BUS103: Introduction to Financial Accounting

Adjusting entries often disrupts routine transactions, so they are simply reversed on the first day of the new period.

Learning Objective

• Describe why and how a reversing entry is made

Key Points

• Reversing entries are optional, and some firms do not perform them.
• A reversing entry reverses an adjusting entry exactly.
• Reversing entries are performed because they reduce errors and save time.
  

Terms

• credit
  an entry in the right hand column of an account; credits increase liability, income, and equity accounts and decrease asset and expense accounts
• debit
  an entry in the left hand column of an account to record a debt; debits increase asset and expense accounts and decrease liability, income, and equity accounts
  

Examples

• In the example of Highland Yoga, adjusting entries are made at the end of July and August. One such entry, at the end of July, is as follows: Expiration of insurance Insurance expense 200 Prepaid insurance 200 At the beginning of August, if Highland Yoga chooses to adopt reversing entries, such an entry would be as follows: Reversing of insurance 200 Prepaid insurance 200
  
  

Reversing Entries

Reversing entries are journal entries made at the beginning of each accounting period. The sole purpose of a reversing entry is to cancel out a specific adjusting entry made at the end of the prior period, but they are optional and not every company uses them. Most often, the entries reverse accrued revenues or expenses for the previous period. Some examples of reversing entries are salary or wages payable and interest payable.

How Reversing Entries Are Used

Reversing entries help prevent accountants and bookkeepers from double recording revenues or expenses. Reversing entries are most often used with accrual-type adjusting entries.

How a Reversing Entry Works

The goal of the reversing entry is to ensure that an expense or revenue is recorded in the proper period. For example, when a company takes out a loan. If the loan is issued on the sixteenth of month A with interest payable on the fifteenth of the next month (month B), each month should reflect only a portion of the interest expense. To get the expense correct in the general ledger, an adjusting entry is made at the end of the month A for half of the interest expense. This adjusting entry records months A's portion of the interest expense with a journal entry that debits interest expense and credits interest payable. At the beginning of the month B that expense is reversed via a reversing entry. The entry credits interest expense and debits interest payable. When the full amount of the interest is paid in month B, each month's books will show the proper allocation of the interest expense.

The General Ledger

Reversing entries prevent double recording expenses or revenues.