5 Things to Know About Reversing Entries
Reversing entries exist to ensure you don’t have duplicate entries for your expense and revenue transactions, which are the greatest indicators of your business’ financial activity. Without reversing entries, your company’s books will look a lot more distorted than your actual performance. For example, if accounting doesn’t have those entries in place, you might end up paying your heating bill twice or thinking you earned twice as much revenue on a sale than you actually did. These inaccuracies can lead to many problems, such as misguided predictions for your next quarter or miscalculations of revenue. Here’s what you need to know so that you can implement reversing entries and avoid any problems.
1. How Duplication Occurs
How does this duplication happen in the first place? Assume you purchased $1,000 of software upgrades in one month, but don’t plan to pay for them until the next. Since most administrators rely on accrual accounting (in which transactions are recognized without any exchange of cash), that purchase has to be reflected in your records as evidence that a transaction still took place. The critical part is making sure that the purchase is eventually taken care of so accounting can avoid duplication.
2. Who Uses Reverse Entries
It doesn’t matter what type of business you have or how large your operation may be. If your transactions are bought in one accounting period and paid for in the next, your organization needs reversing entries to ensure that the purchase is on the books. Reversing entries are necessary only if you’re able to pay for an invoice in the same period or if you strictly pay cash on the spot for all of your purchases.
3. How the Process Works
Consider this situation: You’ve ordered new software that won’t arrive until January, but your quarter ends this month in December. To make sure this is accurately paid for and recorded, consider two stages. First, at the end of the December, your accountant will make the following entry to ensure the purchase is recorded for that month.
- Debit: Software Expense $1,000
- Credit: Accrued Software Expense $1,000
At the beginning of the next month, you reverse the entry to indicate the software purchase isn’t applicable for the new accounting period. It’s just a matter of switching the entries around so they will have zero balances for the new month.
- Debit: Accrued Software Expense $1,000
- Credit: Software Expense $1,000
Finally, when you get the invoice from the software company, it’s paid for and recorded in the following fashion:
- Debit: Software Expense $1,000
- Credit: Accounts Payable $1,000
At this point, you can also adjust depending on if there were any changes in pricing by the time you actually received the invoice.
4. Finding Mistakes With Reverse Entries
Accurately tracking purchase and payment cycles isn’t the only reason for reversing entries. They’re also helpful when pinpointing mistakes. For example, if someone fails to record a purchase properly, an order for office supplies could be mistaken for office furniture. Here’s what the recorded order would look like:
- Debit: Office Furniture $500
- Credit: Accounts Payable $500
By double checking this order, you can notice the error and input the right information into your budget sheets. Here’s how it looks when corrected:
- Debit: Accounts Payable $500
- Credit: Office Furniture $500
Finally, the accountant will record the transaction the way it was meant to be:
- Debit: Office Supplies $500
- Credit: Accounts Payable $500
5. Using Automation To Simplify
Your accountant can save time adjusting and reversing entries if your systems are automated. On much of the latest software like ours, you can program reversing entries ahead of time to increase the efficiency of these tasks. Some features enable you to flag entries where transactions are deemed reversible or where the adjusting entries are made at the end of the fiscal period. The next business day, automated systems create those reversing entries for you. If your company makes many purchases that involve invoicing at a later date, this feature is a huge time-saver.
Reversing entries aren’t compulsory, but if accuracy is top of mind, they can ensure your company’s financial activity is well-documented. Automated software can speed up the process once the accountant makes adjustments and flags any affected transactions. If you haven’t already, consider implementing reversing entries to ensure your expense and revenue transactions are accurate, easy to understand and reliable.
