Every small business must keep a set of financial records (often referred to simply as books) each year. These accounting records are used to analyze the business' performance over the course of the year and to file the company's annual tax return. Before a set of books is considered complete for the year the books must be closed out. The closing of an accounting system is usually done by a trained accountant such as a CPA while the regular entries made into an accounting system during the course of the year are done by a bookkeeper or by the business owner himself. Closing the books of an accounting system also resets the balances of the accounts for use during the following accounting period.
Close the temporary accounts. All revenue and expense entries made during the year must be closed out so that the next year can start with zero balances. All revenue and expense accounts are closed into an account called Income Summary.
Close the Income Summary account. Each year Income Summary shows the profit or loss generated by the operating activities of the business. This account (the profit or loss generated that year) is then closed into the Retained Earnings account.
Close out the Dividends account. Dividends are payments of profit made to owners during the course of the year. This account is also closed to retained earnings to adjust for mid-year profit distributions.
Calculate a Trial Balance to check your work. A Trial Balance is a calculation that ensures that all of the books are in balance. A Trial Balance is always performed when closing out accounting books.
Many accounting software programs perform many of these steps automatically.