Recording Reversing Entries

Reversing Entries are optional journal entries that are made at the beginning of the next accounting period to simplify the accounting process. These entries reverse an Adjusting Entry made at the end of the previous accounting period if the Adjusting Entry increased an asset or a liability account.

A review of last period's Adjusting Entries will allow us to see if Reversing Entries would simplify transactions for the new accounting period.





The first Adjusting Entry increased the Insurance Expense for January and decreased the Prepaid Insurance account by $200. Since the Insurance was not originally recorded in a nominal account, no reverse entry is necessary.

If Sunny Sunglasses Shop originally recorded the Prepaid Insurance in a nominal account, the transaction would appear as follows:





The first accounting journal entry recorded the initial Insurance purchase in the nominal expense account. Because the company issued statements for January, an Adjusting Entry was required to report the January portion of the Insurance in the Expense account. The Adjusting Entry created a balance in the Prepaid Insurance Account of $2,200, and decreased the Insurance Expense account to equal $200.

The Expense Account was closed, correctly reducing Net Income and Retained Earnings by $200 for January.

Since the company in this example initially recorded the insurance as an expense, the reverse entry reduces the balance in Prepaid Insurance to zero and brings the expense balance in February to $2,200. If the company originally records insurance in the expense account, a reversing entry maintains the consistency of the original entry.

When monthly statements are issued, this amount must be adjusted each month to report $200 and show the balance in Prepaid Insurance as of the current month. If the company waits to report the income at year end, no further adjustments would be needed for the year since the Insurance Expense correctly reported Insurance Expense for the year of $2,200, and the Prepaid Insurance Account equals zero.

Since Sunny Sunglasses did not report Insurance in a nominal account originally, but in Prepaid Insurance, only adjusting entries are required each month to report the correct amount of Insurance Expense ($200) and the current balance of Prepaid Insurance for the reporting period.

The Interest Expense was reported in January and represents an expense accrual. Oftentimes, a company will reverse expense accruals to simplify the reporting process for the next period. For example, Sunny Sunglasses Shop may make the following reverse entry at the beginning of February before making an interest payment:





Keeping in mind that the business closed the expense account in January, the reverse entry creates a balance of -$90 for interest expense as of February 1. When the company pays the interest it will debit Interest Expense and credit Cash. The expense account will correctly equal zero (credited for $90 in reversing entries, and debited for $90 when paid) since this amount was already expensed in January.

Conversely, the company can debit Interest Payable and Credit cash as payments are made, and not make any reversing entries.

Similarly, if the company pays the wages that were accrued in January for $817, a reverse entry may be made that debits Wages Payable and Credits Wage Expense as follows:





At the end of January the company entered an adjustment to accrue the Wage and Payroll Tax Expenses. The expense accounts were then closed, reducing Net Income and Retained Earnings by the amounts accrued at the end of January.

The Reversing Entry eliminates the Wage and Payroll Tax Payable account balances, and creates a negative balance in the expense accounts. When Sunny Sunglasses Shop pays the wages on Feb. 2, the expense accounts correctly total zero since this amount was already expensed in January.

Sunny Sunglasses Shop could just as easily debit the payable accounts and credit cash, and not enter any reversing entries at the beginning of the period.

The final adjusting entry for Bad Debt Expense adjusts the Accounts Receivable account, and no reverse entry is necessary.

Reversing Entries are not required but may help maintain consistency in the Accounting Cycle, and simplify bookkeeping. An easy to remember rule is that these entries may be made at the beginning of a new period if: End of period adjustments increased an asset account, such as Prepaid Insurance. End of period adjustments for expense accruals increased a liability account, such as Interest or Wages Payable.




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