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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:
1. Adjusting entry for accrued income,
2. Adjusting entry for accrued expense,
3. Adjusting entry for unearned revenue using the income method, and
4. Adjusting entry for prepaid expense using the expense method.
Adjusting entries for unearned revenue under the liability method and for prepaid expense under
the asset method are never reversed. Adjusting entries for depreciation, bad debts and other allowances
are also never reversed.
Let us illustrate each of the above types.

Reversing Entry for Accrued Income


Example: ABC Company is to receive $3,000 interest income at the end of February 2015. It covers 3
months starting December 1, 2014. At the end of 2014, the accountant properly makes an adjusting entry
for one month's worth of accrued income.
Date
2014

Particulars

Dec 31 Interest Receivable


Interest Income

Debit

Credit

1,000.00
1,000.00

At the beginning of 2015, the accountant can prepare this reversing entry:

Date

Particulars

2015

Jan

1 Interest Income

Debit

Credit

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 2015 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 2015.
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 2015, covering a 3-month period starting
November 1, 2014. The entire amount is $6,000.
At the end of December 2014, the accountant properly prepares this adjusting entry for two months worth
of rent expense (Nov 1 to Dec 31):

Date

Particulars

2014

Dec 31 Rent Expense

Debit

Credit

4,000.00

Rent Payable

4,000.00

At the beginning of 2015, the accountant can prepare this reversing entry:
Date

Particulars

2015

Jan

1 Rent Payable

Debit

Credit

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 2015 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.