Speaker 1: Hey guys, welcome back to another video. Before I close the books and issue financial statements, there is a series of steps that I take as a corporate controller to make sure that all of the business transactions are captured on the financial statements. And in this video, I wanted to create a comprehensive guide of all of the steps, all of the things you have to visit before you go ahead and issue financial statements with confidence. Hey guys, welcome back to another accounting lecture. Bill Hanna here. In today's video, we'll be focusing on period-end closing or closing the books and what it means to close the books and generate financial statements. And if you go back in time when accounting was done in actual physical paper and columnar pages, closing the books literally meant that you entered all of your expenses and all your revenue and you're ready to literally take the book and actually close it. But what we say today when we say close the books, what we mean is that your books and records are complete on the accounting software and that you're ready to generate financial statements. So it's all about completeness and accuracy of the books and records. That is closing the books. And so as you go up in the ladder of an accounting manager, assistant controller, and a controller, and you get to my position today as a corporate controller, you'll find that your CFO will come to you on maybe day five or six of the month and say, are we closed for the previous month? Are we done? Are we closed with the books? And the reason why is because everybody's eager to download the financial statements and begin to analyze the performance of the business. So this is briefly what it means to close the books. And what we'll do in this lecture is I want to break it down to maybe 14 or 15 steps that you can take to close the books and records. All right. So to simplify the process for you, because at the end of the day, it's really easy, right? We're not really launching rockets into space, right? This is pretty easy stuff. So what we'll do is you grab a copy of the financial statements from the previous period, right? So grab a copy of the balance sheet and a copy of the income statement. And we'll go through the main accounts and talk about the things that you need to do to close the books. All right. So we'll grab a copy of the balance sheet from the previous period and look at it. And the first section on the current assets, you'll find cash and cash equivalents. And what you need to do here is a bank reconciliation. And what a bank reconciliation is, is grabbing the ending balance from the bank statement and reconciling it to what you have on your books and records, right? So what that allows you to do is capture any unrecorded expenses or any cash application that's coming in, cash receipts from customer to close out accounts receivable, right? If you don't do a bank reconciliation, what you're going to end up with is that you're going to have expenses that have been incurred by the business and not being captured on the income statement, right? So this is the risk here if you don't reconcile the bank statement. So that's the first thing you have to do. And my pro tip on this one is that you do it on a weekly basis. Don't wait till the month end to reconcile the bank because then you'll end up with a large volume of transactions that you need to record in terms of expenses or cash receipts from customers. My recommendation is to do it on a weekly basis, a preliminary reconciliation in your accounting software where you enter in the balance and then begin to apply expenses and cash receipts from customers as you receive it on a weekly basis. So that's what you do for cash. Step two is to reconcile accounts receivable. And when you look at accounts receivable, the reason why you want to reconcile it, it's very similar to the concept of reconciling the bank statement. It's all about completeness. With the bank statement, you're making sure that all the transactions are complete on your books and records. With accounts receivable, you're also concerned with completeness. And completeness here means that you invoice the customers you need to invoice. So your billing process could be if you are a product-based business, you are issuing an invoice every time you ship a product. So that's if you have a product-based business. If you have a software business, for example, maybe you're issuing only one monthly invoice or annual invoice for the period, covering the whole period. Whatever the case is, if you have a business that ships a product, what you need to do for completeness is to compare a list of invoices in a period that you issued to a list of purchase orders from the customers to a list of shipping notices from the warehouse. That's like a three-way check list of invoices that you issued, purchase orders to shipping notices to make sure that all of the purchase orders that you received have been shipped and fulfilled. And then all of the shipment and fulfillment have been invoiced accordingly. So this is a three-way match you can do to ensure completeness. If you have a software business, for example, or a consumption-based service business, you can do a month-over-month customer analytics. So you grab your customer data or your invoicing data for this current period, the previous period, and maybe the period previous to that, and do a three-period comparison. And then you'll see any kind of fluctuation, any hills or valleys to capture any anomalies, and that will help you capture anything that's incomplete. So that's in terms of completeness. And then what you can do after that is reconcile the aging sub-ledgers. So you take the sub-ledger, which is your ledger by customer, and reconcile it to the general ledger, which is the balance or your trial balance, to make sure they equal each other. Because if they don't equal each other and there is a reconciling item, you're better off catching it now than waiting down the line and having to go back to previous periods to reconcile. So reconciling your balance or trial balance to your sub-ledger is really important here. And then the final thing to do for AR is examining AR aging. So downloading AR aging by bucket, current, 30 days plus, 60 days plus, and looking at your customers who are not paying you and following up to make sure that you're receiving the cash on time. And by the way, all of these items here are addressed in detail in the Controller Academy, link in the description below. Step three is to reconcile prepaid expenses. And as you can see, we are going down the balance sheet accounts right now. So we are at prepaid expenses. And for prepaid expenses, you should keep an Excel file, an outside Excel file, showing the items from the vendor that you've received that are prepaid. And what that means is that this is an expense of the future that you're prepaying today. So it lives on the balance sheet rather than the income statement. And as you then incur the actual expense in the future, then you begin to amortize the prepaid expenses. So what you should do for this here is to look at the Excel file for reasonableness. You go through it item by item and see you're amortizing correctly. You're booking an amortizing journal entry on your books and records to recognize any expense that already got incurred in this current period and make sure it reconciles and it's reasonable at month end. All right, one important pro tip here is to develop a month end closed checklist or a closed calendar. So I'm going to leave a link down below to a video I made on how to develop the checklist and also a link to an Excel file of a sample checklist you can download and begin to use it yourself today. Okay, number four is inventory. And whether you're maintaining your list of inventory by SKU in the accounting ERP software or in Excel, you should be doing a month end reconciliation to the warehouse report. So you should contact the warehouse each month and get a listing by SKU of the quantities of the inventory and reconcile that to what you have on your books and records. Because if you don't do that and you have some sort of discrepancy you're not catching, then the auditor when they come in they'll catch that discrepancy and you have to write it off. So you're better off doing it yourself and reconciling to the warehouse to catch any differences. And then you should also review for obsolescence and expired goods. So you should always get, if you're selling for example perishable goods or some items that have an expiration date, you should always look at it by SKU, by bucket of expiration, a month end to determine if there are any write-offs that you have to do. You have to write down inventory maybe to close the goods sold if you have expired goods or obsolete goods. So two things, reconcile to warehouse, reconcile aging for expired items. Number five is PP&E or property plant and equipment. And this is your factory buildings, your machinery, your laptops, and all this good stuff. And what you should be doing here are three things. Number one, review for large purchases that needs to be capitalized in the period. So maybe you do that by reviewing accounts payable or speaking to somebody from accounts payable team and making sure that every purchase that is large enough to be capitalized under the company's fixed asset policy is being capitalized correctly on the books, number one. Number two is to run depreciation and if you're running SAP or NetSuite, large enough ERP software, that's literally a push of a button that will run depreciation for you. If not, if you're using like QuickBooks online, you might have to run depreciation in Excel and then take the JE or journal entry from Excel and book it into your accounting software. Number three is to review for obsolete property or machinery. So for example, if you have any machinery that's not being utilized anymore, that's obsolete, you might need to write that off to the P&L. The three things, review large purchases, run depreciation, and review for obsolete machinery. All right, up next and under current liabilities, we'll encounter accounts payable. So you need to do three things here. The first one is to ensure that all vendor invoices have been received and recorded. And a lot of times what you have is an inbox, like maybe AP at xyz.com, your AP email that receives all the vendor invoices. So just making sure that you review that inbox and double check that all of the vendor invoices in there have been recorded on the books and records. That's number one. Number two is a reconciliation between the tri-balance and your sub-ledger. So take the amount of balance of AP from the tri-balance, reconcile it to your sub-ledger or your aging in AP by vendor to make sure the balance ties. Because if it doesn't, it means you have a difference that you should resolve now rather than to wait a few periods and then it becomes more complex as the snowball gets bigger and bigger, right? So you should tackle it early. Number three is to check the aging, AP aging, and make sure that there's nothing that's being aged, that for example, if you owe a vendor a certain amount of money, within a certain period of time, you should pay to them because if you don't, you're inflating the cash balance unnecessarily on your books and you're building, maybe breaking down the relationship with the vendor. So you should be paying on time within the credit term or the payment term that you have with the vendor. So three things, ensure completeness of vendor invoices recorded, two, reconciliation sub-ledger, three, check the aging report. All right, number seven, as we're going down the list on the balance sheet here under current liabilities is credit cards. So for credit cards, just like bank statements, we're concerned with completeness. So what you should be doing is reconciling the balance on your books and records to the balance on the credit card statement on month end. And oftentimes what you do is you have a feed, a bank feed, or whether it's a CSV upload or an actual API feed from the bank into your accounting software that just feeds in the information and it gets recorded on your books and records. And you're just, what you do is you're making sure that the expense accounts allocated to each line item is correct. You go in and you review the nature of the expense and you assign to the right expense line item, right? So completeness and reconciliation on month end of credit cards. Credit cards are often issued to executives, certain buyers around the company have credit cards. So make sure you have a good listing of the credit cards that are being used and reconcile those on a monthly basis. Number eight, as we go down the list is accrued expenses. And what accrued expenses is, is a liability to represent the expenses that you incurred, but you haven't yet paid to the vendors, right? So maybe you incur an expense today, but you haven't been invoiced yet. So it's not an accounts payable yet. But you are recognizing a liability here by debiting the expense and crediting the liability account. So what you should be doing for this is that you should be maintaining an Excel file with all of your vendors that you have accrual for, and you review it on a monthly basis. A for reasonableness to check that nothing is aged on it that should be reversed. And B is for reversals. So to check on it line by line and see if you receive the vendor invoice and you booked it to AP, you should be reversing out of this account because it shouldn't live in two places. It should only live either in accrued expenses or accounts payable. If you receive the vendor invoice, you have to reverse the accrual here. So two things to maintain an Excel file. And secondly, is to reverse any accrual that's been already invoiced by the vendor. And number nine, as we go down the list is deferred revenue or sometimes referred to as unearned revenue. And the reason why it's a liability is because you receive maybe some funds from a customer and you haven't yet delivered the good or the service. So what you're recognizing here is a liability or an obligation that you will have to deliver this good or service in the future. So what you should be doing is maintain an Excel table for this to show by customer and by payment to show what you received. And then secondly, is to review on a monthly basis this table here for reasonableness line by line to see what you need to amortize. And so an example is let's say you receive $100,000 for an entire year of platform fees from a customer and you need to amortize that on 12 months. So what you should be doing is going into Excel file and amortizing the $100,000 over a whole year and then record as revenue, recognize the revenue to the P&L every month for the 112th of the $100,000 as an example. So deferred revenue is unearned revenue. You should be maintaining a table outside of the ARP software and then reviewing and amortizing the line items on a monthly basis. All right, number 10 is long-term debt. And this is for loans or business loans that have a term longer than a year or 12 months. That's why it's long-term. With that, you need to be maintaining a table outside of your ARP software to show them the number of loans that you have outstanding and then reconcile those to the statement from the lender just to make sure they're capturing any payments that you're paying down, maybe your loans, and you need to record a journal entry to recognize the reduction in cash and reduction in long-term liability. So review the table that you have. And then for the interest on these loans, you might be having to, for example, if you owe an interest on the loan but you haven't paid it yet, then you need to be recording an accrual for that interest. Okay, that's long-term debt. All right, so with that, we're done with the balance sheet, and now we can move to the income statement. And the income statement, really, we're going to just break it down to step number 11, which is revenue, and step 12, which is expenses. So for revenue, what I do is I download a report of revenue for the month by customer, and I go through it and analyze to see if there are any things that need to be adjusted for accrual accounting, right? And accrual accounting says that you record revenue as you earn it, not when you invoice it or not when you receive the cash, but when you earn the revenue. And earning the revenue is very specific, and it's based on ASC, or Accounting Standard Codification 606, that has rules around when to recognize revenue, and it's mainly around the idea of earning a revenue and fulfilling the performance obligation. So the best way is to download a list of revenue by customer and go through it and identify some of these problematic customers that have specific clauses in their contracts that require some accrual adjustment to revenue. So that's 11, or revenue. And then for step 12, it's going to be analyzing the expenses. So look at your expense accounts for operating expenses. And what I do for expenses is to look at the expense accounts by GL accounts, like the detailed GL accounts, which shows payroll expense, vacation expense, software expense, marketing, all of these things, right? And begin to identify the expense accounts that require an accrual adjustment on month end. And accrual says that an expense is recorded when the expense is incurred, right? Not when the expense is paid, or not when the invoice is received from a vendor, but when the actual expense itself or the service from the vendor or from the employee has been rendered, right? So an example is if you look at payroll expenses, and let's say you're paying your payroll on a two-week cadence, right? So you have two weeks in the period, two weeks plus two weeks, and then you have maybe two or three days toward the end of the period that you need to accrue for as a debit to payroll expense and a credit to accrued payroll, right? So identifying these expenses that require an accrual of month end, that's step number 12. Step 13 is going to be to review an open purchase order report. And what I mean by that is that you download a listing of all of the purchase orders within your company that haven't been invoiced by the vendor. You haven't received an invoice from the vendor yet against it, right? What that allows you to do is to figure out if there's any expense that's been incurred during the period that needs to be recorded in the books and records if the service has been, say, significantly completed by the vendor, but you haven't yet received an invoice from the vendor, right? So I highly recommend implementing a system of purchase orders within your company, whether you're buying inventory or maybe only if you're buying software services, marketing services, or anything like that. Because that allows you for two things. Number one is to control spend. So you're always approving your spend before it happens, not after it happens, right? And then secondly, it allows you for this to have a correct accounting because then if you have a P.O. process, then you can download an open P.O. report of month end and double check it against your accounts payable to make sure that you have accruals that are correct at month end. So step number 13 is to review an open purchase order report. Alright, so now we're at step 14 and we're pretty much almost done. We now have all or almost all of the transactions are complete on the books and records. Step number 14 is going to be to perform an actual versus budget analysis. So now that you're almost comfortable that everything is already recorded on the books and records, you download a set of financial statements and you do an actual to budget comparison. What that allows you to do is to capture any items maybe recorded in the budget but not in the actual financial statements that might prompt a question. And then you say, here I have a marketing expense in the budget for $20,000 but I don't see that in the financial statements. Did something change in the plan? So you reach out to the marketing person and you say did something change in the budget? And you might say, yeah, well the $20,000 is not going to be spent now. It's going to be spent down the line. Then you're fine. Then it's okay. I don't have to accrue anything. But what that might discover is that if the $20,000 has been budgeted for but you don't see it in the actual results, you reach out to the marketing person. He'll say, well, yeah, we have the service. It's been incurred and it needs to be recorded but there is no PO for it and there is no vendor invoice. But the service has been rendered by the vendor, right? So that will enable you to do an accrual for that service in this case. So doing a budget to actual analysis will allow you to figure out any of these variances that will help you catch accounting anomalies. Step 15, and we're almost done here, is to do a period over period comparison. So download the financial statements. If you're doing a monthly close, then you download four months, including the current monthly closing, and you do a comparison, a fluctuation analysis to capture any anomalies. So for example, for payroll, if you do an analysis that shows the payroll have gone up by, say, 5%, right? So what you should be asking is, did my head count increase by 5% to prompt the increase in payroll by 5%? And then if you look at head count and it went up by 5%, then you're like, okay, that makes sense then. But if your head count went up by, say, 20% and you look at a payroll and it went up only by 5%, well, then something is wrong here, right? So you see a period over period analysis is really helpful in capturing anomalies in the accounting. Step 16, or the final step, is to lock the period in the accounting software so that no more changes are being done, either by accident or on purpose by the accounting staff, no more changes. So you need to lock the period once you're satisfied.