What Are Reversing Entries & Why Are They Required?

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The objective of financial reporting consists of communicating the activities of the company during the period being reported. At the end of each accounting period, the company records accrual entries for each transaction that occurred and was not recorded during the period, such as revenue earned and not received. This allows the company to include all transactions when creating the financial statements for the period. Many accrual entries require the company to reverse the entry in the following month.

Definition

The process of reversing entries will back out certain accrual entries from the previous period. The company records the original entry in one period and reverses it the next period. The accrual entries that need reversing consist of those entries that affect automated processes, such as payroll or invoicing.

Automated Entries

Companies create automated entries to their financial records to record repeating transactions. "Repeating transactions" refers to events that occur on a regular basis, such as paying consultant fees. If the company pays consultant fees each month, it may create an automated process for recognizing this expense.

How They Work

The accountant starts the reversing entry by reviewing the original entry from the previous month. She identifies each account used and the dollar amount recorded for those accounts. She then writes up the reversing entry. She lists each account from the original entry. Then she lists the opposite dollar amount from the original entry. After recording each account and the amount, she records the entry in the company’s accounting system.

Examples

Common examples of reversing entries include wages or unbilled revenue. At the end of the month, employees work through the last day, but don’t receive their paychecks until the next month. The company records wages expense when it completes payroll the next month. The company records an accrual entry in the first month to recognize the labor expense. The company reverses the accrual entry in the second month to ensure that the payroll entry flows through smoothly.

Service businesses provide work for their customers through the end of the month and might not bill the customer until the following month. The company records the revenue earned through the billing process. In the first month, the company records an accrual entry to recognize the revenue. In the second month, the company reverses the accrual to ensure that the billing process flows.

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