You should reverse an accrual entry when a specific cash transaction in the next period will settle it, and you should leave the entry alone when it reflects an estimate or a multi-period allocation. That is the whole rule for when to reverse accrual entries: accrued wages, accrued interest, and accrued revenue typically get reversed on the first day of the new period so the bookkeeper can record the incoming payment or receipt as an ordinary single-line entry; depreciation, amortization, and bad debt provisions stay put because no cash event is coming to clear them.
The One-Question Test
Before reversing anything, ask whether an identifiable cash transaction will land in the next period to settle the accrual. If yes, reverse. If no, don’t.
That question works because reversing entries exist for one operational reason: they let the next period’s cash transaction post as a clean, normal entry instead of a split transaction that requires someone to remember what was accrued at year-end. When no such cash event is coming, there is nothing to clean up for, and reversing would simply erase an adjustment the balance sheet still needs.
Reversing entries are optional under Generally Accepted Accounting Principles. An auditor will not flag you for skipping them. Their value is practical: fewer errors in routine processing and less manual analysis on every payment that touches a prior-period accrual.
Accruals You Should Reverse
These share a trait: a near-term cash event will naturally clear the temporary balance.
- Accrued expenses such as wages payable, interest payable, and utilities incurred but not yet billed, where the payment date is known or imminent.
- Accrued revenues where services have been performed or goods delivered and the invoice will go out and get paid in the next period.
A worked example makes the mechanics obvious. Suppose your company owes $1,500 in interest incurred during December, and on January 15 a single $2,000 payment will cover both the December portion and the January portion.
On December 31, the adjusting entry debits Interest Expense $1,500 and credits Interest Payable $1,500. December’s income statement now carries the right interest cost, and the balance sheet shows a $1,500 liability.
On January 1, the reversing entry debits Interest Payable $1,500 and credits Interest Expense $1,500. The liability is gone, and Interest Expense is sitting with a $1,500 credit balance. That looks strange in isolation. It is temporary and intentional.
On January 15, the bookkeeper records the payment the normal way: debit Interest Expense $2,000, credit Cash $2,000. The $2,000 debit offsets the $1,500 credit from the reversal, leaving a net $500 debit in January’s Interest Expense — exactly the interest that belongs to January.
Without the reversal, that same $2,000 payment has to be split: $1,500 against Interest Payable and $500 to Interest Expense. The bookkeeper has to know a prior-period accrual exists and look up the amount. Multiply that across hundreds of transactions and the error rate climbs.
Accruals to Leave in Place
Adjustments that allocate cost over time or rest on an estimate have no cash transaction waiting to clear them. Reversing them would undo work the books still need.
- Depreciation. The entry debits Depreciation Expense and credits Accumulated Depreciation. Accumulated Depreciation builds across the asset’s useful life; no payment ever settles it.
- Amortization. Same logic, applied to intangibles like patents or goodwill. The cost spreads across periods rather than being settled by a transaction.
- Bad debt expense. The entry estimates uncollectible accounts and credits an Allowance for Doubtful Accounts. It reflects a judgment, not an upcoming receipt or payment. Reversing it would wipe out a provision the balance sheet needs.
If the adjusting entry rests on an estimate or a multi-period allocation rather than a pending transaction, leave it alone.
Prepaids and Deferred Revenue Depend on How You Booked Them
Prepaid expenses and unearned revenue sit in a gray area. Whether to reverse depends entirely on how the original transaction was recorded.
Say your company paid $12,000 upfront for a year of insurance and recorded it as an asset: debit Prepaid Insurance, credit Cash. The period-end adjustment moves the used portion to expense: debit Insurance Expense, credit Prepaid Insurance. Do not reverse that. There is no future cash event to settle; you are gradually drawing down an asset you already paid for.
Flip the setup, and the answer flips. If the company recorded that same $12,000 payment directly as Insurance Expense and the period-end entry pulls the unused portion back into Prepaid Insurance, that adjustment can be reversed, because the next period’s ongoing expense recognition will handle the allocation naturally.
The same two-path logic applies to customer prepayments. If you recorded them as a liability (Deferred Revenue) and the periodic adjustment moves earned amounts to revenue, don’t reverse. If you initially recorded the prepayment as revenue and the adjustment defers the unearned portion, that adjustment is a candidate for reversal. The question is always the same: does a routine transaction next period need a clean slate to land correctly?
What Skipping a Needed Reversal Costs You
Forgetting a reversal does not corrupt your financial statements permanently, but it creates a trap for whoever processes the next cash transaction. The usual result is double-counting.
Suppose you accrued $3,000 in wages at the end of March and did not reverse on April 1. When April payroll runs, the bookkeeper records the full payroll as Wages Expense. The $3,000 that was already in March’s accrual now shows up again in April’s expense, and the $3,000 Wages Payable liability sits on the balance sheet with nothing to clear it.
The fix is not complicated, but it is manual. You identify the orphaned accrual, debit the liability, credit the expense for the accrued amount, and move on. In a small operation, it is a nuisance. In a shop processing hundreds of accruals a month, missed reversals can cascade into material misstatements that take real time to unwind.
Let the Software Do It, and Document the Policy
Most accounting platforms can reverse entries automatically. When you create an adjusting journal entry, a checkbox or toggle marks it for auto-reversal, and the system posts the mirror entry on the first day of the next period. Use that feature for every accrual that qualifies under the test above. The one thing to confirm is that the reversal date lines up with your period structure, since some systems default to the first day of the next period and others let you choose.
If you work with a manual system or software without the feature, build a checklist of every accrual entered at period-end and work through it on day one of the new period.
Consistency matters more than the method. A federal audit of the Highway Trust Fund traced a $94 million misstatement to inconsistent reversal practices across operating divisions: a prior-year accrual reversal landed in the wrong fiscal year, understating net costs and distorting opening balances. The same audit found four different methods in use for corrections and reversals, with no standard procedure and no process to assess how journal entries affected prior-year opening balances.1United States Department of Transportation – Federal Highway Administration. Material Weakness in Internal Control – Independent Auditors Report – Highway Trust Fund FY06 Decide which categories of accruals you reverse, write it down, and apply it the same way every close. Every reversing entry should trace back to its originating adjusting entry.
One Boundary: Reversals Are Not a Tax Timing Tool
Reversing entries are a bookkeeping convenience with no direct tax consequence. The IRS does not care whether you use them. What the IRS cares about is whether your accrual-basis deductions meet the requirements for the year you claim them.2Internal Revenue Service. Publication 538 Accounting Periods and Methods
An accrued liability is deductible in a given tax year only when the all-events test is met (both the fact and amount of the liability are established) and economic performance has occurred, which generally means the services have been provided, the property delivered, or the payment made, depending on the type of liability. A recurring item exception can let you deduct in the earlier year if the item is recurring, the all-events test is met during that year, and economic performance happens within 8½ months after year-end, provided the item is either immaterial or produces a better match against income.3Office of the Law Revision Counsel. 26 USC 461 General Rule for Taxable Year of Deduction
The point for the reversal question: deciding to reverse or not reverse a journal entry does not shift when a deduction belongs on your return. If you are using reversals to try to change deduction timing, you are using the wrong tool.