Mastering Reversing Entries: Practical Examples and Effective Solutions

Unearned revenues occur when a company receives payment for services or goods to be provided in the future. If a company receives payment in December for services rendered in January, the revenue is initially recorded as unearned and then recognized in January. Observe that the above entry still recognized a salaries expense of $7,000 on January 15 which is the same amount of expense recognized when a reversing entry was made. This proves that the same results can be achieved whether or not a reversing entry was made so long as you are aware about the correct amount of salaries expense to be recognized when the actual salaries are paid. Considering that salaries expense normally has a debit balance, allowing a credit balance will make sense once the actual salaries are paid on January 15, 2023.

Similar to prepaid expenses, there are also two methods for recording deferred income, also called unearned income. If the reversing entry was not made at the beginning of 2024, then you still need to make sure to prepare an adjusting entry to recognize insurance expense for the expired portion on June 30, 2024. This entry still has the same result as in the case where you posted a reversing entry since it still recognizes $2,000 rent income for 2023. Using a reversing entry would simplify the work of the data entry personnel who doesn’t need to consider the impact of any previously-posted adjusting entry.

Definition of Reversing Entries

That’s why it’s an accounting faux pas to delete transactions in your accounting software. Business owners should familiarize themselves with reversing entries, which can clear previously recorded transactions without erasing any financial data. When the bill is actually paid in January, the bookkeeper must remember that the expense was already recorded in December. The current entry would be to debit the accrual expense account and debit cash. If you were to forget to reverse the expense in the second example, the accounting records would show a $20,000 expense in January and another $20,000 expense in February, where the February amount is erroneous. The key indicator of this problem will be an accrued liability of $20,000 that the accounting staff should locate if it is periodically examining the contents of the company’s liability accounts.

If Paul does not reverse last year’s accrual, he must keep track of the adjusting journal entry when it comes time to make his payments. Since half of the wages were expensed in December, Paul should only expense half of them in January. If the accountant did not make a reversing entry at the beginning reversing entries are optional of the year, the accountant will have this entry upon collection of the income. What was debited is now credited and what was credited is now debited. Adjusting entries for unearned revenue under the liability method and prepaid expense under the asset method do not make sense to reverse.

Accounting with the reversing entry:

It should be noted that whichever method is used, the financial statements for each month will be the same. In each case at the end of month 2, the balance on the wages expense account is 2,500, and the balance on the wages payable liability account is nil. So, these are some tips you shouldc follow while making reversing entries. 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. With automatic reversing entries, your accounting software will automatically make a journal entry at the end of the month and record a reverse entry at the start of the new month.

To illustrate, let’s assume that on July 1, 2023 you purchased a 12-month insurance coverage plan starting July 1 and paid an upfront fee of $60,000. Below we’ll discuss how to record reversing entries and which method it could be applied. 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.

Understanding Accounting: Definition and Importance

After the financial statements are prepared, the closing entries will transfer the balance in the account Temp Service Expense to an owner’s/stockholders’ equity account. As a result, the account Temp Service Expense will begin January with a zero balance. 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. As can be seen in the ledger accounts, the net effect is that a $50 interest expense will be realized in October, and the full $100 of interest will be paid to the holder of the note. After recording this entry, the prepaid insurance should already show a zero balance since the whole insurance plan has already expired. Adjusting entries often disrupts routine transactions, so they are simply reversed on the first day of the new period.