Accounting principle for closing of the books of account

Closing of the books of account refers to the process of preparing accounts for the financial statements’ generation at the end of the accounting period. The preparation of the financial statements begins with the closing of the books of accounts. The Company's Balance Sheet is prepared on the basis of the balance sheet account, and the Company's Income Statement or Profit and Loss (P&L) Statement is created on the basis of profit and loss account.

The profit and loss account shows a company’s profit or loss over a given period of time. To determine the result, the information about income and expenses is needed, these data should be transferred from their own accounts to the income and loss account.

In the profit and loss account: expenses are recorded on the debit side and income on the credit side.

The balances affecting the financial result are transferred to the profit and loss account from the revenue and expense accounts, which at the same time are balanced and closed. This result, i.e., the difference between the income and expenditure accounts (profit or loss), is then transferred to the balance sheet account. After that, the debit and credit sides of all accounts are the same.

The balances from the other accounts are also transferred to the balance sheet accounts, which are referred to as permanent accounts because at the end of the accounting period the balances in these accounts are not closed.

EXAMPLE:

There has been received income in amount of EUR 46 250. When expenses in amount of EUR 42 400 has been deducted from revenue, the profit for the financial year is EUR 3 850.

As shown from this example that Profit and loss account, like all other accounts, is closed by balancing it (debit has to be equal to credit). The steps to balance an account are the following:

• Calculate the difference between the sum of debit entries and the sum of credit entries of the account.
• Put this difference on the smaller side of the account.
• If the sum on the credit side is greater than the debit side, i.e., income exceeds expenditure, it means that company has got a profit for the financial period.
• The amount of this profit is recorded to the debit side to balance an account.
• Otherwise, there would have been a loss that should have been recorded to the credit.

Thus, Profit and loss account or income summary account is also a temporary account that is just used at the end of the accounting period to make the closing entries.

The balance sheet accounts determine and show the company's long-standing financial position. The balances of these accounts will be reported on the company's balance sheet at the end of the accounting period. To define the result, it is necessary to transfer the balances from all temporary accounts to the balance sheet accounts.

In the balance sheet account: cash and cash equivalents, receivables and remaining book value of assets are recorded on the debit side of an account and capital on the credit side.

The accounting principle of the data recording for balance sheet account is the following:

The debit side of the balance sheet account indicates how much and what kind of assets the company has at the balance sheet date. The credit side expresses the types and amounts of liabilities, as well as the amount of owner's equity.