Why to record reversing entries? Is it necessary to record these entries? Will it affect accounting process? Ahhh many questions in mind…….. Don’t worry. In this article you get all your answers. So let’s start.
In the accounting cycle, recording of reversing entries is the last step. These are opposite of adjusting entries. Adjusting entries are made to adjust the unrecorded events while reversing entries are made to cancel out those adjusting entries accounts that are created to just support these adjustments. When making adjusting entries, you create some new accounts where no new event has actually taken place, these are made just to make accounts on accrual basis. So, reversing entries are recorded at the start of the next period and these newly created accounts are reversed to cancel out the adjusting entries effect.
Reversing entries in accounting records at the beginning of an accounting period to cancel out or reverse the effects of adjusting entries of preceding accounting period. According to the going concern accounting principle, previous year prepayments and accruals will be used or paid off in the following year. Thus, there is no need to record these as assets and liabilities.
- Made at the beginning of an accounting period
- Cancel out effect of adjusting entries
- Optional
- Opposite of adjusting entries
- Reduce chances of error
Procedure of Recording Reversing Entry
As the name suggest, reversing entry is recorded by reversing the accounts nature. All of the debits and credits accounts are recorded as contra debits and credits with the same amount to “nullifying” the accounting impact. In other words, the accounts with debit nature will be credited by the same amount in the reversing entries.
Rules to Follow
After making all financial statements, including income statement, balance sheet, cash flow statement and retained earnings statement, this is a time to record reversing entries for those adjusting entries that are actually not happened (no event has occurred). So, these are some tips you shouldc follow while making reversing entries.
Accounts | Debit or Credit | Pass reversing Entry |
Prepaid accounts | Debit Side (in adjusting entry) | Yes |
Receivable accounts | Debit Side (in adjusting entry) | Yes |
Payable accounts | Credit Side (in adjusting entry) | Yes |
Unearned accounts | Credit Side (in adjusting entry) | Yes |
Reversing entries are optional and it is the opposite of adjusting entries that are passed at the end of each accounting period. There is no need to reverse all the adjusting entries. Some of the adjusting entries that require reversing entry are listed below:
- Prepaid expense using expense method
Date | Particular | Debit | Credit |
xxx | Expense | xxxx | |
Prepaid Expense | xxxx |
- Unearned revenue using income method
Date | Particular | Debit | Credit |
xxx | Unearned Income | xxxx | |
Earned Income | xxxx |
- Accrued expense
Date | Particular | Debit | Credit |
xxx | Salaries Payable | xxxx | |
Salaries Expense | xxxx |
- Accrued income
Date | Particular | Debit | Credit |
xxx | Commission Income | xxxx | |
Commission Receivable | xxxx |
Example
Assume that XYZ Company will receive $3000 rent income of three months at the end of January 2021 starting from November 1, 2020. On December 31, 2020, the company will make an adjusting entry based on accrual accounting concept to record the two months accrued rent income. The adjusting entry for accrued rent income would be:
- Original adjusting entry
Date | Particular | Debit | Credit |
Dec 31, 2020 | Rent receivable | $2,000 | |
| Rent income | $2,000 |
- Reversing entry
To simplify the accounting process, the accountant will create the reversing entry in order to cancel out the adjusting entry and nullifying its accounting impact. The reversing entry would be:
Reversing entry
Date | Particular | Debit | Credit |
Jan 1, 2021 | Rent income | $2,000 | |
| Rent receivable | $2,000 |
At the end of January 2021, XYZ Company will receive rent income of $3,000 for the three months’ time duration and accountant will create a simple journal entry to record the transaction. The entry would be:
Simple journal entry
Date | Particular | Debit | Credit |
Jan 31, 2021 | Cash | $3,000 | |
| Rent income | $3,000 |
- How to Record Without Reversing Entry?
It is stated earlier that reversing entries are optional. Accountant can create compound journal entry for rent payable. But for this purpose, he will have to track the previous adjusting entries in his mind that will make the accounting process difficult for him. So, the compound journal entry at the time of rent collection would be:
Date | Particular | Debit | Credit |
Jan 31, 2021 | Cash | $3,000 | |
| Rent income Rent receivable | $1,000 $2,000 |
Benefits of Reversing Entries
- It helps to eliminate the chance of double counting of revenues or expenses.
- Reversing entries simplify the accounting process for accountant who wants to exclude preceding accounting period accruals in the next accounting period.
- It also facilitates more efficient handling of the actual invoices in the new accounting period.
Key Points
- Reversing entries in accounting records at the beginning of an accounting period to cancel out the adjusting entries of preceding accounting period.
- They are optional. These entries help to reduce the chances of error.
- Mostly reversing entries are made for making expenses and revenue accounts balanced.
