What Are Reversing Entries & Why Are They Required?
The accounting cycle is a complex process that requires precision, accuracy and an ability to follow standard procedures. There are many useful and time saving methods used during monthly closing processes and general ledger maintenance. Though reversing entries are not required under Generally Accepted Accounting Principles, they are a useful tool for reducing accounting errors. It is important to understand the purpose and benefit of these entries to determine if they can be helpful in your accounting process.
Reversing entries are journal entries that are created to reverse adjusting entries at the start of the next accounting cycle. These entries are often used to account for expenses on an accrual or deferred basis. For example, if your business incurs an expense for $1,800 during the last week of the month, but the invoice is not expected until the 15th of the following month, you need to accrue the expense in the month you incurred it. The reversal entry offsets the invoice when it is paid, keeping the expense in the proper month.
If you fail to reverse the accrual entry it will recognize the expense twice when the paid invoice posts to the ledger as an expense. This will cause an imbalance in the ledger. Reversing entries offset the expense in the month that it is physically paid, keeping the expense recognition accurate. Automatically-reversing entries are useful for helping you track expense payments.
Some reversing entries are created manually to reverse a transaction in the ledger. Reversing entries can be used when a ledger transaction posts incorrectly, or to adjust the balance of an accrual or prepaid account. You can post a manual reversing entry at any time during the month as needed to balance the ledger. For example, if you post a cash expense to the wrong line item on the income statement, you can reverse the entry by crediting the incorrect account and debiting the correct account.
Some general ledger software provides an option to create a journal entry that will automatically reverse without any additional effort on your part. Automatically-reversing journal entries are usually posted during the monthly closing cycle, and then will reverse automatically on the first day of the new accounting period. These are useful because they can help reduce accounting errors as a result of overlooking an entry. The important thing about automatically reversing entries is to be sure that the corresponding expense posts in the new month. Otherwise you will need to repeat the entry during the next closing cycle.