What are Reversals in Accounting? Definition & Implications

This reversing entry actually puts a negative balance in the expense. When the bill is actually paid in January, the bookkeeper must remember what is the difference between a general ledger and a general journal that the expense was already recorded in December. The current entry would be to debit the accrual expense account and debit cash.

If the accountant did not make a reversing entry at the beginning of the year, the accountant will have this entry upon collection of the income. The reversing entry, to be entered on April 1, would then be a debit to Accrued expenses for $200 and a credit to Advertising Expenses for the same amount. A company takes on a video project that will take 67 hours to complete. 33.5 of those hours will be completed in the last week of January, and the other 33.5 in the first week of February. The client will be billed upon completion of the project in February, so the 33.5 hours worked in January must be accrued in order to be in line with the revenue recognition principle.

They reduce the likelihood of accounting errors

At the beginning of the new accounting period, this adjusting expense would have to be reversed. The reversal entry would create a negative amount of $10,000 in the expense account. Note that the expense accounts of the previous period have already been closed out to the retained earnings. 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.

In this method of accounting, the reversing entries are used to ensure that the revenue and expense accounts are in balance. Without reversal entries, the balances in these accounts may not be accurate, which could lead to incorrect financial statements. The main purpose of reversing entries is to ensure that the revenue and expense accounts are in balance. Reversing journal entries take care of this, so the bookkeeper doesn’t have to make this weird entry. In other words, on January 1 the bookkeeper records a debit to credit to the expense account and a debit to the accrual account. Then the expense can be recorded as usual by debiting expense and crediting cash when the expense is paid in January.

Income Statement

Another option for reversing entries is to make a complex entry that accounts for the accrual amount when the actual expense or revenue arrives. An example of this would be a company that rented some video equipment from a vendor (to use for work with a client) for $150 per day, for a total of 10 days. The accrual entry would debit Equipment Rental and credit Accounts Payable (A/P) for that amount. A reversing entry would debit A/P and credit Equipment Rental for the same amount. If a reversing entry is NOT made at the beginning of the month, then a complex entry must be made when the full bill comes in for $1,500 in February. If this is the case, the entry would need to debit A/P for the $750 from January, debit Equipment Rental for the $750 from February, and credit Cash for the $1,500 payment made to satisfy the expense.

Reversing entries simplify the bookkeeping process and minimize errors that might come from overstating expenses and/or revenues if accruals are kept in and the actual entry is entered as normal. In theory, a reversing entry can be any journal entry that reverses a previous one. In practice, however, the term reversing entry is used for accrual reversals and the term correcting entry for anything that is meant to correct an error in a previous journal entry. This may include a reversal of an incorrect journal entry, but it is not a reversing entry for the purposes of this tutorial.

Under the accrual method of accounting, a business is to report all of the revenues (and related receivables) that it has earned during an accounting period. A business may have earned fees from having provided services to clients, but the accounting records do not yet contain the revenues or the receivables. If that is the case, an accrual-type adjusting entry must be made in order for the financial statements to report the revenues and the related receivables. Adjusting entries are the double entries made at the end of each accounting period. Accountants post adjusting entries to correct the trial balance before prepare financial statements. The entries will ensure that the financial statements prepared on an accrual basis in which income and expense are recognized.

What are Reversing Entries?

Now let’s look at how we would handle this situation using reversing entries. When you prepare the original accrued salary journal entry described above, you also prepare a reversing entry https://online-accounting.net/ at the same time. The reversing entry will generally be recorded on the first day of the succeeding month (in this case January 1) and will be the mirror image of the accrual entry.

• If the reversing entry is made, the May 10 payroll payment can be recorded with a simple entry that increases (debits) wages expense for $200 and decreases (credits) cash for $200.
• Under the accrual method of accounting, the amounts received in advance of being earned must be deferred to a liability account until they are earned.
• The P&L Statement from February 1 to February 7 will have an abnormal negative balance of -$10,000 in the Video Income Account.
• Reversing journal entries are the mirror image of the accrual they are reversing but are recorded at the beginning of the following month.
• The client will be billed upon completion of the project in February, so the 33.5 hours worked in January must be accrued in order to be in line with the revenue recognition principle.
• Therefore, there is a high chance of double-counting certain revenues and expenses.

The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. And, as we’ve seen in many Hollywood films, bad things happen when you try to mess with the past.

Adjusting Entries and Reversing Entries

Business owners use reversing entries to neutralize journal entries prepared in the previous accounting period. Reversing entries are used in accrual accounting, where revenue and expenses are recorded when earned and incurred and not only when cash is involved. Depreciation is an adjustment unlike the others discussed in this article.

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. In the next accounting period the business now has two options, either leave the adjusting entry as it is, or to make a reversing entry. If Paul does not reverse last year’s accrual, he must keep track of the adjusting journal entry when it comes time to make his payments.

Since he reversed the accrued wages, the payroll journal entry is for the entire amount paid to employees. The income method of adjusting and reversing deferred revenue begins by recording the full amount in period one as a revenue, then adjusting it over time as revenue is earned. It requires adjustments made over time as well, since only portions of a long-term asset’s cost can be recorded in each accounting period. Adjusting entries for unearned revenue under the liability method and prepaid expense under the asset method do not make sense to reverse. Adjusting entries for depreciation, bad debts and other allowances also are not reversed. Reversing entries are made at the beginning of the new accounting period to enable a smoother accounting process.

Suppose Mr. Green makes an adjusting entry at the end of April to account for $80 in unpaid wages. This adjustment involves an $80 debit to the wages expense account and an $80 credit to the wages payable account. Since most bookkeeping is done using accounting software nowadays, this process is largely automated as well. The accounting software will reverse this adjusting entry in the next accounting period so that the accountant does not have to remember to do this. Businesses also use reversing entries to delete erroneously recorded transactions.

A reversing entry is a journal entry made in an accounting period, which reverses selected entries made in the immediately preceding 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.