What Is a Reversing Entry in Accounting?

Reversing entries are an optional, beneficial step in the accounting cycle to streamline financial record-keeping. These entries are typically made at the beginning of a new accounting period. Their function is to simplify subsequent transactions by “undoing” temporary adjustments made at the close of the previous period. They help set a clean slate for the new period, easing the workload for bookkeepers and accountants as they record routine transactions.

What Reversing Entries Are

A reversing entry is a journal entry recorded on the first day of a new accounting period that is the opposite of an adjusting entry made at the end of the previous period. These entries “cancel out” the effects of accruals or deferrals. For instance, if an adjusting entry increased an expense or revenue account at year-end, the corresponding reversing entry would decrease that same account. This process ensures that affected temporary accounts begin the new period with a zero balance, simplifying the recording of future cash transactions. This practice is particularly relevant in accrual basis accounting, where transactions are recorded when they occur, regardless of when cash changes hands.

Why Reversing Entries Are Used

Reversing entries are not mandatory for accurate financial statements, but offer practical advantages in daily accounting operations. Their purpose is to simplify routine cash transactions in the new period, especially for items like salaries, interest, or rent. By reversing accruals, they prevent double-counting revenues or expenses when the actual cash transaction occurs. This makes the accounting process more efficient, as individuals can process payments or receipts without recalling prior period adjustments. This convenience reduces manual errors and contributes to a smoother workflow.

How Reversing Entries Work with Examples

The mechanics of a reversing entry involve flipping the debits and credits of a preceding adjusting entry. This creates a temporary, unusual balance in an account, which is then cleared by the subsequent cash transaction. For example, consider accrued salaries at the end of a month. If employees earned $5,000 in the last few days of December, but payment will occur in January, an adjusting entry on December 31 would debit Salaries Expense for $5,000 and credit Salaries Payable for $5,000.

On January 1, a reversing entry would be made. This entry would debit Salaries Payable for $5,000 and credit Salaries Expense for $5,000. After this reversing entry, the Salaries Payable account would have a zero balance, and the Salaries Expense account would temporarily show an unusual credit balance of $5,000.

When the full payroll is processed on January 15 for $12,000 (including the $5,000 accrued from December and $7,000 for January), the bookkeeper debits Salaries Expense for $12,000 and credits Cash for $12,000. Because of the reversing entry, the Salaries Expense account initially had a $5,000 credit balance. When the $12,000 debit is posted, the net effect is a $7,000 debit balance in Salaries Expense, correctly reflecting only the expense incurred in the new period. This simplifies the recording of the cash payment, as the bookkeeper does not need to split the payment between the payable and the current period’s expense.

Common Applications of Reversing Entries

Reversing entries are most commonly applied to adjusting entries that involve accruals, where cash has not yet been exchanged. Accrued expenses, such as salaries payable, interest payable, or utilities payable, are common candidates for reversal. For these, an expense was recognized in the prior period, and a liability was created, but the actual cash payment will occur in the new period. Reversing these liabilities allows the subsequent cash payment to be debited entirely to the corresponding expense account, simplifying the transaction.

Similarly, accrued revenues, where income has been earned but cash has not yet been received, are often reversed. An example includes interest earned but not yet collected, or services rendered but not yet billed. By reversing the accrued revenue, the eventual cash receipt can be simply credited to the revenue account without distinguishing between the portion earned in the prior period and the new period. Certain deferrals can also be reversed if initially recorded as an expense or revenue, such as prepaid insurance or unearned revenue, to streamline future adjustments.