method of accounting, the preferred method by generally accepted accounting principles (GAAP). Using the accrual method, an accountant makes adjustments for revenue that have been earned but are not yet recorded in the general ledger and expenses that have been incurred but are also not yet recorded. The accruals are made via adjusting journal entries at the end of each accounting period, so the reported financial statements can be inclusive of these amounts. An adjusting journal entry involves an income statement account (revenue or expense) along with a balance sheet account (asset or liability).

• Reconcile the 2 to reflect expenses paid and income received for the month.
• If the financial documents required for the month-closing process are stored in different locations, it will be cumbersome to access them quickly.
• All accounts on the balance sheet, like cash, savings, and checking, must be reconciled.
• For example, the sales team may have an unpaid expense relating to a conference in New York, but the invoice is dated for this month.
• It also allows a company to record assets that do not have a cash value, such as goodwill.

By recording accruals, a company can measure what it owes in the short-term and also what cash revenue it expects to receive. It also allows a company to record assets that do not have a cash value, such as goodwill. The information in this article describes the accrued expenses’ significance and meaning in extremely easy terms. It also provides examples of accrued expenses and their importance in assessing how financial stability affects an organisation. The balance sheets of accrued costs appear in current liabilities, and this is because they need to be met within a period which is twelve months.

If you incur an expense during the year, you need to match the expense against the earnings generated by the expense over the period. Even if the expense was not paid in the year, it must be documented with an accrued expense entry in the journal. Costs that are incurred and not paid for are accrued expenses, and some of the most frequently accrued expenses include rent, utility bills and payroll. So, a final review is always done before the closing process is completed. This review is done by the top management or someone who wasn’t involved in the closing process to get a fresh view of all the data once again.

Prepare For the Next Closing

Here’s our month-end close checklist to help you organize your workflows. Small business owners have their plate full with daily business operations, so it’s normal to dread the month-end admin. Since month-end closing is a routine activity, every time you encounter a roadblock or problem, note it down and try to address it effectively. For example, if collecting data takes more time than planned, try to keep everything organized throughout the month. With our help, you can make invoicing easier and access integrations designed to streamline accounting. You’ll parse through a lot of financial information during these account reconciliation processes.

Definition of Accrual Adjusting Entries

Once the payment has been made in the new year, the liability account will be decreased through a debit, and the cash account will be reduced through a credit. An example of an accrued expense for accounts payable could be the cost of electricity that the utility company has used to power its operations, but has not yet paid for. In this case, the utility company would make a journal entry to record the cost of the electricity as an accrued expense. This would involve debiting the «expense» account and crediting the «accounts payable» account. The effect of this journal entry would be to increase the utility company’s expenses on the income statement, and to increase its accounts payable on the balance sheet. Adjusting journal entries can get complicated, so you shouldn’t book them yourself unless you’re an accounting expert.

When it is definite that a certain amount cannot be collected, the previously recorded allowance for the doubtful account is removed, and a bad debt expense is recognized. In contrast to accruals, deferrals are cash prepayments that are made prior to the actual consumption or sale of goods and services. Recording accrued liabilities allows you to prepare for expenses ahead of time. Organizing the statements is just as important so that you aren’t scrambling to find them in the last few days of the month. Most forms of accounting software have features built-in for this purpose. However, you don’t want to show a $12,000 expense for January, so you’ll record it as a prepaid expense, and expense a set amount each month until the prepayment has been used in its entirety.

What is Accrual Accounting?

Since accruals are actually classed as creditors on the balance sheet we can meet all of the above requirements by posting one simple journal. These could differ from the actual cash amount the 4 sectors of the cash flow statement you need paid/received in the future. The elimination of manual data entry is usually the first selling point accounting teams look forward to, but the advantage here extends beyond that.

Step 7 – Reconcile Your Prepaid and Accrued Accounts

For example, a company that has a fiscal year ending December 31 takes out a loan from the bank on December 1. The terms of the loan indicate that interest payments are to be made every three months. In this case, the company’s first interest payment is to be made March 1. However, the company still needs to accrue interest expenses for the months of December, January, and February.

What are the best practices to improve the month-end closing process?

Ideally, you should book these journal entries before you make any big financial decisions or evaluate your finances. If the entries aren’t booked, it’s easy to forget about obligations and get a skewed picture of your financial position. For example, if you have an annual loan interest payment due in February and no liability is reflected on the books in January, you’re going to overestimate your available cash.

However, you can cut that down to as little as 5 days if your accounting team has access to automation software. Some small business owners underestimate the importance of the month end close process. They may not see how tracking what happened during the previous month helps them set a company up for success in the future.