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.
Definition and Examples of Reversing Entries
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.
How Reversing Entries Work
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.
Types of Reversing Entries
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.