Reversing Entries at the Start of a Period

Why Reverse Selected Accruals?

An adjusting entry at period-end records revenue earned or an expense incurred before the related cash receipt or payment. For example, wages earned by employees but not yet paid are an expense of the period in which they were earned, even if payroll is issued later. The adjustment recognizes the expense and the associated liability in the correct period.

At the beginning of the next period, an entity may choose to make a reversing entry: an entry that exactly reverses a selected period-end adjusting entry. This optional bookkeeping step can simplify the later cash or invoice entry. It does not change the amount of the prior period’s expense or revenue in the financial statements. Reversing entries are used selectively; they are not a replacement for making the required period-end adjustments.

Definition: A reversing entry is an entry made on the first day of a new accounting period that uses the same accounts and amounts as a selected adjusting entry, but switches the debit and credit. For an accrued expense, the period-end adjustment debits an expense and credits a payable; the reversing entry debits the payable and credits the expense.

The accrual and its reversal must refer to the same amount. After the reversal, the payable from that accrual is cleared, while the expense account temporarily has a credit balance for that amount. When the entity later records the full cash payment as an expense, that credit offsets the part of the payment that belonged to the prior period. The result is that each period’s expense reflects the service or benefit received in that period.

How the Entries Fit Together

Assume a business closes its books on December 31. It has incurred an expense by that date but will pay it in January. The period-end adjustment recognizes the December expense and liability. If the business reverses the adjustment on January 1, it can record the later full payment as a debit to the expense account and a credit to cash. The reversal prevents the December portion from being counted again as January expense.

\begin{aligned} \text{December 31 adjustment:}&\quad \text{Dr Expense},\ \text{Cr Payable}\\ \text{January 1 reversal:}&\quad \text{Dr Payable},\ \text{Cr Expense}\\ \text{Later payment:}&\quad \text{Dr Expense},\ \text{Cr Cash} \end{aligned}

With the nonreversing method, the entity leaves the payable in place. When it pays, it debits the payable for the amount accrued at December 31 and debits the expense only for the portion attributable to the new period. Both methods can produce the same correctly classified balances and period expenses. The reversing method is a bookkeeping convenience; it does not make a different accounting basis appropriate.

Accrue at period-end.
Record the expense incurred or revenue earned by the reporting date, even if cash has not yet moved.

Choose whether to reverse.
If reversing, make the exact opposite entry on the first day of the next period. If not reversing, retain the accrued balance for settlement.

Record the later transaction.
With a reversal, record the full payment or receipt in the relevant expense or revenue account. Without one, apply the accrued portion to the payable or receivable and record only the remainder as current-period activity.

Check balances and period totals.
Confirm that the prior-period accrual is not counted twice and that the liability or receivable is cleared when settled.

Worked Applications

Worked Example: Accrued Wages and the First Payroll of January

A firm pays employees every Friday at a total rate of $1,800 per workday. December 31 falls on a Tuesday. Employees worked Monday and Tuesday, December 30 and 31, but those two days will be included in the payroll paid Friday, January 3. Assume there are no holidays or other payroll adjustments. Find the December accrual and show the January entries using both methods.

Method: accrue the days worked by year-end, then compare reversing and nonreversing settlement. Two workdays were completed in December, so the December wage expense is $2 \times \$1{,}800 = \$3{,}600$. The five-day payroll paid January 3 is $5 \times \$1{,}800 = \$9{,}000$. Of that payment, three workdays, or $3 \times \$1{,}800 = \$5{,}400$, relate to January.

December 31 adjustment, under either method: Debit Wages Expense $3,600 and credit Wages Payable $3,600. December therefore includes $3,600 of wage expense, and the liability is $3,600 at year-end.

Reversing method: On January 1, debit Wages Payable $3,600 and credit Wages Expense $3,600. On January 3, record the full payroll: debit Wages Expense $9,000 and credit Cash $9,000. January’s net wage expense from these entries is $\$9{,}000-\$3{,}600=\$5{,}400$.

Nonreversing method: Leave Wages Payable at $3,600. On January 3, debit Wages Payable $3,600 and Wages Expense $5,400, then credit Cash $9,000. January expense is again $5,400, and the payable is cleared.

Check: December expense of $3,600 plus January expense of $5,400 equals the total payroll of $9,000. Under either method, the January 3 cash credit is $9,000 and Wages Payable is zero after payment. The common mistake is to record the full $9,000 as January expense without first reversing the accrual or splitting the payment; that would count the $3,600 December wages twice across the two periods.

Worked Example: Accrued Interest on a Short-Term Note

On November 1, a business borrows $120,000 under a note bearing simple interest at an effective annual rate of 8%. Interest is paid every three months, with the first payment due January 31 for the period November 1 through January 31. Assume interest accrues evenly by month, with no compounding or fees. Show the December 31 adjustment and the January entries under both methods.

Method: calculate the amount earned by the lender in each period, then compare the entries. The monthly interest is $\$120{,}000 \times 0.08 \div 12 = \$800$. Two months of interest have accrued by December 31, so the year-end adjustment is $\$800 \times 2 = \$1{,}600$. The full three-month payment due January 31 is $\$800 \times 3 = \$2{,}400$; January’s own interest is $800.

December 31 adjustment, under either method: Debit Interest Expense $1,600 and credit Interest Payable $1,600.

Reversing method: On January 1, debit Interest Payable $1,600 and credit Interest Expense $1,600. On January 31, debit Interest Expense $2,400 and credit Cash $2,400. Net January interest expense is $\$2{,}400-\$1{,}600=\$800$, and Interest Payable is zero.

Nonreversing method: On January 31, debit Interest Payable $1,600 and Interest Expense $800, then credit Cash $2,400. January expense is $800, and Interest Payable is zero.

Check: Total interest expense across November, December, and January is $\$1{,}600+\$800=\$2{,}400$, equal to the payment. The common mistake is to treat the full January payment as January expense under the nonreversing method; $1,600 of it settles the prior-period liability.

Worked Example: An Invoice Exceeds the Accrued Estimate

A business estimates that $900 of December cleaning services have been received but not invoiced by December 31. It records that accrual and reverses it on January 1. On January 10, it receives an invoice for $1,050 covering only those December services and pays it immediately. Assume the invoice is accurate and there are no January cleaning services in this transaction. Show the entries and explain the effect of the estimate difference.

Method: record the estimate, reverse it, then record the actual invoice; separately identify the difference. At December 31, debit Cleaning Expense $900 and credit Cleaning Payable $900. This recognizes the estimate in December.

On January 1, reverse the entry: debit Cleaning Payable $900 and credit Cleaning Expense $900. On January 10, record the invoice and payment: debit Cleaning Expense $1,050 and credit Cash $1,050. Net January expense is $\$1{,}050-\$900=\$150$. The $150 is the amount by which the invoice exceeds the December estimate.

Under the nonreversing method, leave the $900 payable in place. On January 10, debit Cleaning Payable $900 and Cleaning Expense $150, then credit Cash $1,050. January expense is also $150, cash decreases by $1,050, and the payable is cleared.

Check: Across the two periods, expense totals $\$900+\$150=\$1{,}050$, the invoice amount. The January credit to the expense account under the reversing method is not a correction of the December estimate; it is the mechanical offset that makes the January expense reflect the $150 difference. If the $900 estimate was materially wrong, the reversing entry alone does not repair the estimate or change the fact that December reported $900.

Why the Two Methods Agree

The core reason is that a reversing entry cancels the prior-period payable while placing an equal credit in the expense account for the new period. When the full cash payment is later debited to expense, the credit offsets the prior-period portion. The nonreversing approach achieves the same allocation by debiting the payable directly and charging only the new-period portion to expense.

\begin{aligned} \text{Reversing method: January expense} &= \text{full payment} - \text{reversed accrual},\\ \text{Nonreversing method: January expense} &= \text{full payment} - \text{prior-period payable}. \end{aligned}

When the reversal equals the accrued payable, the two January expense amounts are equal. The entries also have equal debits and credits, so each entry preserves the accounting equation. The reversal does not remove the expense from the prior period: that expense was recognized before closing, and closing the temporary expense account does not undo the reported period result.

Key takeaway: Reverse an accrual only when the later transaction can be recorded cleanly using the full cash or invoice amount in the revenue or expense account. The reversal must exactly match the original adjustment. Verify the resulting period totals and confirm that the related payable or receivable is settled.

Common Traps and Practical Limits

Reversing an entry that was not an accrual. Reversing entries are commonly used for selected accrued revenues and expenses, not as a routine reversal of every period-end adjustment. An adjustment for depreciation, for example, is not ordinarily reversed just to simplify a later cash entry.
Reversing on the wrong date. The reversal is normally dated the first day of the new period. Dating it in the prior period could undo the required period-end accrual.
Reversing the wrong amount or accounts. A reversal switches the original adjustment’s debit and credit for the same amounts. It is not an estimate update or a fresh expense calculation.
Confusing a temporary ledger balance with the period’s final expense. The credit to expense from a reversal is followed by the later debit for the payment. Evaluate the net effect of both entries rather than interpreting the reversal alone.
Assuming a reversal fixes an inaccurate estimate. It only simplifies the later entry. If actual information shows the prior-period estimate was materially incorrect, the entity must consider the appropriate accounting treatment rather than relying on the reversal to correct it.

Check Your Understanding

For each situation, identify the relevant amount and determine the entries or period expense requested. Assume each reversal described is made on the first day of the new period.

A shop accrues $2,400 of December wages. In January it pays $6,000, of which $3,600 relates to January work. Under the reversing method, what is January’s net wage expense after the reversal and payment? (Answer: $3,600.)
A company has a $90,000 note at 6% simple annual interest. Interest is paid every six months, and the payment due February 1 covers August through January. The company accrues five months of interest at December 31 and reverses it January 1. What is the full payment, the accrual, and January’s net interest expense? (Answer: Payment $2,700; accrual $2,250; January expense $450.)
A December repair expense of $1,250 is accrued and reversed January 1. The January invoice for that December repair is $1,400 and is paid immediately. What is January’s net expense under the reversing method, and what is it under the nonreversing method? (Answer: $150 under either method.)
A business accrues $700 of December rent owed, reverses it January 1, then pays $2,100 on January 5 for rent covering December, January, and February equally. What January rent expense remains after the reversing entry? What payable remains after payment? (Answer: January expense $700; payable $0.)
A company records a $500 December utility accrual and reverses it January 1. The January invoice for the December usage is $460. After recording the invoice as an expense and payment, what is January’s net expense from these entries, and what does the $40 difference indicate? (Answer: A $40 credit to expense, or negative $40 net January expense; the invoice was $40 below the December estimate.)

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