In part 1, we had an introduction to reversing entries and discussed examples for accrued income and accrued expense. In this part, we will cover the two other types of entries that can be reversed – unearned income and prepaid expense.
If the income method is used in recording unearned income, reversing entries can be prepared. Take note that we do not reverse adjusting entries for unearned income recorded using the liability method.
Example: ABC Company recorded customer advances amounting to $5,000 in December 1, 2021. The company used the income method in recording the adjusting entry for unearned income.
| Date 2021 |
Particulars | Debit | Credit | |
|---|---|---|---|---|
| Dec | 1 | Cash | 5,000.00 | |
| Service Revenue | 5,000.00 | |||
At the end of 2021, the company rendered $2,000 worth of services. We need to set-up the unearned income of $3,000 and bring Service Revenue to its correct balance ($2,000). The adjusting entry would be:
| Dec | 31 | Service Revenue | 3,000.00 | |
|---|---|---|---|---|
| Unearned Revenue | 3,000.00 |
At the beginning of 2022, the following reversing entry can be prepared:
| Date 2022 |
Particulars | Debit | Credit | |
|---|---|---|---|---|
| Jan | 1 | Unearned Revenue | 3,000.00 | |
| Service Revenue | 3,000.00 | |||
Notice that the adjusting entry is simple reversed.
At the end of 2022, Service Revenue will again be checked to see if there is any unearned portion and if an adjusting entry is necessary.
If the expense method is used in recording prepaid expense, reversing entries can be prepared. Adjusting entries for prepaid expense under the asset method are not reversed.
Example: On December 1, 2021, ABC Company paid $7,500 of rent for 3 months starting December 1. The expense method was used in recording this transaction.
| Date 2021 |
Particulars | Debit | Credit | |
|---|---|---|---|---|
| Dec | 1 | Rent Expense | 7,500.00 | |
| Cash | 7,500.00 | |||
At the end of 2021, 1 month worth of rent has already expired. Prepaid Rent should be set-up for the remaining 2 months. The adjusting entry would be:
| Dec | 31 | Prepaid Rent | 5,000.00 | |
|---|---|---|---|---|
| Rent Expense | 5,000.00 |
At the beginning of 2022, the following reversing entry can be prepared:
| Date 2022 |
Particulars | Debit | Credit | |
|---|---|---|---|---|
| Jan | 1 | Rent Expense | 5,000.00 | |
| Prepaid Rent | 5,000.00 | |||
Again, notice that the adjusting entry is simple reversed.
At the end of February, the entire rent paid has already expired. We do not need to make an entry here since we already prepared a reversing entry, i.e., we already recorded the Rent Expense of $5,000.
And there you have the four types of adjusting entries that can be reversed. We've covered all of them and provided examples to guide you. If you are having a hard time understanding the process, don't worry. It requires some time and a little effort for the concepts to sink in. Feel free to go over the material again when you need to.
Aside from accrued income and accrued expense, reversing entries may also be prepared for unearned income (only if it was initially recorded as income) and prepaid expense (only if it was initially recorded as expense).
The purpose of making reversing entries for them is the same – to facilitate a simpler bookkeeping process, and is especially helpful for companies that use a cash basis accounting system.
More chapters under Accounting Basics
