To illustrate reversing entries, let's assume that a retailer uses a temporary help service from December 15 - 31. The temp agency will bill the retailer on January 10 and the retailer agrees to pay the invoice by January 15. If the retailer's accounting year ends on December 31, the retailer will make an accrual-type adjusting entry for the estimated amount. If the estimated amount is $18,000 the retailer will debit Temp Service Expense for $18,000 and will credit Accrued Expenses Payable for $18,000. This adjusting entry assures that the retailer's income statement and balance sheet as of December 31 will include the temp service expense and obligation.
On January 1, the retailer enters the following reversing entry: debit Accrued Expenses Payable for $18,000 and credit Temp Service Expense for $18,000. When the actual invoice arrives from the temp agency on January 11, the retailer can simply debit the invoice amount to Temp Service Expense. If the invoice is $18,000 the Temp Service Expense will show $0. (The credit from the reversing entry and the debit from the invoice entry.) Thanks to the reversing entry, the retailer did not have to stop and consider whether the invoice amount pertains to December or January.
If the invoice amount is $18,180 the entire amount is debited to Temp Service Expense and $180 will appear as a January expense. This insignificant amount is acceptable since the adjusting entry amount was an estimate.
Learn Bookkeeping: Gain unlimited access to our bookkeeping seminar videos, bookkeeping proficiency exams, bookkeeping cheat sheet, visual tutorials, and more when you upgrade to PRO.