During the course of a company’s business month, accountants make several entries into the accounting system. Some of these entries occur as ledger entries called “journal entries,” made directly to the general ledger. Some of these entries, when entered in one month, must reverse in the next month to clear out the account. One area to which this applies is monthly accruals.
An entry that requires reversing includes amounts entered into the accounting system to allocate expenses that span two accounting periods. For instance, if an invoice for an interest-only loan payment is due each month on the 15th, only one-half of the entry applies to the current month, while the other half of the entry applies to the next month. To accommodate this transaction, the accountant would expense half of the amount in the current month and make an adjusting entry for the second half of the amount. At the beginning of the next month, the accountant would need to reverse the adjusting entry to clear the account. The advantage of using reversing entries is that it allows the accountant to reflect expenses in the period they occur.
Accountants create entries for expense items not received. For instance, if you billed a client for $500, but needed to pay a vendor $100 for completing the work for that invoice and didn’t receive the vendor invoice, you need to accrue for it. The purpose is to ensure that for the revenue generated, the expenses are recorded as well. For the month you billed the client $500, you would accrue an expense of $100 for the vendor, which requires a reversing entry in the next month. However, when you accrue and reverse entries, you cannot forget to make the reversing entry or your expense account will be overstated. A disadvantage of using reversing entries is the possibility that you will forget to make them.
Making reversing entries requires a system for tracking them to ensure they complete successfully. Without tracking reversing entries on a spreadsheet, you won’t know what to reverse in the next period. Accounting systems that require you to enter reversing entries manually require the accountant to do double work. For every entry made that requires reversal in the next period, the accountant must make two entries, one in each period. This can be a cumbersome task and requires tracking any errors, because the amounts entered in one period and reversed in the next must be the same to zero out.
Overstated or Understated Accounts
Another drawback to using reversing entries is that errors can overstate or understate the account. While accruals allow for an accountant to properly track incurred but not received income or expenses, forgetting to reverse the entry may end up in an overstated or understated amount in the account, because the reversing entry would be absent.
More Entries, More Errors
Using reversing entries doubles the work of the accountant, and the chance for errors increases when the manual work increases. A system that provides for the automatic reversing of accrued entries may be the most efficient, because the original entry must be made only once. Although the accountant would still review the reversing entries, she wouldn’t have to double her work.