Out With the Old and In With the New: Reversing Entries in Accounting
As you probably know by now, accounting is essential for any well-run and organized business or entity. Even if you don’t work in accounting in your business, it’s still important to have a general understanding of certain key concepts. One of those key concepts is reversing entries. Keep reading to find out more about them!
What Are Reversing Entries?
Reversing entries are accounting entries, typically, made at the beginning of a new year to reverse some kind of entry from the immediately preceding period. It’s used to reverse expenses or revenues that have been accrued.
Reversing Entry Example
In order to make this example clearer, let’s look at a couple of examples.
Let’s say you ordered raw materials from a supplier to make some product that you want to sell. You receive the raw materials, but you still haven’t gotten the invoice by the end of an accounting period, that would be recorded like this in a balance sheet:
Although the bill isn’t paid just yet, this is to clearly mark this invoice as a liability before the accounting period ends.
But we’re not finished yet, when the invoice arrives later you have to make another entry reversing the previous one we just did. That would look a little like this:
This offsets the expense from the last entry, effectively closing it.
Note: The only types of entries that can be reversed are:
- accrued income
- accrued expenses
- unearned revenue
- prepaid expense
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 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.
- Avoid likely accounting mistakes
- Make it easier for other people looking at the books
- In case of an audit
Why Is It Important?
As we stated before, getting rid of past entries, especially when those entries are expenses, is a key part of accounting entries. Accounting entries, reversing entries included, of course, are really important because they’re key in keeping your financial situation up to date. And the importance of keeping your financial records and situation updated is pretty self-explanatory, if you don’t then your company, besides for regulatory reasons, won’t be able to make sound and reliable decisions.