Definition: A reversing entry is an optional journal entry that is recorded at the beginning of an accounting period to undo the prior period’s adjusting entries. In other words, these entries cancel out or reverse the adjusting journal entries recorded at the end of the prior accounting period.
What Does Reversing Entry Mean?
The purpose of recording reversing entries is clear out the prepaid and accrual entries from the prior period, so that transactions in the current period can be recorded normally. Since GAAP and the accrual basis of accounting requires that revenues and expenses be matched in the periods in which they occur, accrual journal entries are recorded at the end of each period.
For example, if the utilities for each month are paid at the beginning of the next month, you would have used the utilities as of December 31, but you won’t have to pay for them until the next year. The matching principle states that we should recognize the expenses when they are incurred and match them to the revenues they help generate. In this case, the utilities expense should be recorded in December even if it is not paid until January. This expense is accrued by debiting utilities expense and crediting the accrued utilities account.
When the bill is actually paid in January, the bookkeeper must remember that the expense was already recorded in December. The current entry would be to debit the accrual expense account and debit cash.
Reversing journal entries take care of this, so the bookkeeper doesn’t have to make this weird entry. The reversing entry cancels out the adjusting enter by reversing it. In other words, on January 1 the bookkeeper records a debit to credit to the expense account and a debit to the accrual account. This reverses the prior period’s adjusting journal entry. Then the expense can be recorded as usual by debiting expense and crediting cash when the expense is paid in January.