In accounting, financial results are measured by periods. Some periods are set by outside authorities, such as the bank that gave you your business loan, or the IRS. Some are set solely at your discretion, so you can have as many periods as you want as long as you meet legal requirements. Any period with a defined beginning and end can be used for an accounting period. Most of the time, though, it's just easier to go along with the periods you need to have for tax purposes — and that usually means quarters.
Some small businesses can get by with a single, annual accounting period. These companies have relatively few transactions, predictable income, and no outsiders (such as loan officers or investors) clamoring for reports throughout the year. If the only time you really need financial statements is to figure out your taxes at the end of the year, you can make the year your sole accounting period.
Why use a fiscal year that's different from the calendar year?
The end of the fiscal year is a pretty busy time, with all the year-end responsibilities that need to be handled. For that reason, a lot of companies pick their slowest season for the fiscal year-end, even if that doesn't mesh with the calendar year.
When your business income is not very predictable, you need to run financial statements at least quarterly, at the end of every three-month period. That's really the only way to stay on top of your estimated income tax obligations, to avoid coming up too short at year-end. Also, in most cases, quarterly reports are frequent enough to satisfy any outside demands.
To keep things simple, most companies match their accounting periods to the calendar, which also tends to match up with a lot of tax filings. That means their business year (or
No matter which periods you decide to use to measure your company's results, there are standard activities you have to do at the end of every period. The point of these procedures is to give you accurate numbers to look at. Yes, you can look at the numbers every day all year, but you'll be seeing rough numbers that may not reflect the exactly true picture of what's going on in your company. They may be pretty close, but they are almost never completely correct.
What's Wrong with Rough Numbers?
When you look at rough numbers, the problem isn't so much that they're incorrect as that they're incomplete. For example, as you learned in Chapter 10, you may not know your true cash balance until you've reconciled your account with your bank statement. You won't have your bank statement for December on December 31, though; you probably won't get that until the middle of January. That means your cash account will be a rough number until you get the bank statement and make any necessary adjustments, such as recording interest or fixing a mistake.
Some other accounts may also need tweaking. Which ones and how many depend somewhat on whether you use cash or accrual basis and how accurate your bookkeeping is. Accrual basis by its nature calls for account adjustments, and mistakes in your records call for formal correction before you can move ahead. Most of the time, though, you'll adjust the same accounts over and over. Here are the usual suspects:
Accumulated depreciation and depreciation expense
Prepaid assets and whichever expenses are linked to them
Unearned revenues and their related revenue accounts
Accrued revenue and expense accounts
In addition to these old standards, you'll fix any account that has a mistake in it. Throughout the year, you can correct simple errors as you notice them; now, though, you will actually look for any mistakes that need to be fixed.
Working in Two Periods at Once
Since there's virtually no way you'll be able to close an accounting period until you are well into the next period, you have to work in two periods at the same time. The trick is to make sure you keep the information separated, by
When you are using a manual accounting system, the easiest way to change without closing is to simply start a new page for that account. If it's an account with very little activity (such as your capital account), you can skip down on the page and leave a big enough gap to record any adjustments or closing entries. Just make sure to clearly indicate the new period before you make any new entries so there's no confusion when you are ready to close the old period.
For software users, the steps you need to take may differ slightly based on the program you're using, so check your instruction manual. Most of the time, though, you can move to the next accounting period by just changing the dates. That will put you squarely into the new period for entering current transactions, but it won't bar you from going back to the prior period. The trick is to leave both periods open and switch back and forth between them as needed. Once you actively close a period — and that typically takes more than just changing a date — you won't be able to flip back to it any more.