Hello, in this presentation, we will take a look at the reversing entry related to payroll. In order to do this, we first need to think about the adjusting entry and then consider how we are going to reverse the adjusting entry and why do so. So this is going to be our adjusting entry we've looked at in the past where we had the debit to wages expense and the credit to wages payable. Why do we have the adjusting journal entry? We know that if the payroll happens sometime in the next time period, meaning after the cutoff date, it's very possible that a few days happen before the cutoff date. And we're then going to have to adjust for that recognizing the expense in the time period that it was earned.

So the adjusting process remember happens after the normal accounting cycle. We have the normal accounting process where we have invoices checks bills, then we do the adjusting process to be more on an accrual basis as of the end of the month or year end of the year in business. case. And then we are going to do that adjusting process to make the financial statements. payroll is one of those items that typically will need an adjustment. Why?

Because when we run the payroll cycle, we're always going to be thinking, Hey, we're just going to let the payroll cycle run on Whatever's easiest for the payroll cycle. We don't want to mess it up by trying to force it to fit within the cutoff date, because that makes payroll more complicated than it already is. So we're going to say, I will let you run however you run on the payroll process. If you just record the transaction, when you create the checks, possibly, then that's one way you can run this and then we'll just make adjustments at the end of the time period. So in this case, we're saying that payroll that's close to the cutoff date happened on January 4 of year two, and that means that probably some of it was over here before the cutoff date, meaning people worked before December 31, who were not paid until after the country.

Off date. And therefore, in order to be in accordance with the matching principle to record those expenses, we need to pull back what was earned into this time period. The way we're going to do that is our adjusting journal entry. So of course, we'd have to do some type of ratio and figure out how much had been earned before the cut off, then we're going to debit the wages expense, credit, wages payable, this is the adjusting entry. So wages payable going up, meaning we owe the employees this money. The only reason we owe it is just the short term time period have been whatever the the time period is, if we pay people weekly, bi weekly, semi monthly, or monthly, it just means that this will be paid when we pay them.

But there's that there's that time period over the cutoff date that we have to record here. Then we have the wages payable, wages payable or wages expense should say wages expense is increasing and we're recognizing that expense in the time period. That is has been incurred, that will decrease net income. So net income is revenue minus the expenses was at 88 680, then we increase the expense 2500, bringing the net income down to 86 180. That's our adjusting process. Now on the reversing process, we have this issue of this will mess up our payroll process.

And once again, we don't want to mess up the payroll process, it is possible for payroll to take into consideration our adjusting entry when they process the payroll. But that's going to complicate the payroll and it might be easier not to do that. And in not doing that would involve having a reversing entry. So this would be the normal payroll entry if the normal payroll wasn't taken into account. Our adjustment here was just to record their normal payroll, we're going to say that they process payroll as of the one for 2000 next to the second year. They process the payroll.

And we already had the adjusting entry here. So if they processed the entire payroll, then it would be overstated in terms of the wages payable. And we're assuming it's going to go into wages payable and then pay later. So we're going to debit wages expense, increasing the expense for the payroll, credit, wages payable, rather than cash. And then we'll credit cash after we pay that out. So we're going to increase wages payable, we're not taking into account here, the withholdings, which would of course complicate things a little bit more.

So we're just going to keep the simple journal entry to see the concept of the reversing entries. We can see up here in the wages payable then that if this was the entire wages payable that was recorded on this transaction, and we already had 2500 debt as part of this wages payable, then we've overstated the payable here by the 2500. So it It is possible for the wait for the accounting department to compensate for that, and understand that there's an adjusting entry and fix that. But usually the adjusting process and the accounting and the payroll process are wanting to be separate. So they often will not look at those things. And we in the adjusting department would want to fix that by reversing our adjusting entry.

We can also see that wages expenses down here, and we're recording the expense which would decrease net income. But this is the entire expense for the entire time period. And really, there's only four days that happened in this time period in this year. So this would be overstated in terms of the matching principle in terms of what actually happened in terms of what actually work was done. So if we see this side by side, we can see this a little bit more clearly. Here's our adjusting entry went from zero up by 2500 to 2500 at the end of our cutoff when we made the financial statements 1231 Then we had the wages expense, increasing the expense, decrease in net income.

Then, if we had the actual payroll being processed here, the payroll was processed, as of the first day of the next time period, wages payable is going up by the entire payroll. And it's going up too much by the 2500. The other side starts at zero on the wages expense. Why? Because all of this information has been closed out to the owner capital to the equity section when we start the new time period. And then the new time period is counting just this 12,500.

But it's overstated, because it's it's processing the entire payroll and we need to be processing just the portion of the four days related to the new year. The way we can solve this is to have a reversing entry. Now the reversing entry process is not going to be a perfect process. But logistically it works well. It works well for us to have the financial statements correct. Due to our adjusting process as of the end of the time period, and it works well for us to set up the process so that it will be correct by the end of the month, at least in the next time period.

So in order to do that, we're going to say that we're going to, we're going to want to have a reverse of the transaction as of the first day of the next time period. So we made the financial statements correct as of 1231 x one. Now we're going to reverse this as of one, one, x two, this journal entry should look very unnatural because it's it's decreasing or crediting wages expense, and debiting wages payable. And we typically never really credit an expense like the employees never pay us. We only pay the employees it only goes one way typically. But here we're doing the opposite.

And we're reversing just exactly what we did on the adjusting entry and what that does when we posted as of the first day of the next month, is it we'll close out the wages payable, bringing it back down to zero and then it will to record a credit to the wages expense, again very odd. And once we do this, it will actually have a negative to income income will go up net income is higher because of this because we have this negative expense. So that is actually not correct in terms of accrual basis. But once we process the payroll, it will work out. So if we process the payroll, then as of remember, that happened on January 4, then these two will cancel each other out. And that's going to be the idea of it.

So this time period between January 1 to January 4, our accrual process is not proper, it's wrong really. Because that you know, we have we don't have this recorded properly, but after this time period, it will be correct. And that's in alignment with kind of our our time period assumption where we're going to just basically chunk up the the time periods into months and years. And we're going to make the financial statements as proper as possible as of the end of those time periods. That's when the financial statements are at their best. If we look at the financial statements for January 2, then we'd have to recognize that there's a problem here.

So once we do this, if we post both of these, then we can see the wages payable if we reverse that brought it back down to zero. And then we said the wages expense was a credit here. And then we're going to do our normal journal entry, the normal journal entry for payroll, this is just normal payroll, they're not taking into account our reversing entry, and they're recording wages expense 12,500 going here. So we've got the wages expense nnedi. Now, here's our credit. Here's the debit, and it's recording the 10,000.

And that would be just the amount applied to the second year to 2000 x two, and this should be January 4 x two. So this is going to record everything as of the second year. So these two are going to cancel each other out and leave us with just the amount recorded in the second year. The rest of it, even though it's paid in the second year, is earned in the year prior. And we already recorded that in our adjusting journal entry. And then we got the wages payable, we're going to credit wages payable.

And once again, it's going to net out to, to the 10,000 of the journal entry, but given us the full 12,500 because that's what's actually paid or owed as of this time period. And then of course, we'll write the checks and we'll reduce the payroll payable the payable by 12,500 and reduce the cash