What is a reversing entry in accounting?

Reversing entries refer to those journal entries passed in the current accounting period to offset the entries for outstanding expenses and accrued income recorded in the immediately preceding accounting period. As these entries are no longer required to be recorded as the business’s assets or liabilities, they are reversed at the period’s start.

Table of Contents Show

• Example of Reversing Entries
• Disadvantages
• Recommended Articles

Reversing Entries are generally used to simplify the system of bookkeepingBookkeeping is the day-to-day documentation of a company’s financial transactions. These transactions include purchases, sales, receipts, and payments.read more in the new financial year of the company. It helps in improving the accuracy of the financial statements of the company because when the entry passed in the previous year is reversed, it prevents the duplication of the recognition of revenue or expense in the current year.

The account debited initially in the books of accounts, of the preceding financial year, is credited in the reversing entries with the same amount at the beginning of the current financial year; and the account which was credited originally in the books of accounts is debited in the reversing entries with the same amount.

Frequently, reversing entries are passed to fix input errors made during the passage of any journal entry. However, reverse entries add to the workload of the individual performing the entries.

Example of Reversing Entries

We can take the example of Mr. Daniel, who has an established company of electronics. The financial year of the business closes at the end of December every year. The company has employed staff in the mid of December, for which salary amounting to $4,200. This amount is accrued at the end of December 2018 and not paid. So at the time of closing the books of accounts at the end of December 2018, the following adjusting entry will be passed:

Now in the next year, i.e., at the beginning of the financial year 2019, the above entry will be reversed, and the following entry will be passed:

By this reversal entry example at the beginning of the new financial year, the effect of the previous entry will get canceled out as the reverse entry puts a negative balance in the salary expense account.

Now, suppose the company paid the salary on January 9th, 2019. The company will record the payment of the salary to the staff by debiting the salary expense account amounting to $ 4,200 with the corresponding credit to the cash accountingCash Accounting is an accounting methodology that registers revenues when they are received & expenditures when they are paid in the given period, thereby aiming at cash inflows & outflows. read more having the same amount.

Since there is a negative balance in the salary expense account in the current financial year of $4,200 after passing out the reversing entry, the payment entry of $4,200 will bring the balance of the salary expense account to positive from negative.

Advantages

The different advantages related to it are as follows:

• The passing of such entries helps in improving the accuracy of the financial statements of the companyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. When the entry passed in the previous year is reversed, it prevented the duplication of the recognition of revenue or expense in the current year.
• A person passing such entries don’t require thorough and in-depth knowledge of the accounting systemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm.read more because of the simplicity of the recording of the reversing entries. That’s because the account debited originally in the books of accounts is credited in the reversing entries with the same amount, and the account credited, is debited in the reversing entries, with the same amount.

Disadvantages

• In case there is an error in recording the reverse entry by the company then it can lead to the overstatement or understatement of the balances in the accounts used for the reversing entries, and this will provide the wrong financial information of the company to the users of the financial statement of the company
• The system of the passing of the reverse entry increases the burden of work of the person making such entries as the person making the reversing entries requires some system for tracking the same to ensure that they complete successfully. This increase in workload also leads to an increase in the chances of getting errors.

Conclusion

Reversing entries are different journal entries that are passed to offset the journal entries which were passed at the end of the immediately preceding accounting year. i.e., they are made in the books of accounts of the company on the first day of the accounting period to remove the adjusting entries of the company’s previous accounting period, and it is the last step of the accounting cycle.

Recommended Articles

This article has been a guide to Reversing Entries and its definition. Here we discuss how it works along with step by step examples. Here are the other articles in accounting that you may like –

Reversing entries are journal entries are used to cancel or neutralize entries made in the previous accounting period. They are typically made at the start of a new accounting period as a way to mitigate accounting errors or to balance the ledger. 

Let’s learn what reversing entries are, how to properly record them and use them in a double-entry accounting system, as well as how they can help with your company’s finances. 

Reversing entries are journal entries used in the accounting to reverse an entry that was made in the preceding period or clearing out old accruals entry before starting a new one. Rather than deleting an entry, reversing entries allow you to make adjustments while still maintaining the integrity of your financial records.

For example, if you posted a purchase order with the wrong quantity of products in one period, you could undo that posting with a reversing entry at the beginning of the next period. You could correct the entry as, say, invoiced.

A reversing entry should not be confused with an adjusting entry. 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 can make it easier to record future transactions. For example if Company X wanted to make an adjustment for $600 in unpaid wages, it would debit that amount from the wages expense account and credit it to the wages payable account. 

If the business owner does not make a reversing entry and pays more in wages in the next month, they would need to later on make a more complicated entry taking into account that part of November’s payroll has already been recorded. 

However, reversing entries can make it easier. In this scenario, Company X can simply make a reversing entry at the beginning of the November accounting period. The reversing entry will decrease wages payable by $600 and decrease wages expense by $600. Then, when the November payroll is paid in whatever amount, it can be recorded by increasing (debiting) wages expense and decreasing (crediting) cash with the total amount paid.

Reversing entries work to clear out any accruals that you do not want reflected in the new accounting period. 

There are several scenarios where reverse entries come into play. One is when it comes to accrued payroll, where you would need to make a reverse entry the following month when wages are actually paid.

You might also need to make a reversing entry if you mistakenly paid a vendor twice for a good, or if you made a miscalculation. Even if you don’t have accounting software, a reversing entry works by simply adjusting an entry from credit to debit or vice versa during the current period depending on the transaction. 

Another example of a reversing entry would be if you accrued a $10,000 expense in February, but the supplier does not send the actual invoice until March. You would do a reversing entry at the beginning of the month in anticipation of the invoice, which will result in a debit to accrued expenses payable and a credit to expense. Then, once the actual invoice arrives, you would record the entry and the $10,000 expense credit would balance out to $0.

While you record reversing entries at the beginning of the month, it is possible to have an accrual that you do not immediately reverse. Make note of this each month until you do reverse the entry, as this can prevent entries mistakenly going unreversed. Having an end-of-month review process can help prevent errors on your ledger. 

There are two types of reversing entries—automatic and manual. A manual reversing entry is when you record your journal entry yourself, ensuring that you record the appropriate entries at the end of the preceding month as well. 

With automatic reversing entries, your accounting software will automatically make a journal entry at the end of the month and record a reverse entry at the start of the new month. Both types of reversing entries work the same as far as debiting and crediting your general ledger.

• Reversing entries are used to reverse journal entries that were made the month prior.
• A reversing entry is often used in payroll, but may also be used to fix errors like miscalculating revenue.
• You can manually record reversing entries or have them entered automatically.

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