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:
Two of the adjusting entries recorded by a company on year ending Dec 31, 20X2 are shown below:
|Dec 31||Interest Expense||$1,500|
|Dec 31||Rent Receivable||$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.
Interest Rate on Loan
= (1,500 ÷ 2) × 12 / $100,000
Total Interest Payment on Feb 1, 20X3 (a)
= 9% × 3/12 × $100,000
Rent Payable on Feb 1 (b)
= 29,000 × 2
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
Rent Expense in 20X3 resulting from (b)
= $58,000 − $29,000
|Feb 1||Interest Expense||$750|
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:
|Jan 1||Interest Payable||$1,500|
|Jan 1||Rent Revenue||$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 relate to last period. Thus,
|Feb 1||Interest Expense||$2,250|
by Irfanullah Jan, ACCA and last modified on