Q10: What are ‘reversing entries’?
As well as closing entries, the other thing we do to get ready for the next accounting period is to reverse some of the balance-day adjustments. The balance-day adjustments that we reverse are the accrual entries made that created temporary assets and liabilities accounts. So much of accrual accounting only exists on balance date and is not part of the transactions firms record day-to-day.
Some of the balance-day adjustments that we make at the end of an accounting period we reverse at the start of the next accounting period. These reversing entries are journal entries made on the first day of a new accounting period that close off, or remove, the temporary assets and liabilities accounts a firm sets up as balance-day adjustments at the end of an accounting period. We introduced accrual entries into a firm’s accounts at the end of an accounting period to help match the expected costs and benefits of economic activities in that period. On the first day of the next accounting period we remove these journal entries and bring the asset and liability ledger accounts back to the way they were before these balance-day adjustments were made. In other words, we undo the accruals we introduced to help make a firm’s financial statements for a period more meaningful or representative of what happened to a firm during the accounting period.