How Adjusting Entries Are Used in Month-End Closing

Month-end is the busiest time for a bookkeeper, as it’s when they close the monthly ledgers within 5 to 10 business days. Collecting and integrating reports from different departments, finalizing financial activities, reconciling them with bank statements, and adjusting entries to align transactions in their respective reporting period are all part of the month-end closing. If you slack off on any of the tasks, errors will snowball, taxes and payments will be delayed, and you may never know the accurate financial performance of your business.

How To Close Month-End Accounts

The month-end closing may look overwhelming with so many elements involved, but a checklist and defined process can remove the fear of bookkeeping.

• Set a Cut-off Date: Business transactions are ongoing, but for record-keeping, the business has to set a cut-off date for invoices (revenue recognition), bills (expense recognition), payroll, and deliveries (inventory).
• Collect Reports: The bookkeeper has to collect reports from banks, the payroll team, accounts receivable (A/R) and accounts payable (invoices and open bills), purchasing (amortization and depreciation schedules), and other teams.
• Bank Reconciliation: This is the first layer of checking missing and duplicate entries, uncaptured or unsent invoices, and unrecorded vendor bills. An entry appearing in bank statements but not in journal entries, or vice versa, can help identify the missing link, because these errors become difficult to detect later on.
• Posting Repeatable Adjusting Entries: The biggest challenge in month-end closing is adjusting entries, some repeatable and some one-off. The recurring adjustments occur because accrual accounting requires companies to recognize revenue and expenses when earned, rather than when cash is received or paid. Suppose you buy an annual software subscription for $1,200. You will recognize a $100 expense each month by adjusting entries in your balance sheet (prepaid expenses) and your income statement.

Finance teams can have standard templates and defined owners for recurring adjustments. For instance, the A/R manager could be responsible for sending details of prepaid and pending invoices, the explanation of accrual or deferral, and the necessary supporting documents. If someone traces a transaction report, the documents, explanation, and journal entry should be able to show the timeline of deliverables and the invoice raised.

• Adjust Complex Entries: After tackling recurring adjustments, the bookkeeper will look for any one-off and subjective adjustments that will require a detailed explanation.
• Reconcile Balance Sheet Accounts: The adjustments will lead to changes in the balance sheet accounts, from accounts receivable and payables to payroll and tax liabilities to prepaid revenues.
• The final step in the closing is to review the income statement and balance sheet at the account level to identify any unusual spikes, negative balances, or missing accrual patterns from the previous month, and to look for an explanation. This will help identify misclassifications or mathematical errors in adjustment amounts.

Now that you understand the month-end closing, we will dig deeper into adjusting entries, where most errors happen.

Types of Accounting Adjustments

There are two major entries: revenue and expenses. They can be accrued, deferred, estimated, or amortized, depending on the timing of the activity. Let’s understand these adjustments one by one.

Accrued Revenue and Expenses

A transaction is accrued when the business activity is completed but not billed. Some recurring accrued expenses include wages payable, utilities payable, and loan interest payable. These are the expenses that you pay after using the services. Some recurring accrued revenue includes rent, consulting fees, and more. You invoice the client after delivering the service.

For instance, you accrue $5,000 wage expense in June but make the payment on July 5. You will realize a $5,000 expense in June, as the work was done in June to earn revenue in June. This gives a true picture of the expense incurred to earn that revenue.

Adjustment: Accrued revenue and expenses will be recognized in the income statement, and those amounts will be added to payables and receivables on the balance sheet. You can support accrued expenses transactions with documents such as purchase orders, receiving records, supplier estimates, service confirmations, or prior-month run rates.

Estimates

In accrual transactions, you report revenue and expenses before the invoice or bill is even generated. This could require you to make an estimate, which may differ from the actual amount when the invoice and bill are generated, and money actually changes hands.

For instance, you recognized the accrued electricity expense of $500 in June based on last year’s June bill. However, when the actual bill came in July, it was $560. The extra $60 could be due to revised rates or more usage. The adjustment needs to be made to accommodate that $60.

Deferred Revenue and Expenses

A transaction is deferred when the business receives advance revenue or prepays expenses before the business activity is completed. Hence, you defer recording revenue and expenses when the business activity is completed. You can support deferred revenue transactions with documents such as customer billing records, contract terms, and revenue recognition schedules.

For instance, you run a software company, and a client makes a one-time payment of $1,200 for a 12-month subscription. You will recognize $100 in revenue each month and deduct that amount from the unearned revenue in current liabilities on the Balance Sheet. This adjustment is necessary because if you show a $1,200 revenue in January without incurring the expense to provide the service, your reporting will be skewed. It will not show the true financial picture of your monthly business activities, making budgeting difficult.

Depreciation and Amortization

One form of deferred expense is depreciation, which defers the cost of a fixed asset over its useful life. There is a well-defined formula for the same. You can support these transactions with depreciation and amortization schedules.

Review and Audit Month-End Reports

The bookkeeper will perform all the above month-end closing entries and adjustments, reconcile transactions, and provide an explanation for every adjustment. A controller will analyze the monthly adjustments alongside budgets, forecasts, and prior-period adjustments to identify any sharp upticks and match each uptick to the business explanation. Auditors may select some entries and trace them back to the supporting documents, explanations, and adjustments to ensure accounts are audit-ready.

Month-end closing and adjusting entries are important to ensure that a company’s financial statements accurately reflect its financial performance in the correct reporting period. It will help business owners make better projections and budgets, ensuring adequate cash reserves are available to pay pending dues and plan expansion.

Contact KSSP Partners LLP in Markham to Help You with The Month-End Closing

Talk to a professional bookkeeper and accountant to help you prepare accurate books of accounts with audit-ready supporting documents. At KSSP Partners LLP, our accountants and bookkeepers can provide services such as preparing the books of accounts and financial statements as well as providing assurance services. To learn more about how KSSP Partners LLP can provide you with the best accounting and bookkeeping services, contact us online or by telephone at XXX-XXX-XXXX.