How to Manage the Year End Closing Process More Effectively

The year-end closing is a challenging process for the entire accounting department. Accountants must complete the day-to-day work on transactions, and perform other tasks to close the books. The accounting team works longer hours, and faces a number of additional deadlines.

With proper planning and the right tools, however, the accounting department can complete the closing process in less time, and reduce the risk of errors. As this podcast episode points out, companies can use technology to scale the business. To create a smoother process, start with the end in mind.

Issuing Year-End Financial Statements

The primary goal is to issue the financial statements for the end of the fiscal year. To accomplish the goal, the accounting staff must complete a number of steps. As an example, assume that Sally is the CFO of Vintage Furniture, a company that produces custom furniture pieces for the residential market. Vintage must issue financials for the 12/31/21 year end, which is the closing date.

Post all accounting transactions

Every transaction that occurred before year end must be posted, and that includes all necessary adjusting entries.

Most businesses comply with generally accepted accounting principles (GAAP), which requires businesses to use accrual-basis accounting for financial reporting purposes. This method posts revenue when earned, and expenses when incurred to generate revenue. The accrual method differs from the cash-basis accounting, a method that posts revenue and expenses based on cash inflows and outflows.

Here are three common accrual entries:

• Accounts payable: Vintage purchases $20,000 of maple wood as a raw material, and uses the wood in production during December. The invoice has not been paid as of 12/31. The company increases a material expense account, and increases accounts payable.

• Accounts receivable: Vintage sells and delivers a $1,700 table to the Smith family on 12/21, and the Smith’s have not paid Vintage’s invoice as of 12/31. The firm increases sales (a revenue account) and increases accounts receivable.

• Prepaid insurance: On December 1st, the company pays $6,000 in insurance premiums for the next six months. The firm increases prepaid insurance, an asset account, by $6,000 and reduces cash $6,000. On December 31st, Vintage has one month of insurance expenditures. The company posts a $1,000 debit to insurance expenses and reduces prepaid insurance by $1,000. 

All three journal entries are posted to record either revenue or expenses in December, before the fiscal year-end closing. The remaining $5,000 balance in prepaid insurance is expensed in the next fiscal year. Accrual accounting entries are not recorded in the accounting records based on cash inflows or outflows.

Record adjusting entries

Vintage also records adjusting entries before year end, and these are two common examples:

• Interest earned: The company earned $200 in interest on account balances for December, but the cash is not credited to the account until early January. On 12/31, Vintage increases accounts receivable and increases interest income for the earnings.

• Payroll accrual: Vintage owes $5,300 in payroll expense for the last week of December, and the next pay date is January 5th. The company records payroll expense and accrued payroll (a liability account) on 12/31.

Accounting departments typically maintain a closing checklist of required month-end and year-end closing entries in the accounting system.

Reconciling each account

The accounting staff uses a number of documents to reconcile each account, so that the account reports the correct year-end balance. Accountants need a complete set of receipts, vendor invoices, bank statements, and credit card statements to reconcile each account in the general ledger.

Cash is often the account with the most transactions, and reconciling cash is time consuming. Accountants must reconcile the cash balance per the books to the bank statement balance, and post any required adjusting entries. 

Credit card statements are also used to reconcile the cash account, because cash payments are made to reduce the credit card balance. If any employees pay for a business procurement out of pocket, the business must pay reimbursements for the spending. Each credit card transaction must be assigned to the proper expense account.

Generating an adjusted trial balance

The trial balance lists each account and the current balance, and the financial statements are created using an adjusted trial balance. Businesses must post all transactions, reconcile accounts, and record adjusting entries to produce an adjusted trial balance. Here are the three most important financial statements:

• Balance sheet: Lists asset, liability, and equity balances as of a specific date. Balance sheet accounts are permanent accounts, meaning that the balances carry over from one year to the new fiscal year.

• Income statement: Reports revenue, expenses, and net income for a period of time (month or year). Income statement accounts are temporary accounts that are adjusted to zero when the books are closed each month and year. The impact of closing the accounts is a profit (or deficits) posted to net income, or as a net loss. The net income or net loss is recorded to equity in the balance sheet.

• Statement of cash flows: This statement groups cash inflows and outflows into three categories: cash flow from operations, investing, and financing activities.

There are other tasks that must be completed during the year-end close.

Other Year-End Closing Tasks

The year-end close requires the accounting department to complete all of the monthly close tasks, and to work on other tasks that are unique to year end. Here are some of those important tasks:

Documentation for an audit

The accounting staff must provide documentation and answer questions for an audit. Not all companies have an audit performed, but stakeholders (investors, creditors, regulators) may require an audit down the road.

When a CPA firm performs an audit, it provides a written opinion that states whether or not the financial statements are “free of material misstatements.” Put another way, the auditor did not find any errors that are large enough to change a financial statement user’s opinion on the statements. The dollar amount that is considered material is based on judgment. 

Let’s assume that Vintage has a $600,000 accounts receivable balance. The CPA firm does not consider a $40 error to be material, but a $5,000 error is cause for concern. The $5,000 material error must be investigated, and Vintage may have to post an adjusting entry to correct the error.

Auditors typically complete their work in the two to three months after the fiscal year-end. The CPA firm needs access to receipts, invoices, the general ledger, and the other documents used to post accounting transactions. 

Reports for the annual budget

Well-managed businesses operate based on an annual budget, and the accounting department provides reports to help managers create the budget. Variance analysis is a financial management tool used to increase profitability. Companies often include budgeted amounts in the accounting system, so that management can compare budgeted results to actual results during the current fiscal year. 

Vintage’s managers need the prior year’s budget, along with information regarding sales, production, and costs. If the VP of sales estimates a 20 percent increase in revenue, the VP of operations must plan for additional material purchases and higher labor costs. 

While the budget process starts before year end, the annual budget may not be completed until early in the new year. This timing creates more work during the year-end close. 

Getting through the year-end closing procedures can feel overwhelming, but you can take action to make the process less time consuming.

How to Make the Process Easier

These steps can help your staff save time, and reduce the risk of error during year-end processes. If you can complete more work in less time, you can issue the financial statements and complete other year-end tasks without incurring huge overtime costs.

Complete tasks before year end

Investigate unusual transactions and post adjustments before year end. If the accounting staff is proactive and doesn’t put off work until after 12/31, the year-end close will be easier. Small account balances with fewer transactions, such as petty cash, can be reconciled quickly. Gather and file all supporting documents as transactions are completed.

Use a closing schedule

Create a closing schedule that lists each task that must be completed, all required reports, and the deadlines for the year-end processes. The schedule ensures that all accounts are reconciled, and that each adjustment is posted. Explain the closing schedule to your staff, and ask for feedback on how the schedule can be improved. Are the deadlines realistic? Does your staff have the tools needed to make the deadlines? Find out.

Embracing automation is the most effective strategy to reduce the time required for the year-end close.

Use accounting automation

You may already use an ERP system or accounting software, but there are other tools that can automate manual processes, including Stampli.

Stampli AP automation platform offers flexibility and visibility to everyone involved in the accounts payable process. These issues apply whether or not you use a purchase order to buy items from a vendor. This is all possible within the Stampli platform, which provides these benefits:

• When an invoice is uploaded, Stampli uses AI and machine learning to auto-populate fields, such as the invoice number and general ledger accounts. Stampli will recommend approvers, based on past invoices. 

• Stampli provides a communication hub with each invoice, and each step in the process is documented from invoice field changes to invoice-related communications. Questions and answers are listed, so that everyone can review the status of an invoice. 

• Vendor relationships are important, and Stampli provides each of your vendors access to a vendor portal. Vendors can see the status of invoices that are being processed in Stampli. 

Stampli’s end-to-end AP automation platform gives you full control and visibility over all of your corporate spending- all in one place. Don’t just manage spend, control corporate spend with Stampli.