Reversing Entry

The purpose of a reversing entry is to reset all adjusting entries to zero prior to the next accounting cycle. These entries simplify subsequent accounting period transactions, since they will be recorded as if the adjustments never occurred.

Adjusting entries are needed to ensure revenues are matched with expenses in the current accounting period. The two most common entries involve:

• Prepaid Items: an expense that is recorded in advance of its actual consumption; part of the prepaid item may be used in the current period, while the unused portion would remain an asset of the business.

• Accruals: an expense incurred in the current period, but not yet invoiced by the provider or paid by the business.

As part of the accounting cycle, subsequent entries are needed to reverse the effects of an adjustment. When new or better cost / revenue information is obtained, these final entries are used to settle an account.

Company A has entered into a time and material agreement with Company B to restore a walk in center. During the last week in January, Company B provides an estimate of $75,000 to Company A for work through month end.

Since Company A has not yet received an invoice for the work, they accrue an expense of $75,000 in the month of January.

On February 1, the accrual reverses itself following the monthly financial close, providing a credit in the expense account. On February 15, Company A receives an invoice from Company B of $76,000 for the work completed in January.

Company A would then debit the expense account for $76,000, thereby booking a net expense of $76,000 (actual expense) - $75,000 (accrual), or $1,000.

accounting cycle, prepaid items, accrual accounting, adjusting entry, trial balance, financial close