What are reversing entries and why are they used?

30 Dec What are reversing entries and why are they used?

When the bill is actually paid in January, the bookkeeper must remember that the expense was already recorded in December. The current entry would be to debit the accrual expense account and debit cash. As the name suggest, reversing entry is recorded by reversing the accounts nature. All of the debits and credits accounts are recorded as contra debits and credits with the same amount to “nullifying” the accounting impact. In other words, the accounts with debit nature will be credited by the same amount in the reversing entries. In this case, because the reversing entries have already been made, there is no need to separate the payment out into the parts relating to month 1 and month 2.

Interest was accrued during the months of November and December on loan of $100,000 obtained on Nov 1, 20X2. Rent receivable is related to a building given on rent on Dec 1, 20X2. Reversing entries work to clear out any accruals that you do not want reflected in the new accounting period.

Adjusting Entries and Reversing Entries

You have been exposed to the concepts of recording and journalizing transactions previously, but this explains the rest of the accounting process. The accounting cycle is the repetitive set of steps that must occur in every business every period in order to meet reporting requirements. On January 7th, Paul pays his employee $500 for the two week pay period. Paul can then record the payment by debiting the wages expense account for $500 and crediting the cash account for the same amount. Similar to prepaid expenses, there are also two methods for recording deferred income, also called unearned income.

• Lastly, review and reconcile your accounts regularly, especially if you use reversing entries often or for large amounts.
• These transactions aim to correct the income and expense amount that will be included in the Income statement.
• Below are separate approaches for recording this transaction using the two methods.
• The remaining $1,000 that has not been earned will be deferred to the following accounting period.
• If the cost of the equipment is $120,000 and will have no salvage value, then each month’s income statement needs to report $1,000 for 120 months in order to report depreciation expense under the straight-line method.

Reversing entries are the entries post at the beginning of the accounting period which aims to eliminate the accrue adjusting entries which we made at the end of prior accounting period. Without reversing entries, the accountant is highly likely to make a double posting for the same transaction. Reversing entries are optional accounting journal entries that are made at the beginning of an accounting period, to cancel https://www.wave-accounting.net/fund-accounting-101-basics-unique-approach-for/ adjusting entries which were made at the end of the previous accounting period. In part 1, we had an introduction to reversing entries and discussed examples for accrued income and accrued expense. In this part, we will cover the two other types of entries that can be reversed – unearned income and prepaid expense. Reversing entries help prevent accountants and bookkeepers from double recording revenues or expenses.

Accrue revenue

For example, if the utilities for each month are paid at the beginning of the next month, you would have used the utilities as of December 31, but you won’t have to pay for them until the next year. The matching principle states that we should recognize the expenses when they are incurred and match them to the revenues they help generate. In this case, the utilities expense should be recorded in December even if it is not paid until January. This expense is accrued by debiting utilities expense and crediting the accrued utilities account. Taking into account the 1,500 credit balance the reversing entry has already created, the balance on the wage expense account is now equal to 2,500 (4,000-1,500), which is the amount relating to month 2 as required. Adjusting entries for unearned revenue under the liability method and prepaid expense under the asset method do not make sense to reverse.

If the bookkeeper does not record these reversal entries, then he would have to remember which portion of the current expenses, for example, has already been paid out in the previous period. Therefore, there is a high chance of double-counting certain revenues and expenses. The practice of making reversal entries at the beginning of the accounting cycle will ensure that this error of double counting is avoided. Reversal entries will significantly make life of a bookkeeper easier since he won’t have to remember which expenses and revenues were accrued and prepaid. He can record the reversing entries to negate the effect of the adjusting entries that were passed in the preceding year and essentially start anew.

Reversing Entry for Accrued Expense

Adjusting entries for depreciation, bad debts and other allowances also are not reversed. Adjusting entries are made at the end of each accounting cycle, while reversing entries are made at the beginning of the following cycle. Reversing entries are journal entries that are made by an accountant at the beginning of the Law Firm Finances: Bookkeeping, Accounting, and KPIs 2023 accounting cycle. This is an optional step in the accounting cycle and if the bookkeeper wishes can skip it entirely. Since you’re expecting to fully earn the unearned portion of $2,400 from the customer’s advance payment on February 29, 2024, the reversing entry has already transferred this amount to service revenue.