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Reversing entries, or reversing journal entries, are journal entries made at the beginning of an accounting period to reverse or cancel out adjusting journal entries made at the end of the previous accounting period. This is the last step in the accounting cycle.

Reversing entries are made because previous year accruals and prepayments will be paid off or used during the new year and no longer need to be recorded as liabilities and assets. These entries are optional depending on whether or not there are adjusting journal entries that need to be reversed.

Why are Reversal Entries Used?

Reversing entries are usually made to simplify bookkeeping in the new year. For example, if an accrued expense was recorded in the previous year, the bookkeeper or accountant can reverse this entry and account for the expense in the new year when it is paid. The reversing entry erases the prior year’s accrual and the bookkeeper doesn’t have to worry about it.

If the bookkeeper doesn’t reverse this accrual enter, he must remember the amount of expense that was previously recorded in the prior year’s adjusting entry and only account for the new portion of the expenses incurred. He can’t record the entire expense when it is paid because some of it was already recorded. He would be double counting the expense.

Example

It might be helpful to look at the accounting for both situations to see how difficult bookkeeping can be without recording the reversing entries. Let’s look at let’s go back to your accounting cycle example of Paul’s Guitar Shop.

In December, Paul accrued $250 of wages payable for the half of his employee’s pay period that was in December but wasn’t paid until January. This end of the year adjusting journal entry looked like this:

Accounting with the reversing entry:

Paul can reverse this wages accrual entry by debiting the wages payable account and crediting the wages expense account. This effectively cancels out the previous entry.

But wait, didn’t we zero out the wages expense account in last year’s closing entries? Yes, we did. This reversing entry actually puts a negative balance in the expense. You’ll see why in a second.

On January 7th, Paul pays his employee $500 for the two week pay period. Paul can then record the payment by debiting the wages expense account for $500 and crediting the cash account for the same amount.

Since the expense account had a negative balance of $250 in it from our reversing entry, the $500 payment entry will bring the balance up to positive $250– in other words, the half of the wages that were incurred in January.

See how easy that is? Once the reversing entry is made, you can simply record the payment entry just like any other payment entry.

Accounting without the reversing entry:

If Paul does not reverse last year’s accrual, he must keep track of the adjusting journal entry when it comes time to make his payments. Since half of the wages were expensed in December, Paul should only expense half of them in January.

On January 7th, Paul pays his employee $500 for the two week pay period. He would debit wages expense for $250, debit wages payable for $250, and credit cash for $500.

The net effect of both journal entries have the same overall effect. Cash is decreased by $250. Wages payable is zeroed out and wages expense is increased by $250. Making the reversing entry at the beginning of the period just allows the accountant to forget about the adjusting journal entries made in the prior year and go on accounting for the current year like normal.

As you can see from the T-Accounts above, both accounting method result in the same balances. The left set of T-Accounts are the accounting entries made with the reversing entry and the right T-Accounts are the entries made without the reversing entry.

Recording reversing entries is the final step in the accounting cycle. After these entries are made, the accountant can start the cycle over again with recording journal entries. This cycle repeats in the exact same format throughout the current year.

Post Closing Trial BalanceAccounting Cycle

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The post closing trial balance is a list of all accounts and their balances after the closing entries have been journalized and posted to the ledger. In other words, the post closing trial balance is a list of accounts or permanent accounts that still have balances after the closing entries have been made.

This accounts list is identical to the accounts presented on the balance sheet. This makes sense because all of the income statement accounts have been closed and no longer have a current balance. The purpose of preparing the post closing trial balance is verify that all temporary accounts have been closed properly and the total debits and credits in the accounting system equal after the closing entries have been made.

Format

An post closing trial balance is formatted the same as the other trial balances in the accounting cycle displaying in three columns: a column for account names, debits, and credits.

Since only balance sheet accounts are listed on this trial balance, they are presented in balance sheet order starting with assets, liabilities, and ending with equity.

As with the unadjusted and adjusted trial balances, both the debit and credit columns are calculated at the bottom of a trial balance. If these columns aren’t equal, the trial balance was prepared incorrectly or the closing entries weren’t transferred to the ledger accounts accurately.

As with all financial reports, trial balances are always prepared with a heading. Typically, the heading consists of three lines containing the company name, name of the trial balance, and date of the reporting period.

Preparation

Posting accounts to the post closing trial balance follows the exact same procedures as preparing the other trial balances. Each account balance is transferred from the ledger accounts to the trial balance. All accounts with debit balances are listed on the left column and all accounts with credit balances are listed on the right column.

The process is the same as the previous trial balances. Now the ledger accounts just have post closing entry totals.

Example

After Paul’s Guitar Shop posted its closing journal entries in the previous example, it can prepare this post closing trial balance.

Notice that this trial balance looks almost exactly like the Paul’s balance sheet except in trial balance format. This is because only balance sheet accounts are have balances after closing entries have been made.

Now that the post closing trial balance is prepared and checked for errors, Paul can start recording any necessary reversing entries before the start of the next accounting period.

Income Summary AccountReversing Entries

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The income summary account is a temporary account used to store income statement account balances, revenue and expense accounts, during the closing entry step of the accounting cycle. In other words, the income summary account is simply a placeholder for account balances at the end of the accounting period while closing entries are being made.

At the end of each accounting period, all of the temporary accounts are closed. You might have heard people call this “closing the books.” Temporary accounts like income and expenses accounts keep track of transactions for a specific period and get closed or reset at the end of the period. This way each accounting period starts with a zero balance in all the temporary accounts, so revenues and expenses are only recorded for current years.

How to Close an Account into Income Summary

There are two ways to close temporary accounts. You can either close these accounts directly to the retained earnings account or close them to the income summary account.

Closing temporary accounts to the income summary account does take an extra step, but it also provides and an audit trail showing the revenues, expenses, and net income for the year.

Once the temporary accounts are closed to the income summary account, the balances are held there until final closing entries are made. This provides a useful check for errors. Once all the temporary accounts are closed, the balance in the income summary account should be equal to the net income of the company for the year.

Then the income summary account is zeroed out and transfers its balance to the retained earnings (for corporations) or capital accounts (for partnerships). This transfers the income or loss from an income statement account to a balance sheet account. This is the only time that the income summary account is used. For the rest of the year, the income summary account maintains a zero balance.

Example

After Paul’s Guitar Shop prepares its closing entries, the income summary account has a balance equal to its net income for the year. This balance is then transferred to the retained earnings account in a journal entry like this.

After this entry is made, all temporary accounts, including the income summary account, should have a zero balance.

Now that Paul’s books are completely closed for the year, he can prepare the post closing trial balance and reopen his books with reversing entries in the next steps of the accounting cycle.

Closing EntriesPost Closing Trial Balance

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Closing entries, also called closing journal entries, are entries made at the end of an accounting period to zero out all temporary accounts and transfer their balances to permanent accounts. In other words, the temporary accounts are closed or reset at the end of the year. This is commonly referred to as closing the books.

Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period. For example, the revenues account records the amount of revenues earned during an accounting period—not during the life of the company. We don’t want the 2015 revenue account to show 2014 revenue numbers.

Permanent accounts are balance sheet accounts that track the activities that last longer than an accounting period. For example, a vehicle account is a fixed asset account that is recorded on the balance. The vehicle will provide benefits for the company in future years, so it is considered a permanent account.

At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. In other words, revenue, expense, and withdrawal accounts always have a zero balance at the start of the year because they are always closed at the end of the previous year. This concept is consistent with the matching principle.

Closing Entry Types

Temporary accounts can either be closed directly to the retained earnings account or to an intermediate account called the income summary account. The income summary account is then closed to the retained earnings account. Both ways have their advantages.

Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow. The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period.

Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again.

Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet.

Example

In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example.

There are three general closing entries that must be made.

Close all revenue and gain accounts

All of Paul’s revenue or income accounts are debited and credited to the income summary account. This resets the income accounts to zero and prepares them for the next year.

Remember that all revenue, sales, income, and gain accounts are closed in this entry. Paul’s business or has a few accounts to close.

Close all expense and loss accounts

All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary.

Close all dividend or withdrawal accounts

Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account. These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings.

Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income shown on Paul’s income statement. Now Paul must close the income summary account to retained earnings in the next step of the closing entries.

Accounting WorksheetIncome Summary Account

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An accounting worksheet is a tool used to help bookkeepers and accountants complete the accounting cycle and prepare year-end reports like unadjusted trial balances, adjusting journal entries, adjusted trial balances, and financial statements.

Format

The accounting worksheet is essentially a spreadsheet that tracks each step of the accounting cycle. The spreadsheet typically has five sets of columns that start with the unadjusted trial balance accounts and end with the financial statements. In other words, an accounting worksheet is basically a spreadsheet that shows all of the major steps in the accounting cycle side by side.

Each step lists its debits and credits with totals calculated at the bottom. Just like the trial balances, the work sheet also has a heading that consists of the company name, title of the report, and time period the report documents.

Example

Here is what Paul’s Guitar Shop’s year-end would look like in accounting worksheet format for the accounting cycle examples in this section.

As you can see, the worksheet lists all the trial balances and adjustments side by side. During the accounting cycle process, an accounting worksheet can be helpful to keep track of the different steps and reduce errors.

It can also be used for a analytical and summary tool to show how accounts were originally posted to the ledger and what adjustments were made before they were presented on the financial statements.

I suggest using the accounting worksheet for all your year-end accounting problems. It saves time and maintains accuracy in the process. Here is a downloadable excel version of this accounting worksheet template, so you can use it with your accounting homework.

Financial StatementsClosing Entries

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