Reversing entries are the important journal entries in the accounting. It actually helps a lot in implementation of the accrual basis of accounting which requires the recording of expenses and revenue items in the month/ year to which they relate. No matter whether the payment is paid/ received or not.
In modern accounting systems, there is no need to pass the reversing entries. When you are passing a accrual journal entry, you just need to flag it as a reversing entry, so that upon the arrival of a date, software does the reversing entry itself without human involvement. Reversing entries are made on the very first day of the accounting period.
Example # 1
In order to make the concept of reversing entry more crystal clear, let’s take an example:
Electricity bill for every month comes after the end of the month, let’s say electricity bill of the month of December comes on January. Under this case, we are not aware of the amount of bill. But according to the accrual basis of accounting, we have to estimate it. Let’s suppose the estimated electricity bill amount is $5,000. We will pass on following adjusting entry on 31 Dec:
| Debit | Credit | |||
| Electricity Expenses | 5,000 | |||
| Accrued Electric Expenses | 5,000 | |||
Now, on the 1st January, we will pass on the following reversing entry:
| Debit | Credit | |||
| Accrued Electric Expenses | 5,000 | |||
| Electricity Expenses | 5,000 | |||
As you can see that the electricity expenses was recorded in the month of December over the basis of accrual accounting. On the 1st January, we reversed the entry which caused the negative amount in the Electricity Expenses ledger account. Later when we receive the Electricity Bill Invoice, we can make the entry as follows:
| Debit | Credit | |||
| Electricity Expenses | 5,000 | |||
| Accounts Payable | 5,000 | |||
By making the above journal entry, we are making the Electric Expenses account to zero. The example above shows how we can record the electricity expense in the correct month with the help of a reversing entry.
Example # 2
B Engineering is involved in the development of infrastructure and road. The following data is available regarding its financial year ended 31st Dec 2015:
- On 1st January, 2016 B ENGINEERING acquired a warehouse at a monthly rent of $800.
- B ENGINEERING has to pay employee’s wages amounting to $4,000 for December.
- On 31th December, B ENGINEERING provided services for constructing the road near the sea port. For rendering its services, it charged the customer $10,000.
- Electricity bill received on 31 Dec, 2017 amounting to $ 2,000.
- Revenue received from sale of scrap stock is $ 2,000. Payment has not received for this yet.
Required:
Pass the adjusting journal entries and corresponding reversing entries.
Solution
First we need to pass on the adjusting entries of the above transactions.
| Debit | Credit | |
| Rent expense | 800 | |
| Rent payable | 800 | |
| Being the rent of December recorded on accrual basis of accounting. | ||
| Payroll expense | 4,000 | |
| Accrued payroll | 4,000 | |
| Being the payroll of December recorded on accrual basis of accounting. | ||
| Accounts receivable | 10,000 | |
| Sales | 10,000 | |
| Being the revenue of December recorded on accrual basis of accounting. | ||
| Electricity expense | 2,000 | |
| Electricity bills payable | 2,000 | |
| Being the electric expense of December recorded on accrual basis of accounting. | ||
| Other receivable | 2,000 | |
| Other income | 2,000 | |
| Being the scrap sale income of December recorded on accrual basis of accounting. |
Now, it is the time to make reversing entries. These entries are passed on at the start of the new month which is January 2017 in our example.
| Debit | Credit | |
| Rent payable | 800 | |
| Rent expense | 800 | |
| Accrued payable | 4,000 | |
| Payroll expense | 4,000 | |
| Sales | 10,000 | |
| Accounts Receivable | 10,000 | |
| Electricity Bill Payable | 2,000 | |
| Electricity expense | 2,000 | |
| Other income | 2,000 | |
| Other receivable | 2,000 |
When the payment will be done in the month of January, we will debit relevant expense and credit the revenue item. This way, the expense and revenue accounts will become zero in balance.
Reversing entries are important journal entries that are passed at the start of the period related to previous period. Reversing entries is a simple concept that most of the student find it difficult to handle. Following problems and solutions will help you greatly in getting maximum marks in the examinations.
Reversing Entries Problem and Solutions
Sunil and Gupta are running a cosmetics business since 5 years. Following is the data of unadjusted trial balance received from their accounting records.
| Debit Balances | Credit Balances | ||
| Cash | Rs.40,000 | Accounts payable | Rs.85,000 |
| Accounts receivable | 350,000 | Sales revenue | 850,000 |
| Prepaid insurance | 40,000 | Purchase returns | 90,000 |
| Purchases | 690,000 | Capital | ? |
| Utility expense | 25,000 | ||
| Rent expense | 180,000 | ||
| Office equipment | 400,000 | ||
| Total | 1,725,000 | Total | 1,725,000 |
Data for Adjustment: (1) Prepaid insurance Rs.15,000. (2) Depreciation expense Rs.30,000. (3) Inventory ending Rs.50,000. (4) Unpaid salaries Rs.15,000. (6) Unrecorded sales Rs.50,000.
You being the management accountant of the business, are required to passing on necessary reversing entries.
Solution
Sunil and Gupta
Reversing Entries
For the Period Opening July 1, 202X
| Date | Particulars | Folio | Debit | Credit |
| (a) |
Salaries payable Salaries expense |
15,000 |
15,000 |
|
| (To reverse the salaries expense) |