What Are the Cons of Using Reverse Entries?
Companies use accrual-based accounting in order to follow the matching principal of accounting, which means the company records expenses when incurred and revenues when earned, not necessarily when either is paid. While a company uses an adjusting entry at the end of each accounting to correct for any expenses or revenue not recorded or which need to be split between two accounting periods, it uses reversing entries at the beginning of the next accounting period to change it back in some cases. However, there are several cons to using this method.
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Reversing Entries
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At the end of an accounting period, most companies create financial statements in order for management to review. In the case of a public corporation, the Securities and Exchange Commission and the public review these documents, as well. Therefore, adjusting entries must be made to correct any journal entries that leave the books out of line with accrual-based accounting. The reversing entries to change these accounts back and avoid a double counting that might occur if the accountant fails to do so.
Under- or Overstatement of Liabilities or Assets
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For short periods between the date of the reversing entry and the date that a transaction actually occurs, there is an under- or overstatement of the liability or asset account on which the entry is made. For example, if the accountant makes an adjusting entry to wages payable in the first accounting period and then reverses it is the subsequent period, the liability account for wages payable and expense account for wage expense are understated. Correcting the account occurs once the pay period passes and the accountant eliminates the wages payable and the wage expense matches, as the full amount is paid to employees.
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More Journal Entries
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Reversing entries requires the bookkeeper or accountant to use several more journal entries each period. Instead, she could use a compound entry to eliminate the effects of the adjusting entry at the beginning of the subsequent period. Reversing entries do make it easier to begin with a clean slate, but require a good deal more work than a compound entry.
Chance for Human Error
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Reversing entries can increase the chance for human error. If the accountant or bookkeeper fails to make the appropriate reversing entry or fails to recognize that an adjusting entry was made, than the account these entries affect will be misstated. Often companies have more than one accountant, so it is not always easy to remember where changes have occurred. For example, in the above scenario with wages payable, if one accountant makes the reversing entry but another does not recognize this, the balance in the account could be wrong after his own entries for the period.
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