How Do Reversing Accruals Work?
Reversing accruals cancel the prior month’s accruals. Accrual-based accounting matches revenue and expenses to the current accounting period. Accruals accumulate until an adjusting entry is made. According to "Intermediate Accounting," by Donald E. Kieso, Jerry J. Weygandt and Terry D. Warfield, reversing accruals simplify the accrual by eliminating the prior month’s accrual. In the event of an accrual error, reversing accruals eliminate the need to make adjusting entries because the original entry is canceled at the beginning of the next accounting period.
Reversing accruals are optional and can be implemented at any time because they do not affect the financial statements. Accruals can be used to match revenue, expenses and prepaid items to the current accounting period. Accruals cannot be made for depreciation or bad debt expense. Therefore, reversing accruals cannot be used for reversing depreciation or bad debt expenses.
Businesses record numerous accruals at month end. The entries can span several months and become confusing. Assume, for example, that a business has purchased supplies from a vendor but has not received invoices for several months. The accrual entry totals three months’ worth of invoices. The next month, an invoice is received and paid. The accountant will need to review the accrual, look at three invoices and make an adjusting entry to eliminate the paid invoice. If reversing accruals were used, the entries would be reversed and the accountant would simply accrue for outstanding invoice.
A business can implement an accrual process at any time because it does not affect the financial statements. Reversing accruals can be manual or automatic. A manual process would require entries to be made on the first day of the month. The majority of accounting software systems allow the accountant to “flag” the accrual as “reversing accrual” when it is posted. The system automatically reverses the entry on the first day of the next accounting period.
Reversing accruals benefit large corporations and the small business owner. They minimize the risk of double booking entries and save time by eliminating the need to research prior accrual history. The entries are simple because they are canceling a prior entry, so a junior staff member can complete the task.