What Is a Reversing Journal Entry and Why Are They Used?

A reversing journal entry is an optional step within the accounting cycle. It streamlines record-keeping and helps businesses manage financial records efficiently, particularly concerning accruals from previous periods.

What Reversing Entries Are

A reversing entry is a journal entry made at the beginning of an accounting period to cancel out a specific adjusting entry from the preceding period. This practice is optional and commonly used in accrual basis accounting. Its purpose is to “undo” accrual-based adjustments, preparing accounts for normal transaction recording in the new period.

Reversing entries are distinct from adjusting entries; adjusting entries are made at the end of an accounting cycle, while reversing entries are made at the beginning of the next. They flip the debits and credits of the original adjusting entry. This process helps prevent the duplication of revenues or expenses.

Why Reversing Entries Are Used

Reversing entries simplify the accounting process for ongoing transactions. By reversing accruals, accountants can record cash receipts and disbursements in the new period without manually accounting for prior period adjustments. This simplification reduces the likelihood of errors, such as double-counting revenues or expenses. For example, if an expense was accrued in one period, a reversing entry allows the full cash payment for that expense in the next period to be recorded as a straightforward expense.

This method is beneficial in organizations where different individuals handle end-of-period adjustments and daily bookkeeping tasks. It allows daily transactions to be recorded routinely, as if no accrual had occurred, contributing to efficient processing of invoices and cash flows.

Typical Situations for Reversing Entries

Reversing entries are commonly applied to accruals, which are revenues earned or expenses incurred that have not yet been recorded through a cash transaction. A frequent scenario involves accrued expenses, such as salaries payable or interest payable. For instance, if employees earn wages at the end of one month but are paid in the next, an adjusting entry records the accrued salary expense and the corresponding liability. A reversing entry at the start of the new month clears this liability.

Another common application is with accrued revenues, such as interest receivable or services rendered but not yet billed. If a company earns revenue in one period but expects to receive cash or bill the customer in the next, an adjusting entry records the revenue and a receivable. A reversing entry eliminates this receivable at the beginning of the new period.

Steps to Create a Reversing Entry

Creating a reversing entry involves a straightforward process, typically performed on the first day of a new accounting period. The first step is to identify the adjusting entry from the previous period that needs to be reversed. Only certain types of adjusting entries, primarily those for accrued expenses and accrued revenues, are generally reversed.

Once identified, the reversing entry is the exact opposite of the original adjusting entry. For example, if an adjusting entry at the end of December recorded accrued salaries (debit Salaries Expense, credit Salaries Payable), on January 1, the reversing entry would debit Salaries Payable and credit Salaries Expense for the same amount. This effectively zeros out the Salaries Payable account and creates a temporary credit balance in the Salaries Expense account.

When the actual salary payment occurs later in January, the entire amount paid is debited to Salaries Expense and credited to Cash. The temporary credit in the expense account from the reversing entry is offset by this subsequent debit, ensuring that the correct salary expense for the period is reported without requiring complex calculations or memory of prior adjustments.