What Are Reversing Entries in Accounting?

Reversing entries are an optional step in the accounting cycle to simplify their bookkeeping processes. These entries are made at the beginning of a new accounting period to cancel out adjusting entries from the prior period. Their purpose is to streamline the recording of future transactions by essentially resetting temporary accounts affected by accruals.

The Role of Reversing Entries

The primary purpose of employing reversing entries is to simplify the accounting process for routine transactions that span across accounting periods. They prevent accountants from needing to manually account for prior period adjustments when recording cash receipts or disbursements. This practice allows for the straightforward recording of transactions as they occur, without having to dissect amounts related to previous accruals.

By making reversing entries, the accounting system is prepared for routine entries for cash payments or receipts in the new period. This reduces double-counting revenues or expenses and makes invoice processing more efficient. It ensures that the financial records remain accurate and consistent, especially when different individuals handle month-end adjustments versus daily bookkeeping.

Common Scenarios for Reversing Entries

Reversing entries are typically applied to adjusting entries that involve accruals, specifically accrued expenses and accrued revenues. Accrued expenses are costs incurred by a business but not yet paid, such as salaries or interest owed on a loan. Reversing these entries ensures that when the actual payment is made in the new period, the entire amount can be simply debited to the expense account without concern for the portion accrued in the prior period.

Similarly, accrued revenues are income earned but not yet received, like interest earned on investments or unbilled services. Reversing an accrued revenue entry allows the full cash receipt in the new period to be credited directly to the revenue account. This prevents the need to distinguish between the revenue accrued in the prior period and the new period’s revenue, simplifying subsequent recording. Adjusting entries for depreciation or unearned revenue are generally not reversed.

The Mechanics of Reversing Entries

A reversing entry is the opposite of the adjusting entry it negates. If an adjusting entry debited an expense and credited a payable, the reversing entry would credit the expense and debit the payable for the same amount. This zeroes out the temporary liability or asset account created by the accrual and places an opposite balance in the related income statement account.

For example, if an accrued salaries adjusting entry in December debited Salaries Expense and credited Salaries Payable for $2,000, the reversing entry on January 1 would debit Salaries Payable and credit Salaries Expense for $2,000. When the actual payroll of $5,000 is paid on January 15, the entire amount can be debited to Salaries Expense and credited to Cash. The initial credit to Salaries Expense from the reversing entry, combined with the subsequent debit for the full payment, ensures only the new period’s expense portion is recognized.