QuickBooks will generate reversing entries with a click of a checkbox!

Year-End Accrued Expense Reversals

Article written by EricBank

While many businesses maintain their books on a cash basis, the vast majority perform accrued accounting, the method recommended under generally accepted accounting principles (GAAP). One consequence of the GAAP method for closing your books at year's end is to remove the balances from temporary accounts for income and expenses and distribute those balances to retained earnings, a permanent account that appears on the balance sheet. Under the GAAP matching principle, you must recognize expenses and income when incurred, not when you exchange money. To ensure that you book accruals in the correct periods while avoiding double counting, you make reversal entries from accrued expenses at the start of the new year to reverse year-end incurred expenses that haven't been billed.

Reversing Accrued Expenses

Your business might experience unpaid income and expenses at the end of the current accounting period. For instance, suppose in December you use $400 of electricity but the utility won't invoice you until January. You could choose to avoid reversal accounting by simply booking $400 as a debit to the utility expense account and a credit to A/P. But here's the rub: suppose someone tries to pay the utility invoice when your company receives it in January, unaware that it's already been booked. The expense would be double-counted, a potential problem you can avoid by using reversal entries.

At Year Close

If you want to use reversal entries at year close, first set up a liability account named accrued expenses. This account is different from other expense accounts because it doesn't enter retained earnings via the income statement at period close. In other words, use accrued expenses as if it was a balance sheet account, although it in fact never goes on the balance sheet. Its sole purpose is to carry a balance into the start of the new year. In our example, you would book the $400 electricity expense in December as a debit to utility expense and a credit to accrued expenses, thereby recognizing the expense in the current period.

Year-End Income Statement

You've followed GAAP by booking the expense in the current period and showing it on the year-end income statement as an operating expense. As you close the books, you will sweep your net income, reported at the bottom of the income statement, into retained earnings and then zero out all the temporary income and expense accounts, but not accrued expenses. You might use an intermediate temporary account, income summary, to transfer all your regular income and expense accounts and then update retained earnings with the income summary balance. In any event, you enter the new year with zero balances in your temporary accounts.

Reversal Entries

In January, you reverse the accrued expense transactions. For example, you would debit $400 to the accrued expense account and credit it to the utility account, creating a balance of negative $400. When you get the utility invoice in January, debit the utility account and credit A/P or cash for $400. This doesn't create a new expense, but it does return your utility account to a zero balance and it pays the bill. You can set up your accounting system to do this automatically.