Definition
Reversing entries are journal entries made at the beginning of an accounting period to cancel out adjusting entries made at the end of the previous accounting period. They are used to simplify the bookkeeping process and are usually related to accruals and deferrals. Essentially, they ensure that expenses and revenues are recorded in the correct period.
Key Takeaways
- Reversing Entries are a type of accounting entry which is used to offset or negate the effect of a previous entry. They’re typically made at the beginning of a new accounting period to neutralize temporary adjusting entries made at the end of the preceding period.
- Reversing entries are used to simplify the recording of future transactions by eliminating the need for certain compound entries. They help reduce errors and make it easier to record transactions in the appropriate periods without undue complexity.
- While not utilized by all businesses, reversing entries are seen most commonly in accrual accounting systems, as these systems require more adjusting entries. Businesses with fewer transactions might not use reversing entries.
Importance
Reversing entries are significant in financial accounting as they simplify the recording of both accrued and prepaid items in future periods.
These entries, made at the beginning of an accounting period, reverse or cancel out adjusting entries made at the end of the previous accounting period.
By doing this, they prevent double counting of revenues or expenses, thereby ensuring the accuracy of financial statements . Essentially, they prepare the books for standard, straightforward entries related to recurring transactions in the new period, eliminating the risk of forgetting that an item was already accounted for.
This can streamline accounting processes and improve the efficiency of financial management.
Explanation
Reversing entries are an accounting procedure primarily used to simplify the process of recording transactions in future periods. The principle purpose of these entries is to eliminate the impact of an adjusting entry from the end of a previous period.
This happens because by reversing the original journal entry, it allows for easier processing of related future transactions without the need for detailed adjustments. For example, suppose a business records an accrued expense at the end of a financial period, which will not be paid until the next period.
When the payment is made in the next period, a reversing entry at the beginning of the period removes the accrued liability, ensuring the total expense is recorded in the proper period and there is no double-counting. Overall, reversing entries are used to simplify the bookkeeping process, thus reducing the risk of errors in recording transactions.
Examples of Reversing Entries
Accrued Expenses: Suppose a company has to pay its employees overtime on a project that ended on the last day of December. However, due to the holiday season, they can only process the payment in the first week of January. To maintain accurate accounts, they record this as an accrued expense in December, but create a reversing entry on January 1st. This ensures that the overtime payment is recorded in the appropriate period when it was earned, not when it was paid.
Prepaid Expenses: If a company pays for 12 months of insurance in advance in September, that’s a prepaid expense. They would initially record the whole amount to an asset account. But at the fiscal year end on December 31, they need to recognize that they have used 4 months of the insurance. They make a reversing entry on January 1 to recognize an expense for 4 months of insurance.
Unearned Revenue: A subscription box company may receive payment from customers in December for a box that they will not ship until January. In December, this is recorded as a liability under ‘unearned revenue’, as the company has a future obligation to deliver a box. A reversing entry would then be made on January 1st when the boxes are shipped, moving the amount from unearned revenue to earned revenue, reflecting the fulfillment of obligation.
FAQ Section: Reversing Entries
What are Reversing Entries in Accounting?
Reversing entries are a type of accounting entry where certain entries made in the previous period are reversed out at the beginning of the current period. They are used to cancel out entries from the previous period and are typically used when a company has made an accrual or deferral in the previous period.
When are Reversing Entries Used?
Reversing entries are used at the beginning of an accounting period. They are used to avoid double counting of revenues or expenses when the actual amount of revenue or expense is recorded in the subsequent period.
Are Reversing Entries Mandatory?
No, reversing entries are not mandatory in accounting. They are typically used to simplify the accounting process and reduce the risk of errors. It’s a common practice, but not a requirement.
What are the Types of Reversing Entries?
There are two main types of reversing entries: accrued revenues and accrued expenses reversing entries. Both are used to reverse the effect of accrual basis accounting entries made in a prior period.
How to Record a Reversing Entry in Accounting?
Reversing entries are recorded at the beginning of the next accounting period. The first step is to identify the journal entries made in the previous period that need to be reversed. Next, a journal entry is made that exactly reverses the adjusting entry.
Related Entrepreneurship Terms
- Accrual Accounting: An accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged. This method often requires the use of reversing entries.
- Adjusting Entries: These are journal entries made at the end of an accounting period to adjust income and expense accounts so that they comply with the accrual concept of accounting. Reversing entries are usually made from adjusting entries.
- Temporary Accounts: These are ledger accounts used to record transactions for only a single accounting period and are cleared at the end of each period. Reversing entries are often used in relation to these accounts.
- Accrued Expenses: Costs that a company has incurred but hasn’t yet paid. At the end of an accounting period, accountants might use reversing entries to record these unpaid expenses.
- Deferred Revenue: Revenue received by a company for goods or services that are yet to be delivered or performed. A reversing entry might be used in the following accounting period to recognize this revenue correctly.
Sources for More Information
- Investopedia: This website offers definitions and explanations of thousands of financial terms, including reversing entries.
- Accounting Tools: This site provides numerous resources for accounting and finance terms and concepts, such as reversing entries.
- Double Entry Bookkeeping: This resource specializes in accounting principles and practices, including reversing entries.
- Accounting Coach: A comprehensive site for understanding accounting terms, including reversing entries.
