What Are Reversing Entries?

Business owners should familiarize themselves with reversing entries, which can clear previously recorded transactions without erasing any financial data. Company C provides car rental service to customers and they record revenue base on invoice bills on a monthly basis. In Nov 202X, they sign a contract with a customer to rent the car for 2 months from 01 Dec 202X to 31 Jan 202X+1, the fee is $5,000 per month.

• If accountants using reversing entry, they should record two transactions.
• Hence, office equipment with a useful life of 5 years and no salvage value will mean monthly depreciation expense of 1/60 of the equipment’s cost.
• If the actual invoice is $18,000 the balance in Temp Service Expense will change from a credit balance of $18,000 to a balance of $0.
• This adjusting entry assures that the retailer’s income statement for the period ended December 31 will report the $18,000 expense and its balance sheet as of December 31 will report the $18,000 liability.

They just wait for the final invoice from the supplier and record the different amounts only. First, we can’t recognize the whole amount as revenue because we do not yet provide service to client. This unearn balance should be reclassed to revenue when we provide service to customer.

What Are Reversing Entries?

While initially recording an adjusting entry in the previous period, the accountant would “flag” the entry. The accounting software will reverse this adjusting entry in the next accounting period so that the accountant does not have to remember to do this. Most of the bookkeeping software such as QuickBooks have a module to Law Firm Accounting and Bookkeeping: Tips and Best Practices record revenue, expense and other routine transaction. However, the adjusting entries require accountants to manually selected chart accounts before posting into the system. If accountants do not understand the nature of transactions, it is highly likely to select the wrong accounts and it will impact financial statements.

For example, the service company who provide consulting service to client. At year-end, they must estimate the amount of work complete and recognize revenue. By making the above journal entry, we are making the Electric Expenses account to zero. The example above shows how we can record the electricity expense in the correct month with the help of a reversing entry.

The Accounting Cycle

Reversing entries are made on the very first day of the accounting period. Reversing entries exist to ensure you don’t have duplicate entries for your expense and revenue transactions, which are the greatest indicators of your business’ financial activity. Without reversing entries, your company’s books will look a lot more distorted than your actual performance.

For example, if an accrued expense was recorded in the previous year, the bookkeeper or accountant can reverse this entry and account for the expense in the new year when it is paid. The reversing entry erases the prior year’s accrual and the bookkeeper doesn’t have to worry about it. Reversing entries are made because previous year accruals and prepayments will be paid off or used during the new year and no longer need to be recorded as liabilities and assets. These entries are optional depending on whether or not there are adjusting journal entries that need to be reversed. At the beginning of the new accounting period, this adjusting expense would have to be reversed.

Bookkeeping Outline

As you saw in the examples we just showed, reversing entries are used to get rid of something that was leftover from the previous period. Having an outstanding balance, like an invoice, in this https://personal-accounting.org/accounting-for-startups-7-bookkeeping-tips-for/ case, isn’t good for a business. It can lead to miscalculations of your overall financial situation concerning assets and liabilities and lead you to make decisions based on faulty data.