How to Use Reversing Entries in Your Business Accounting

When reversing entries are not made, the accountant needs to remember last period adjusting entries and account for any expense/revenue previously recognized relating to current period payments or receipts. At the beginning of each accounting period, some accountants use reversing entries to cancel out the adjusting entries that were made to accrue revenues and expenses at the end of the previous accounting period. Reversing entries make it easier to record subsequent transactions by eliminating the need for certain compound entries. This reversing entry should decrease the prepaid insurance account by $30,000, resulting to a zero balance again, effectively reversing the adjusting entry. At the same time, the insurance expense account would be debited for $30,000 which corresponds to the unexpired portion.

Payroll expense is the operating expense that should record in the month of occurrence. If we do not record, we will understate operating expenses and liability (amount owed to staff). We can use the best estimation, which is the amount from the prior month if we don’t expect any changes. The variance between accrue and actual expense will adjust to the profit and loss account in next period. On the other hand, we may pay cash to our suppliers before using service or receive goods, so these transactions must record into prepayment. It will classify to asset or expense when we receive goods or consume the service.

Understanding Business and Its Purpose

The need to prepare reversing entries for prepaid expenses depend on which method you use in recording prepayments. The reversing entry simplified the recording process by allowing the recording of the entire $12,000 salaries paid as expense when the actual payroll was made. The data entry personnel won’t need to worry for the impact made by the adjusting entry on December 31, 2022. Preparing the reversing entries is the last step in the accounting cycle of the business.

This leaves the original $18,000 expense in the income statement in January, but now creates a negative $18,000 expense in the income statement in February. To illustrate, let’s assume that on July 1, 2023 you purchased a 12-month insurance coverage plan starting July 1 and paid an upfront fee of reversing entries are $60,000. Below we’ll discuss how to record reversing entries and which method it could be applied. 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.

Out With the Old and In With the New: Reversing Entries in Accounting

Without reversing entries, the accountant is highly likely to make a double posting for the same transaction. Company C provides car rental service to customers and they record revenue base on invoice bills on a monthly basis. In Nov 202X, they sign a contract with a customer to rent the car for 2 months from 01 Dec 202X to 31 Jan 202X+1, the fee is $5,000 per month.

After recording this entry, the prepaid insurance should already show a zero balance since the whole insurance plan has already expired. They just wait for the final invoice from the supplier and record the different amounts only. Therefore, all the adjusting entries must be reviewed by the management teams such as accounting manager or finance manager. The person who approves these kinds of transaction must know the impact and know what he is doing. First, we can’t recognize the whole amount as expense cost we not yet consume the service yet, so we should record as prepayment (Asset account). In order to receive a discount from internet service provider, Company D pays the annual fee of $ 2,000 which covers from 01 June 202X to 31 May 202X+1.

The 3 Legal Forms of Business

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. When the temporary accounts are closed at the end of an accounting period, subsequent reversing entries create abnormal balances in the affected expense and revenue accounts. For example, if the wages expense account is closed on April 30, a reversing entry on May 1 creates a credit balance in the account. The credit balance is offset by the May 10 debit entry, and the account balance then shows current period expenses.

The net effect of both journal entries have the same overall effect. Wages payable is zeroed out and wages expense is increased by $250. Making the reversing entry at the beginning of the period just allows the accountant to forget about the adjusting journal entries made in the prior year and go on accounting for the current year like normal.

If you were to forget to reverse the expense in the second example, the accounting records would show a $20,000 expense in January and another $20,000 expense in February, where the February amount is erroneous. The key indicator of this problem will be an accrued liability of $20,000 that the accounting staff should locate if it is periodically examining the contents of the company’s liability accounts. At the beginning of new accounting period, accountant reverses all adjusting entries which record at the end of previous period. And subsequently, they just record transactions normally, it prevents any confusion regarding double booking. 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.

The reversing entry typically occurs at the beginning of an accounting period. It is commonly used in situations when either revenue or expenses were accrued in the preceding period, and the accountant does not want the accruals to remain in the accounting system for another period. Reversing entries are prepared and posted to the ledger on the first day of the succeeding accounting period, even though they are the last step in the accounting cycle.

Understanding Accounting: Definition and Importance

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. At the end of 2022, Service Revenue will again be checked to see if there is any unearned portion and if an adjusting entry is necessary. The payroll accrual is $1,500, which accounts for three days of wages for two employees ($250 per workday x 2 employees x 3 days). If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. While you might have been well-intentioned in deleting incorrect journal entries, it’s better to lay your cards out to auditors by showing them your erroneous and corrective journal entries.

• Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• So, reversing entries are recorded at the start of the next period and these newly created accounts are reversed to cancel out the adjusting entries effect.
• To avoid the need for a compound entry, Mr. Green may choose to reverse the April 30 adjustment for accrued wages when the May accounting period begins.
• On the first day of the next accounting period, they may prepare reversing entries that clear the adjusting entries.
• Accountants must record only $ 1,000 as they already accrue $ 5,000 in the prior year.
• Reversing entries work to clear out any accruals that you do not want reflected in the new accounting period.