Reversing Entries

Reversing entries are made at the beginning of the new accounting period to enable a smoother accounting process.

This step is optional and is especially useful to companies that use the cash basis method.

In this step, adjusting entries made at the end of the previous accounting period are simply reversed, hence the term "reversing entries".

However, not all adjusting entries qualify for this step.

The following are the only types that can be reversed:

Adjusting entries for unearned revenue under the liability method and for prepaid expense under the asset method are not reversed. Adjusting entries for depreciation, bad debts and other allowances are also not reversed.

Let us illustrate each of the above.

Reversing Entry for Accrued Income

Example: ABC Company is to receive $3,000 interest income at the end of February 2014. It covers 3 months starting December 1, 2013. At the end of 2013, the accountant properly makes an adjusting entry for one month's worth of accrued income.

Date
2013
Particulars Debit Credit
Dec 31 Interest Receivable 1,000.00  
    Interest Income   1,000.00

At the beginning of 2014, the accountant can prepare this reversing entry:

Date
2014
Particulars Debit Credit
Jan 1 Interest Income 1,000.00  
    Interest Receivable   1,000.00

The adjusting entry is simply reversed. Debit what was credited and credit what was debited.

When the ABC Company receives the interest income at the end of February, the accountant will then prepare this journal entry:

Feb 28 Cash 3,000.00  
    Interest Income   3,000.00

Notice that Interest Income is credited for 3,000. Now you might be asking this: Under the concept of accrual, the interest income to be recognized in 2014 should be $2,000. Then why credit $3,000 Interest Income?

Very good. Well, in the reversing entry at the beginning of the period, Interest Income was already debited for $1,000. So if we combine them ($1,000 debit and 3,000 credit), then we'll end up with $2,000 Interest Income which is the correct amount to be recognized in 2014.

We said that reversing entries are optional. If the accountant did not make a reversing entry at the beginning of the year, the accountant will have this entry upon collection of the income.

Feb 28 Cash 3,000.00  
    Interest Receivable   1,000.00
    Interest Income   2,000.00

Note: Actually, if you combine the reversing entry and journal entry for collection. You'll come up with the journal entry above.

Reversing Entry for Accrued Expense

Example: ABC Company will pay rent at the end of January 2014, covering a 3-month period starting November 1, 2013. The entire amount is $6,000.

At the end of December 2013, the accountant properly prepares this adjusting entry for two months worth of rent expense (Nov 1 to Dec 31):

Date
2013
Particulars Debit Credit
Dec 31 Rent Expense 4,000.00  
    Rent Payable   4,000.00

At the beginning of 2014, the accountant can prepare this reversing entry:

Date
2014
Particulars Debit Credit
Jan 1 Rent Payable 4,000.00  
    Rent Expense   4,000.00

Again, notice that the adjusting entry is simply reversed.

When the company pays the entire rent, the accountant will then prepare this journal entry:

Jan 31 Rent Expense 6,000.00  
    Cash   6,000.00

In effect, Rent Expense for 2014 is $2,000 even if the accountant debits $6,000 upon payment. This is because of the reversing entry which includes a credit to Rent Expense for $4,000.

If the accountant did not make a reversing entry at the beginning of the year, the accountant will have this entry upon payment of the rent.

Jan 31 Rent Payable 4,000.00  
    Rent Expense 2,000.00  
    Cash   6,000.00

There you have the first two types of adjusting entries that can be reversed. If you are having trouble understanding the process, don't worry. It requires some time and a little effort for the concepts to sink in. In part 2, we'll take a look at the other two types.

Part 2: Reversing Entries for Unearned Income and Prepaid Expense

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