A chief consideration in any business is whether to use a “calendar” or “fiscal” year. In most cases the business should use a calendar year which means reporting income for the year beginning January 1st and ending December 31st. A fiscal year is any other 12 month period other than a calendar month, ie. April 1st through March 31st, or July 1st through June 30th. Unless a company elects otherwise it is assumed that they are choosing the calendar system.
Incidentally, the business may select either method regardless of when the company started doing business. For instance, a business may start on December 1st and still choose the calendar year even though the first year may be only one month long.
There are a couple of instances where a business would be justified in choosing a fiscal year. The first consideration is in dealing with seasonal fluctuations in the business cycle. If the business cycle favors December and January, such as winter ski resorts, or Christmas season, as in toy stores, the business may choose to end their year during a slower time. For instance, many department stores use a fiscal year beginning February 1st and ending January 31st.
Secondly a business may choose a fiscal year if the company foresees that most of their sources of funds may be coming at a time other than January. This is particularly important if the provider of those funds will be asking for some type of stewardship reporting on a fiscal year basis. For instance, businesses that depend on government grants for funding. In this case, the company should consider choosing a fiscal year that corresponds with the government agency's fiscal year.
At the end of each calendar year (Jan. 1 - Dec. 31) or fiscal year (any 12 month term other than the calendar year), all Earnings accounts are closed out to "0" and net earnings transferred to Capital. In a proprietorship or partnership, net earnings (or losses) should be added to (or subtracted from) the Owner's Equity (investment) account. In a corporation, net earnings are transferred to the Retained Earnings account.
Before closing Earnings accounts at year's end, you need to take a physical count of Inventory, Fixed Assets, and Liabilities (comparing your calculation of remaining principle to the bank's figure). Differences between your actual count and what is reported on the Balance Sheet will require adjusting entries to the appropriate Asset, Liability, and Accrual accounts. These entries are normally made in the General Journal and subsequently transferred to the General Ledger.
Advancing Your Account-Ability, Module III of the Professional Bookkeeper™ Program, explains Year End Closing in detail.
Click HERE to see what else is taught in Module III.