A soft close is closing the books at the end of an accounting period without many of the more rigorous steps used in a normal closing process. By doing so, the accounting department can issue financial statements very quickly and then return to its normal day-to-day activities.
This enhanced closing speed comes at a cost, for the accuracy of the financial statements is reduced by the various revenue and expense accruals that are normally included in a more comprehensive close. This means that the results reported through a soft close may be materially inaccurate. Or, they may have more variable results from month to month because accruals are not being used to smooth out results over multiple periods.
The reduced accuracy level makes the soft close impractical for reviewed or audited financial statements that are read by outsiders. However, it may be perfectly acceptable to use the soft close for internal management reporting, where total accuracy is not entirely necessary. Thus, a reasonable compromise is to use a more thorough closing process whenever a complete set of financial statements is needed for the use of outsiders, and the soft close for all other months.
The financial statements of a publicly-held company are the most rigorously examined, with reviews at the end of three quarters and a full audit at the end of the year. This means that a soft close can still be used for the other eight months of the year. Thus, even a public company can take advantage of a soft close two-thirds of the time.
Steps that are commonly skipped during a soft close include:
- Revenue accruals
- Expense accruals
- Intercompany eliminations
- Overhead allocations
- Physical inventory counts
- Account reconciliations
- Reserve account updates
The key remaining steps still needed for a soft close are:
- Customer billings
- Commission accruals
- Investigating inventory irregularities (if the inventory balance is large)
- Error-checking the financial statements
If the results of your company are particularly susceptible to any item that has been removed from the soft close checklist, then by all means add it back in. For example, if the wage accrual is a large one, you should consider calculating and accruing it every month, irrespective of the type of close that you are engaged in.
Episode 160 of the Accounting Best Practices podcast discusses the soft close.