(Last Updated On: November 1, 2018)
Although there are many different benefits of proper , companies frequently rely on it for evaluative purposes. Meaning, they take advantage of their data to quantify their financial position. For instance, think about the way that the depicts some entity’s operational efficiency.
In order to facilitate these outcomes, however, experts must rely on a number of different factors. One of them revolves around the basic division of accounts that classifies them into temporary or permanent ones. The are those that will perpetually roll over their credit or absent any adjustments. The temporary ones, on the other hand, will mandate a periodical adjustment in order to properly display some firm’s position during a specific time frame.
In order to reset the , one must do a closing entry that will negate whatever balance may be present. Examples of these accounts include revenues, expenses, gains, and losses. Thus, going back to the concept of resetting the , consider the impact of a closing entry. When an on the is closed out, per se, its balance is brought back to a zero. As a direct consequence of this, the firm is now ready to begin another without any values that could skew the final figures.
Depending on some company’s practices, the may differ when it comes to the transfer of values. A lot of businesses rely on the so-called where all of the ‘ values are transferred to. Thus, for instance, for will be credited to eliminate the balance while the entry goes to the . The exact same process is repeated for all nominal accounts.
What happens to the ?
Expectedly, closing out all of the to another temporary would be quite futile. This is why the process of is not completed until the are brought into the equation. Once every nominal has been zeroed out and the cumulative sum is transferred to the , one will make a /credit entry to it. The other leg of that adjustment will then credit/ the . Thus, whatever balance was left over at the end of an will either increase or decrease the net income for the company.
Failing to Take Action
Firms that may not complete their closing entries are always going to materially misstate the balance of their . After all, not having any adjustment will make it impossible to have an accurate depiction of someone’s financial position. This is why the SEC has implemented strict auditing rules that do not allow publicly traded firms to abuse any loophole in the world. Doing so would mislead the investors who may spend money based on a false narrative painted by inaccurate .
Additionally, failing to close all of the will affect other areas of reporting like the general ledger. When businesses move their balances from nominal accounts to the , the accountants must go through an in-depth review of all accounts that are posted in the general ledger. Doing so allows them to check the integrity of the amounts displayed and ensure that no mistakes of any kind exist. Naturally, failing to close the will also mean that one seldom conducts the necessary general ledger reconciliations. Hence why at the end of a is important for proper tracing of all nominal balances before the beginning of a new .