Please teach me this!!?

Question

I'm having difficulty understanding the what and why of reversing entries. Is there a simpler example that someone can use to explain? The book states, "They are recorded in response to accrued assets and accrued liabilities that were created by adjusting entries at the end of a reporting period." So, are they only used on accrued assets and liabilities, not on expenses or revenues? Also, how do I spot when reversing entries are needed?

Answer 1

Well, when you reverse accrued assets and accrued liabilities, your corresponding entries would be to revenues and expenses, isn't it?

The why of reversing entries is harder to explain. Let's try a simple example. Let's say you haven't received your Dec utilities bill and you need to close your books and Nov's bill was for $556. So you make an estimation for Dec and you make an adjusting entry for $500:
Dr Utilities expense $500
Cr Utilities payable $500

On Jan 15 you receive and pay the Dec bill and it's actually for $568. You have 2 ways of going about it. One way is to take up the difference:
Dr Utilities expense $68
Dr Utilities payable $500
Cr Cash $568
This method requires tracking of what you've previously accrued and taking up only the difference.

The 2nd method is to reverse all accrued items the moment you commence the new year. So in our example, on Jan 1, you bring forward all the balance sheet items of Dec 31, including our accrual entry. Immediately after that, you reverse all the accrued items, so you'd:
Dr Utilities payable $500
Cr Utilities expense $500
This has the effect of not having made the accrual, cos the utilities payable a/c now has a 0 balance.

Then on Jan 15 when you pay the $568, you simply post the whole amt from the cash book or journal:
Dr Utilities expense $568
Cr Cash $568
Some prefer this method cos it does not require tracking of how much has been accrued before.

The net effect is the same. The utilities expense a/c by Jan 15 has a balance of $68. It's a matter of preference.

How do you spot when reversing entries are needed? You don't "spot" them. Hopefully, you would have been the person who made them in the first place, so you just reverse them all at the beginning of the next yr. Othewise, look thru all the adjusting entries at the end of last yr and read the explanations, and pick up all those that are accrual entries.