We perform month end closings for every client, regardless of their industry. It is arguably one of the most important accounting functions. A month end closing procedure clearly stamps your business performance in time. So we deploy it to gauge profitability, tax payments, and our own accounting skills.
In this article:
- 3 reasons why every business needs to do a month end closing
- Our month end closing flow chart
- 4 phases of our monthly close procedure
- Month end closing procedure checklist
3 Reasons why every business needs to do a month end closing
It is a tell tale sign that bookkeeping and taxes are going to be off, if a new client informs us “the last accountant didn’t do a monthly close.” A lot of businesses and some accountants do not perform monthly closeouts. Either due to a time constraint, a cash-based accounting method, or confusion with the accounting process. Whatever the reasoning, having a clear month end close process in your accounting is vital. Here are 3 reasons why every business needs to do a month end closing:
1. To Clearly Report Income
You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns — IRS
From a compliance perspective, a definitive period close is recommended. The IRS states you must clearly report income for an accounting tax year, and have the paperwork to back it up. The GAAP Principle of Periodicity acknowledges a financial closing procedure as a consistent method for reporting accounting periods.
2. Proper Revenue Recognition Process to Avoid Audits
In business accounting you need to avoid improper revenue recognition. Extending financial periods, and other forms of money manipulation can induce an audit. With a clearly recorded procedure you can avoid penalties. You can always perform a quarterly period end closing vs a month end closing procedure. So long as you have a consistent way of showing how you track and report revenue, you are compliant.
3. Successful Investor Rounds And Business Performance
When you are in a cash crunch, who do you turn to for more funding? Investors! Certainly they will want to see company performance. Plus, with every successful round your investors also want to keep tabs on the business. Financial statements are the product of your financial month end closing. It acts as your company report card, displaying an accurate picture for investors to grade.
Our Accounting Month End Closing Procedure
Many business owners struggle with the month end closing procedure. It is hard to prioritize the essential tasks that need to get done. That shouldn’t nix the process though. Not having a clear procedure will provide inaccurate reporting and tax bills. To simplify and ease confusion, here is our month end closing flow chart with an explanation of each phase of our process. At the end, you can find our complete month end closing checklist.
4 Phases Of The Monthly Close
We divided the process into 4 phases. Each phase is broken down further into steps. This month end closing procedure is a catch all for any type of company. As you fine tune this month end closing procedure for your business, you will figure out which steps apply to your business. Here is a detailed description of each phase in the month end closing procedure:
Phase 1: Document Collection
This step is happening all month long, rather all year long. It goes without saying that you should be organizing and saving receipts, invoices, statements, etc. In the accounting cycle we call this identifying transactions. You are sorting the day to day documents into proper accounts.
Downloading all bank statements will be your reference for confirming transactions in your accounting software. If you are keeping up with bank reconciliations, during the period, this initial phase will move quickly. Otherwise go line by line with items that fall within the period, to ensure all activity is present in the close out. Confirm that your customer invoices match the deliverables provided.
Part of the document collection process is updating our vendor list, to include only approved vendors. Inventory fulfillment issues or cancelled subscriptions, should be noted along with the point in time when a business relationship has ended. This will prevent any additional expenses. Take this time to reach out to your vendors for any outstanding expense payments that are coming due. We like to set up an email account that is strictly for payables, to never miss a bill.
You also want to gather all pertinent monthly reports. We rely on a multitude of apps to assist this part of the closing. The manual labor is greatly reduced with image capture, artificial intelligent transcription, and storage. As soon as a sale is made or a vender invoice comes, all it takes is a quick snapshot and you are done. Cloud-based accounting tools make the month end closing smooth sailing.
Accounting Tools for Document Collection
- Hubdoc and Bill.com for Accounts Receivable and Accounts Payable Processing
- Expensify – for Expense Reporting
- Carta – For Stock Option Expense Reports
Phase 2 Transaction Entry
Warning transaction entry requires a close attention to the details. Our theme for the month end close is “how do we know that X really happened?” That question will surface in this phase. Always keep a skeptical mind and understand human error happens in accounting.
You can start by entering all transactions throughout the period. If you have entered everything you aren’t off the hook yet. We like to allocate a healthy chunk of time to verifying each transaction is accurately inputted. It is a tedious step but it pays off later in the workflow if everything is correct.
Take your time to enter all bills or or deposits, and link them to an invoice. If they are not linked to an invoice, put a note as to why. From there, address expense account items not attached to a bill or invoice. Lump sum items like Use Tax and employee credit card transactions, are filed into their appropriate expense accounts and will not have corresponding vendor bills.
You should also be verifying the customers you are awaiting payments from, and the bills you haven’t paid. This includes any additional late payment fees. These numbers need to be correct because they will be addressed in the next step.
Phase 3 Accrual Adjustments
With document collection and transaction entry finalized you are ready for accrual adjustments. To be certain that you can begin this crucial step, your bank reconciliations should be done! Bank reconciliations certify that all revenue and expenses for the month are in.
In this phase, you will be making accrual and deferral adjustments. Essentially you are recognizing revenue, and making adjustment journal entries for items not occurring within the period. Journal entries are how you take control of the close. To eliminate arduous monthly manual entries, many businesses will have recurring journal entries set up.
Before you start adjusting, perform a flux analysis on the balance sheet and the P&L. Compare the accounts in the month you are closing with the previous month. This will keep large fluctuations in your accounts on your radar. After the close is final you should be able to explain any major money changes or new transactions.
Your customer contracts will dictate how you recognize revenue. Merchant accounts generally provide adjustment reports. These reports will help isolate revenue that can be accepted for the month, and sales that need to be pushed to the next period.
Accrue Payroll and Expenses
In the accrual adjustment phase, all major expenses will be taken care of. The number one accrual adjustment to concentrate on—payroll. Accounting for employee wages, expenses, and commissions should be handled with precision. Since bi weekly pay periods usually cross over the month, you will need to accrue employee pay for this month, that is paid in the next period.
In your accounting software, make all additional entries for vendor prepayments, estimated expenses due, change in equity, depreciation, amortization and loan interest. You need to adjust properly, otherwise your starting balance for the next period will be off. A way to self audit your process is to check for items that should be on the balance sheet, showing up on the P&L statement, and vice versa.
Phase 4 Working Papers
Rounding out the month end closing procedure is the working papers phase. Working papers are your reference for the month end closing procedure. These papers show all adjustments and calculations as you reconcile all major accounts for the period. If everything is correct each Ledger results in a zero balance for the month end closing.
The trial balance or the beginning balance for the next month needs to be reviewed by another coworker or superior. You should always have fresh eyes, review the working papers. It is a safeguard for your process, to rule an accurate start to next month This step concludes with polished financial statements.
Accounting Month End Closing Procedure Checklist
To get the entire breakdown of our process, use this accounting month end closing procedure checklist. It will bring more clarity on the steps above for the month end closing. This can be implemented each month to produce better reporting, simplify tax season, and gain traction with your business goals.
- Download bank statements
- Confirm transactions are in the accounting software
- Confirm customer invoices match statements of work (SOW-if SOW’s are issued)
- Update major approved vendor list
- Gather outstanding vendor expense estimate (if you have no bill) For Example:
- Vendors who performed service for you, but did not send the bill.
- Estimated Taxes in December because you don’t pay them until you finish the tax return.
- Accountant Tax Preparation Bill since the work is completed next year.
- Gather stock option expense reports
- Gather employee expense reports
- Commission Calculations
- Payroll journal entries – If you pay employees weekly or bi-weekly, accrue for the days they worked in a calendar month
- Enter outstanding bills
- Record all client deposits and wires against invoices
- How To: All received money transactions should be connected to an invoice. There should be an explanation if any received money transactions are sent directly to the revenue account w/o an invoice.
- Record all expenses against vendor bills
- How To: All spent money transactions should be connected to an invoice, with exception to credit card transactions. Typical employee credit card transactions, not reimbursable, are applied to an expense report.
- Calculate Use Tax for expenses
- Enter all bank and credit card transactions w/o a corresponding bill.
- Perform bank reconciliations!
- Perform flux analysis on balance sheet and P&L – Review all accounts month to month, explain big fluctuations.
- Deferred revenue adjustments
- If you are using a merchant system such as Shopify, Amazon, SaaSOptics, Chargebee or Zuora you have a full proof way of confirming all the revenue is recorded properly. Usually these billing systems have revenue adjustment reports.
- If you are recognizing monthly recurring revenue (MRR) and revenue via spreadsheets you should have a separate process for revenue confirmation.
- Vendor prepayment recognition
- For Example: Software that’s prepaid for a duration of time.
- Unpaid wages and commissions accrual
- The wages accrual typically applies to businesses that pay weekly because the payment month differs from when the employee performed service.
- For commissions use the matching principle-commissions expense must align with the revenue earned. If you are paying cash for commissions in advance record them as prepayments. If you pay them after the client pays you, accrue the commission.
- Estimated expenses accrual
- Depreciation and amortization: Follow company policy on capitalization of fixed assets and intangible assets
- Loan interest recognition: Based on loan amortization table
- Change in equity – you need:
- New equity issued
- Option expenses
- Common stock increase from options buyout
- Cost of new stock issuance
- Bank reconciliation
- Sales tax ledger reconciliation
- AP ledger reconciliation
- AR ledger reconciliation
- Depreciation schedule reconciliation
- Revenue recognition schedule reconciliation
- Working papers review
- Create financial statements