Reversing Entries - Part 2

In part 1, we had an introduction to reversing entries and discussed examples for accrued income and accrued expense. This part covers the two other types – unearned income and prepaid expense.

Reversing Entry for Unearned Income

If the income method is used in recording unearned income, reversing entries can be prepared. Take note that adjusting entries for unearned income recorded using the liability method are never reversed.

Example: ABC Company recorded customer advances amounting to $5,000 in December 1, 2014. The company uses the income method in recording unearned income.

Date
2014
Particulars Debit Credit
Dec 1 Cash 5,000.00  
    Service Revenue   5,000.00

At the end of 2014, the company rendered $2,000 worth of services. We need to set-up the unearned income of $3,000 and bring Service Revenue to its correct balance ($2,000). The adjusting entry would be:

Dec 1 Service Revenue 3,000.00  
    Unearned Revenue   3,000.00

At the beginning of 2015, the following reversing entry can be prepared:

Date
2015
Particulars Debit Credit
Jan 1 Unearned Revenue 3,000.00  
    Service Revenue   3,000.00

Notice that the adjusting entry is simple reversed.

At the end of 2015, Service Revenue will again be checked to see if there is any unearned portion and if an adjusting entry is necessary.

Reversing Entry for Prepaid Expense

If the expense method is used in recording prepaid expense, reversing entries can be prepared. Adjusting entries for prepaid expense under the asset method are not reversed.

Example: On December 1, 2014, ABC Company paid $7,500 of rent for 3 months starting December 1. The expense method was used in recording this transaction.

Date
2014
Particulars Debit Credit
Dec 1 Rent Expense 7,500.00  
    Cash   7,500.00

At the end of 2014, 1 month worth of rent has already expired. Prepaid Rent should be set-up for the remaining 2 months. The adjusting entry would be:

Dec 31 Prepaid Rent 5,000.00  
    Rent Expense   5,000.00

At the beginning of 2015, the following reversing entry can be prepared:

Date
2015
Particulars Debit Credit
Jan 1 Rent Expense 5,000.00  
    Prepaid Rent   5,000.00

Again, notice that the adjusting entry is simple reversed.

At the end of February, the entire rent paid has already expired. We do not need to make an entry here since we already prepared a reversing entry.

Nonetheless, Rent Expense will be reviewed at the end of the year. Rent Expense and all other expenses will be checked to see if there are any unexpired portions which will require adjusting entries.

Author's Notes

And there you have the four types of adjusting entries that can be reversed. We've covered all of them and provided examples to guide you. Again, if you are having a hard time understanding the process, don't worry. It requires some time and a little effort for the concepts to sink in. After all, the process will always be the same.

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