What it means
At the end of a period, accountants record accruals for costs incurred but not yet invoiced, such as wages earned in the final days of December. Those accruals make the year-end figures right, but they create a problem in January when the full payment goes out and the bookkeeper naturally posts the whole amount as an expense.
A reversing entry solves that problem by removing the accrual on the first day of the new period. The expense account temporarily shows a negative balance, and when the full payment is posted a few days later, only the portion that genuinely belongs to the new period remains.
The point is to keep day-to-day bookkeeping simple. Without reversals, whoever processes the payment has to remember to split it between the accrual account and the expense account, which is exactly the kind of manual step that gets forgotten when someone is on leave.
Not every adjustment should be reversed. The convention is to reverse accrued expenses, accrued revenue and some prepayment entries, but never to reverse depreciation, bad debt provisions or inventory adjustments, because those are not followed by a single offsetting cash transaction.
Most accounting systems automate the process: you tick a box on the journal, name the reversal date, and the software posts the opposite entry on the first day of the next period. The nuance to watch is that a reversal posted into a period that has already been reported can change comparative figures, so timing and period locks matter.
In practice
Real-world examples.
Example
A logistics company accrues $15,000 of fuel costs at year end for deliveries made in the last week of December. The system reverses the accrual on 1 January, so when the fuel card statement of $46,000 arrives covering both periods, the team posts it in full and January still shows only its own $31,000 of cost.
Example
A consultancy accrues $40,000 of unbilled revenue for work completed in June but invoiced in July. The reversal on 1 July means the July invoice can be raised for the full $40,000 without anyone having to remember to credit the accrued income account manually.
Example
A manufacturer accrues $6,000 of estimated electricity for December. When the actual bill arrives at $6,400, the reversal has already cleared the estimate, so the difference of $400 simply lands in January's costs rather than requiring a fiddly correcting journal.
Think of it
“Reversing entries are like erasing a pencil mark you made as a placeholder. You made a note at period-end, and now you're erasing it.
Formula
Calculation
Expense recognised in the new period = Cash paid in the new period - Accrual reversed
A design agency's payroll period runs from the 20th of one month to the 19th of the next. At 31 December it accrues $8,000 of wages for the days already worked in December, debiting wages expense $8,000 and crediting accrued wages $8,000. On 1 January it posts a reversing entry: debit accrued wages $8,000, credit wages expense $8,000, leaving wages expense at -$8,000. When the full payroll of $20,000 is paid on 19 January, the bookkeeper simply debits wages expense $20,000 as normal. January wages expense is therefore $20,000 - $8,000 = $12,000, which is exactly the amount earned in January, and the accrued wages account is back to zero.Case study
Seen in the real world.
Ashcombe Foods is a fictional ready-meal producer, used here as an illustrative example. Its year-end accruals covered contract labour, utilities and haulage, totalling $180,000, and the finance manager did not use reversing entries because she preferred to control each release herself.
When she left in February, her replacement processed the January and February supplier invoices in the usual way. Nobody released the accruals, so costs were counted twice and the management accounts showed the company $180,000 worse off than it really was. The board delayed a hiring decision on the strength of those numbers.
The error was found during the March review and corrected. Ashcombe then set every routine accrual to auto-reverse on the first day of the following month, keeping manual releases only for a short list of unusual items that a second person signs off. The illustrative point is that reversing entries are less about theory and more about making the books resilient to staff turnover.
Watch out
Common mistakes.
- Reversing entries that should never be reversed, such as depreciation or a bad debt provision, which wipes out an adjustment that was meant to stay in the accounts.
- Forgetting to post the reversal, so the later payment is recorded in full on top of the accrual and expenses are overstated in the new period.
- Dating the reversal in the closed period rather than the first day of the new one, which changes figures that have already been reported to lenders or the board.
Questions
People also ask.
Are reversing entries required by accounting standards?
No, they are an optional bookkeeping convenience; the standards care about the final reported figures, not the route taken to reach them.
Which entries are normally reversed?
Accrued expenses, accrued revenue and prepayments recorded directly to expense are the usual candidates, because each is followed by a single cash transaction covering both periods.
Do reversing entries change annual profit?
No, over a full cycle they net to zero; they only affect how cleanly the amounts fall into the correct month.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%