Businesses of all sizes can sometimes find it challenging to manage proper attribution and adjustment of assets and liabilities for a given accounting period. The risk of double payments, miscalculated revenue, and inaccurate forecasts means you need a reliable method for making sure your revenue and expenses are not only accurately recorded, but attributed to the proper period.
Using reversing entries as part of the accounting cycle can help. As the final step taken during any given accounting period, they make it easier to avoid costly errors and make sure you’ve got an accurate snapshot of your accounts.
Reversing entries keep your accounts on track
You can think of reversing entries as a bit like time travel—except they help you account for past expenses and revenue without complicating the present. These entries are made at the end of the accounting period to simplify the next one. If (for example), your business accrued revenue (or an expense) in the previous fiscal month, but you aren’t being paid (or paying the invoice) until this month, you can create a reversing entry to connect the revenue or expense to when it occurred instead of when it was paid. In effect, these entries cancel out the prior year’s accrual.
Without reversing entries, you’ll need to account for whatever portion of the revenue or expense occurred in the previous period on its books, and the remainder on this year’s. Using this approach keeps you from inadvertently “doubling up” by recording the revenue or expense in both sets of books.
Not every business uses reversing entries; cash-only businesses and businesses that bill and receive payment within the same accounting period are generally exempt. But these journal entries are a powerful tool to have in your accounting kit if your business operates on an accrual basis and frequently deals with adjusting entries at the end of each accounting period.
You can think of reversing entries as a bit like time travel—except they help you account for past revenue and expenses without complicating the present.
When to use reversing entries
Does your business have accruals and prepayments on the books for the previous accounting period, and you plan to pay off or use them during the new one? Reversing entries ensure they’ll be processed properly and removed from the list of assets and liabilities for the current period.
Examples of reversing entries
To get a deeper understanding of how these entries work, it can be helpful to consider a few typical scenarios.
For example, let’s say your accounting year ends on December 31st. You order $17,000 worth of widgets from your supplier during the first week of December, and will be billed in January.
When you accrue the expense by placing your order, you create an entry that looks something like this:
In January, you create a reversing entry at the start of the new accounting period. The original $17,000 expense from the end of the previous accounting period remains in the income statement in December as part of the closing entries, and creates a negative $17,000 expense in January’s income statement:
The final step is completed when the supplier’s invoice arrives in January. You record a new entry to counterbalance the -$17,000 balance that (without this entry) would’ve shown up in your company’s January income statement, like so:
The net result (so to speak) is that the expense for the widgets shows up on your income statement for December—when you actually ordered the widgets—instead of January’s. Your accounting reporting period reflects when you incurred the expense, instead of when you were billed for it.
The process is largely identical for revenue, with a few necessary changes. If (again, for example) your company accrues $50,000 in revenue for December, but you won’t be billing the client until January, you would create a reversing entry at the beginning of January to reverse the original $50,000 revenue accrual.
In this example, the end result is reflected in an entry for $50,000 in revenue in December, when you actually accrued the revenue, and not January, when you billed for it.
Reversing entries aren’t just for period-end reconciliation, however. They can also make it easy to catch minor errors before they can snowball into major problems. If, for example, a $400 travel expense is incorrectly recorded as a $400 software purchase, you can simply create a reversing entry to remove the item from the wrong category (software) and assign it to the correct one (travel). This will ensure accuracy in your financial statements and balance sheet.
Move your business forward with reversing entries
For accrual-based businesses, reversing entries can reduce unwanted expenses and prevent wasted time and work-hours spent chasing errors. Better still, you can make the process even more convenient, and improve your efficiency further, by using a comprehensive procure-to-pay software package. With advanced features such as two- and three-way matching for every transaction, you can rest easy knowing your accounts are always up to date, accurate, and ready for forecasting, reporting, and auditing, month to month and year over year. When reversing entries and other accounting essentials are streamlined, you’ll have more time to focus on what matters most: building your business.