What are reversing journal entries?
September 26, 2012
If you ever worked in an accounting department, you are probably familiar with reversing entries. However, for non-accountants reversing entries represent an accounting term which may sound technical and confusing. In this article we will talk about reversing entries and why they are used.
At the end of an accounting period (e.g., month, quarter, year), accountants prepare adjusting entries. Adjusting entries are part of accrual accounting under which all revenues and expenses must be matched (i.e., recorded in the same period) regardless of when the actual cash inflow or outflow takes place. Thus, adjusting entries only exist in accrual accounting and donít exist in cash accounting.
Adjusting entries may relate to expenses or revenues. Examples of adjusting entries related to expenses (also called accrual liabilities) include: payroll, rent, property taxes, shipping, and interest expense accruals. Examples of adjusting entries related to revenues (accrued assets) include: accrual for services provided by not invoiced, interest income accrual, and accrual for goods shipped but not invoiced. For more information about accrued liabilities and assets refer to article What is the meaning of accrued in accounting?
Adjusting entries serve the purpose of making sure all revenues and expenses are recorded in the correct period. When such entries are posted at the end of a period, they may distort the financial statements of the following accounting period (because a lot of accrued items self-correct during the following period). Thus, at the beginning of the next accounting period accountants post journal entries that are opposite to the adjusting entries posted at the end of the prior period. By doing so, accountants effectively reverse the adjusting entries from prior period and eliminate their impact on the current period financial statements. That is why such entries are called reversing entries.
Reversing entries are opposite to adjusting entries posted at the end of the prior accounting period. Reversing entries are normally posted at the beginning of the period following the period in which adjusting entries were posted. Reversing entries can be created manually or automatically by accounting software.
Even though reversing journal entries eliminate the impact of adjusting entries in the following period, they donít change anything in the period when adjusting entries are posted. So, for that period the financial statements will be correctly adjusted.