Reversing Entries

Reversing entries are passed at the beginning of an accounting period as an optional step of accounting cycle to cancel the effect of previous period adjusting entries involving future payments or receipts of cash. The benefit of reversing those adjusting entries is that this eliminates the need to identify what part, if any, of a particular payment or receipt made or received in the period relates to the previous period expense or revenue.

When reversing entries are not made, the accountant needs to remember last period adjusting entries and account for any expense/revenue previously recognized relating to current period payments or receipts. This is done using compound journal entries.

Reversing entries are best explained using an example:

Example

Two of the adjusting entries recorded by a company on year ending Dec 31, 20X2 are shown below:

DateAccountDebitCredit
Dec 31Interest Expense$1,500
Interest Payable$1,500
Dec 31Rent Receivable$29,000
Rent Revenue$29,000

Interest was accrued during the months of November and December on loan of $100,000 obtained on Nov 1, 20X2. Interest is payable after every three months. Rent receivable is related to a building given on rent on Dec 1, 20X2. Rent is payable after every 2 months.

Pass the journal entries recording the actual payment of interest and receipt of rent first without reversing entries and then with reversing entries.

Solution

Interest Rate on Loan = (1,500 ÷ 2) × 12 / $100,000 = 9%
Total Interest Payment on Feb 1, 20X3 (a) = 9% × 3/12 × $100,000 = $2,250
Rent Payable on Feb 1 (b) = 29,000 × 2 = $58,000

Without Using Reversing Entries:

Under this method, each payment is apportioned between expense and payable and each receipt between a revenue and a receivable. Thus:

Interest Expense in 20X3 resulting from (a) = $2,250 − $1,500 = $750
Rent Expense in 20X3 resulting from (b) = $58,000 − $29,000 = $29,000

DateAccountDebitCredit
Feb 1Interest Expense$750
Interest Payable$1,500
Cash$2,250
Feb 1Cash$58,000
Rent Receivable$29,000
Rent Revenue$29,000

Using Reversing Entries:

This method involves two steps, first, the last period adjusting entries which involve future payments or receipts are reversed as shown below:

DateAccountDebitCredit
Jan 1Interest Payable$1,500
Interest Expense$1,500
Jan 1Rent Revenue$29,000
Rent Receivable$29,000

At the time of actual payment or receipt, a simple journal entry is used to record them without any regard to the part of the payment or receipt which may related to last period. Thus,

DateAccountDebitCredit
Feb 1Interest Expense$2,250
Cash$2,250
Feb 1Cash$58,000
Rent Revenue$58,000

Written by Irfanullah Jan