The Accounting Process

Question: Analyze, record, adjust, and report—the four basic steps in the accounting process. Is the work year

complete for the accountant after financial statements are prepared?

Answer: One last mechanical process needs to be mentioned. Whether a company is as big as Microsoft or as

small as the local convenience store, the final action performed each year by the accountant is the preparation

of closing entries. Several types of accounts—specifically, revenues, expenses, gains, losses, and dividends

paid—reflect the various changes that occur in a company’s net assets but just for the current period. In order for

the accounting system to start measuring the effects for each new year, all of these specific T-accounts must be

returned to a zero balance after the annual financial statements are produced.

• Final credit totals existing in every revenue and gain account are closed out by recording equal and off-

setting debits.

• Similarly, ending debit balances for expenses, losses, and dividends paid require a credit entry of the same

amount to return each of these T-accounts to a zero balance.

After these “temporary” accounts are closed at year’s end, the resulting single figure is the equivalent of the net

income reported for the year less dividends paid. This net effect is recorded in the retained earnings T-account.

The closing process effectively moves the balance for each revenue, expense, gain, loss, and dividend paid into

retained earnings. In the same manner as journal entries and adjusting entries, closing entries are recorded initially

in the company’s journal and then posted to the ledger. As a result, the beginning retained earnings balance for the

year is updated to arrive at the ending total reported on the balance sheet.

Assets, liabilities, capital stock, and retained earnings all start out each year with a balance that is the same as

the ending figure reported on the previous balance sheet. Those accounts are not designed to report an impact

occurring just during the current year. In contrast, revenues, expenses, gains, losses, and dividends paid all begin

the first day of each year with a zero balance—ready to record the events of this new period.