Reversing Entries for Deferrals With 2 Worked Examples
Reversing entries for deferrals are optional journal entries dated the first day of a new period that exactly undo qualifying prior period-end adjustments. For deferrals, reverse only when the original payment was recorded as an expense or the customer advance was recorded as revenue. If cash first went to a prepaid asset or unearned revenue liability, don’t reverse.
Even then, the reversal is optional. It simply lets the bookkeeper keep recording routine purchases and customer receipts the usual way. So before you decide, look at the original entry that was paired with Cash.
Watch Professor Farhat. Compare the two ways to record supplies starting at 10:02.
Which deferrals qualify for reversing entries?
A deferral arises when cash changes hands before a benefit is used or before a service is provided. The amount still available to use is an asset. The part of a customer advance still owed in services is a liability. Those amounts must appear on the balance sheet at the reporting date whichever account the bookkeeper used when cash moved.
To decide whether to reverse, find the original account paired with Cash. The table uses four common starting points. Each row assumes the business made the necessary period-end adjustment.
| Original account | Period-end adjustment | Next period |
|---|---|---|
| Prepaid asset | Expense the portion used. | Carry the remaining asset forward. |
| Expense | Move the unused portion to an asset. | May reverse the unused portion into expense. |
| Unearned revenue liability | Recognize the portion earned. | Carry the remaining liability forward. |
| Revenue | Move the unearned portion to a liability. | May reverse that unearned portion into revenue. |
For the underlying adjustments, see our guide to deferral adjusting entries for prepaids and unearned revenue. New to the topic? Start with the four types of adjusting entries. For an additional explanation of why reversals are optional and can simplify routine recording, see the reversing entries chapter in Principles of Accounting.
Example 1: How do reversing entries work for unused supplies?
Hypothetical example. Birch Bindery begins December with no packing supplies. It pays $1,350 for book mailers. A physical count on December 31 shows $420 of unused mailers. December consumed $930. The first number to write on the balance sheet is the $420 still on the shelf.
When the purchase starts in Supplies
On purchase, debit Supplies $1,350 and credit Cash $1,350. On December 31, debit Supplies Expense $930 and credit Supplies $930 for mailers used. The asset now holds $420. Carry it into January and reduce it as the remaining supplies are consumed.
When the purchase starts in Supplies Expense
On purchase, debit Supplies Expense $1,350 and credit Cash $1,350. The expense account includes mailers that Birch still owns. On December 31, debit Supplies $420 and credit Supplies Expense $420. The adjustment leaves $930 of expense and records the same $420 asset as the first method.
If Birch uses reversals, on January 1 it debits Supplies Expense $420 and credits Supplies $420. This returns the opening mailers to the account used for routine purchases. It does not mean that someone used every mailer overnight. Birch must count its remaining supplies again before preparing the next financial statements.
Check January. Suppose Birch buys another $780 of mailers in January and has $300 on hand at month-end. After the reversal and purchase, Supplies Expense holds $1,200. Debit Supplies $300 and credit Supplies Expense $300 at month-end. January expense is $900, which also equals $420 beginning supplies plus $780 purchased less $300 ending supplies.
What if Birch skips the reversal?
Reversals are optional, so here is the same January without one. Supplies starts January at $420, and Supplies Expense starts at zero. Birch debits Supplies Expense $780 for the January purchase. At month-end, the count shows $300, so Supplies must drop by $120. Debit Supplies Expense $120 and credit Supplies $120.
January expense is $780 plus $120, or $900. That’s the same result as the reversal path. The only difference is that the bookkeeper had to remember the $420 opening balance.
| Step | With reversal | Without reversal |
|---|---|---|
| January 1 | Debit Supplies Expense $420; credit Supplies $420 | No entry |
| January purchase | Debit Supplies Expense $780; credit Cash or Accounts Payable $780 | Debit Supplies Expense $780; credit Cash or Accounts Payable $780 |
| January 31 adjustment | Debit Supplies $300; credit Supplies Expense $300 | Debit Supplies Expense $120; credit Supplies $120 |
| January Supplies Expense | $900 | $900 |
| Supplies on January 31 | $300 | $300 |
Example 2: How do reversing entries work for unearned revenue?
Hypothetical example. Kite Audio receives $2,400 in December to edit six episodes at $400 each. The customer accepts two episodes by December 31. Kite has earned $800 and still owes four edits worth $1,600.
Liability method. On receipt, debit Cash and credit Unearned Service Revenue for $2,400. At year-end, debit Unearned Service Revenue and credit Service Revenue for $800. The $1,600 liability carries forward. Under ASC 606, Revenue from Contracts with Customers, issued by the FASB, this liability is also called a contract liability. As Kite delivers each remaining episode, it can debit the liability and credit revenue for $400.
Revenue method. On receipt, debit Cash and credit Service Revenue for $2,400. At year-end, debit Service Revenue and credit Unearned Service Revenue for $1,600. If Kite reverses, it debits Unearned Service Revenue and credits Service Revenue for $1,600 on January 1. At the next reporting date, it must again defer the value of any undelivered episodes.
Suppose Kite completes only three episodes in January. One $400 edit is still owed. Debit Service Revenue $400 and credit Unearned Service Revenue $400 at January 31. January revenue is $1,200. Reversing the December adjustment did not give Kite the right to report all $1,600 as January earnings.
What if Kite skips the reversal? Then Unearned Service Revenue starts January at $1,600. At January 31, Kite has delivered three more episodes, so it debits Unearned Service Revenue $1,200 and credits Service Revenue $1,200. The liability drops to the $400 still owed, and January revenue is $1,200. That’s the same result as the reversal path.
Why aren’t depreciation and bad-debt adjustments reversed?
A depreciation adjustment builds the accumulated depreciation balance. A bad-debt adjustment under the allowance method updates the allowance for credit losses. Both balances carry forward to measure the related assets, and no routine January transaction will record the same amount again. A first-day reversal would leave a credit balance in the expense account and shrink the contra account, with nothing coming later to offset it. Leave these period-end adjustments in place.
An accrual raises a different question because the company has already earned revenue or incurred an expense before ordinary billing or payroll captures it. Compare the timing in the reversing entries guide with payroll and billing examples.
Key takeaways
- A reversing entry is optional and is dated the first day of the new period.
- For deferrals, the test is the original entry. Expense or revenue first: you may reverse. Prepaid asset or unearned revenue first: don’t reverse.
- Reverse the part that was moved to the balance sheet (the unused or unearned amount), not the part that was used or earned.
- Reversing doesn’t change net income, as long as the next period-end adjustment is made. Birch reports $900 of January supplies expense either way.
- After a reversal, still adjust at the next period-end based on what’s left.
- Don’t reverse depreciation or bad-debt adjustments.
Common mistakes with reversing entries for deferrals
- Reversing an asset-method adjustment. Suppose Birch had recorded the purchase in Supplies and then reversed its $930 December adjustment. January would open with $1,350 in Supplies and a $930 credit balance in Supplies Expense, even though only $420 of mailers are on the shelf.
- Reversing the wrong amount. Under the expense method, Birch reverses the $420 of unused mailers, not the $930 it used.
- Forgetting the next adjustment. After the reversal and the January purchase, Supplies Expense holds $1,200 and Supplies shows zero. Without the January 31 count adjustment, January expense would be overstated by $300 and the balance sheet would show no supplies.
- Dating the reversal on the last day of the old period. It belongs on the first day of the new period.
- Reversing depreciation or bad-debt adjustments. Those balances carry forward.
Accounting practice · 6 questions
Deferrals and Reversing Entries: Interactive Exercise
Practice identifying how deferrals are recorded, when they may be reversed, and why a company may initially use revenue or expense accounts.
Before you begin: Real accounts are balance sheet accounts, so for deferrals that means assets and liabilities. Nominal accounts are income statement accounts, meaning revenues and expenses. Recording a purchase as an asset helps track supplies and parts used over several periods. Recording routine purchases straight to expense is quicker for frequent buys that aren’t capital assets (long-lived items like equipment), as long as unused amounts are adjusted at period-end. Questions 4 and 6 use the Birch Bindery and Kite Audio examples above.
Choose one answer for each question, then select Check answers. Review the explanations and change your answers to try again.
Study notes: deferrals, nominal accounts, and reversing entries
- Usual recording: Deferrals are generally entered in real accounts, meaning assets and liabilities. The assumed approach records them as prepaid expense or unearned revenue.
- Reversing deferrals: Asset-first and liability-first recording generally makes reversals unnecessary. When the original entry used expense or revenue, the related period-end adjusting entry may be reversed at the start of the next period.
- Allocation across periods: The real-account approach is advantageous for items apportioned over several periods, such as supplies and parts inventories.
- Birch Bindery (Question 4): The $420 January 1 reversal represents unused mailers moved back into Supplies Expense so routine purchases can continue to be recorded in that account. It does not mean the mailers were consumed on January 1. A new period-end adjustment records the supplies still on hand.
- Consistency and efficiency: Using nominal accounts supports consistent, efficient recording, particularly when many such transactions occur during the year.
- Kite Audio (Question 6): One $400 episode remains undelivered at January 31. Debit Service Revenue $400 and credit Unearned Service Revenue $400 to restore that liability. January revenue is $1,200: the $1,600 reversal less the $400 still unearned.
Practice questions
1. Which amount should the company reverse?
A print shop charges a $900 ink purchase to expense and has $260 of ink left at year-end. Answer. The year-end adjustment debits Supplies and credits Supplies Expense for $260. The optional January 1 reversal debits Supplies Expense and credits Supplies for $260. The $640 used already belongs in the prior year.
2. Should the customer advance be reversed?
A studio originally credited a $3,000 deposit to Unearned Revenue. By year-end it had earned $1,200 and adjusted the liability. Answer. Carry the $1,800 liability forward. The studio started with the liability method, and this balance measures services it still owes.
3. How much liability must be restored?
A company reverses a $750 revenue-method deferral on July 1. It performs $500 of the work in July. Answer. At July 31, debit Service Revenue $250 and credit Unearned Revenue $250. July keeps $500 of earned revenue and shows the remaining obligation.
Frequently asked questions
When are reversing entries unnecessary for deferrals?
When the original entry used a prepaid asset or an unearned revenue liability. The period-end adjustment already leaves the right balance in that account, so you simply carry it forward. If the original entry used an expense or revenue account, the company may reverse the related adjustment on the first day of the next period. Either way, it still adjusts again before its next financial statements.
Do reversing entries change net income?
No. A reversal only changes which account the routine entries flow through. As long as the next period-end adjustment is made, the period’s expense or revenue is the same either way. Birch reports $900 of January supplies expense with or without the reversal, and Kite reports $1,200 of January revenue either way.
Are reversing entries required?
No. They’re an optional bookkeeping step. A company can skip them as long as it adjusts correctly at each period-end, and the financial statements come out the same.
Can I identify the method from the adjusted balance sheet alone?
No. Each method can produce the same ending asset or liability. Inspect the original purchase or receipt entry to see which method the company used.
What if all the supplies were used by year-end?
If the entire purchase was charged to expense and none remains, the expense already reflects consumption. There is no unused balance to defer and no related adjustment to reverse.
Which date belongs on the reversing entry?
Use the first day of the new accounting period. Dating the reversal on the old reporting date would cancel the adjustment needed to present the ending asset or liability.
About the author
Mansour Farhat, CPA, CIA, DBA, is the professor behind Farhat Lectures. He teaches the video lessons on this site for CPA, CMA, and EA candidates and accounting students. Learn more about Professor Farhat.
Learn with Farhat Lectures
Practice the accounting cycle with Professor Farhat’s lessons and sample exercises.
Explore the free sample course →
Responses