Question

Assume that one of your colleagues states that a company’s books should be ongoing and therefore not closed until that business is terminated. Explain the concept of the closing process by drawing analogies between (1) a scoreboard for an athletic event and the revenue and expense accounts of a business or (2) a sports team’s record book and retained earnings. (Hint: Think about what would happen if the scoreboard were not cleared before the start of a new game.)

Answer 1

It is important for a company to close its accounts yearly as many financials can be prepared only once they are closed. Until financials are prepared company will be unable to judge its performance just like scoreboard which tells us how is team performing. The figures in the financial statements are just like scores on the scoreboard. If financials are not closed it will have figures carried forward from the previous year which would be similar to the situation where for the new game, scores of previous games are already mentioned on the scoreboard. In this case one will not be able to judge the performance of the current game. It is important to study the revenue and expenses of the company to judge how the company is performing . In other words revenues and expenses helps in judging whether the company is winning or loosing . If revenues are higher than expenses then it can be said that company is winning and if its the other way round then company is loosing.

Similarly Retained earnings of the company can be compared with the sports team’s record book where the final score if each game is mentioned. Retained earnings is the final score of the company which helps the management decide that finally company has won or lost. A credit(positive) balance of retained earnings would mean that company has won and debit(negative) balance would mean it has lost.