Bank Recons

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Topic list Syllabus reference

1 Bank statement and cash book E4(b)

2 The bank reconciliation E4(a), (c)-(f)

3 Worked examples E4(c)-(f)

Bank reconciliations

Introduction It is very likely that you will have had to do a bank reconciliation at work. If not, you will probably have done one on your own bank account without even being aware of it.

The first two sections of this chapter explain why we need a bank reconciliation, and the sort of differences that need to be reconciled. The third section takes you through some examples of increasing complexity.

PART E PREPARING A TRIAL BALANCE

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Study guide Intellectual level

E4 Bank reconciliations

(a) Understand the purpose of bank reconciliations 1

(b) Identify the main reasons for differences between the cash book and the bank statement

1

(c) Correct cash book errors and/or omissions 1

(d) Prepare bank reconciliation statements 1

(e) Derive bank statement and cash book balances from given information 1

(f) Identify the bank balance to be reported in the final accounts 1

Exam guide Bank reconciliations test your understanding of double entry. You are extremely likely to have a bank reconciliation question in the exam.

1 Bank statement and cash book

In theory, the entries appearing on a business's bank statement should be exactly the same as those in the business cash book. The balance shown by the bank statement should be the same as the cash book balance on the same date.

The cash book of a business is the record of how much cash the business believes that it has in the bank. In the same way, you yourself might keep a private record of how much money you think you have in your own personal account at your bank, perhaps by making a note in your cheque book of income received and the cheques you write. If you do keep such a record you will probably agree that when your bank sends you a bank statement from time to time the amount it shows as being the balance in your account is rarely exactly the amount that you have calculated for yourself as being your current balance.

Why might your own estimate of your bank balance be different from the amount shown on your bank statement? There are three common explanations.

(a) Error. Errors in calculation, or recording income and payments, are more likely to have been made by you than by the bank, but it is conceivable that the bank has made a mistake too.

(b) Bank charges or bank interest. The bank might deduct charges for interest on an overdraft or for its services, which you are not informed about until you receive the bank statement.

(c) Time differences

(i) There might be some cheques that you have received and paid into the bank, but which have not yet been 'cleared' and added to your account. So although your own records show that some cash has been added to your account, it has not yet been acknowledged by the bank - although it will be in a very short time when the cheque is eventually cleared.

(ii) Similarly, you might have made some payments by cheque, and reduced the balance in your account accordingly in the record that you keep, but the person who receives the cheque might not bank it for a while. Even when it is banked, it takes a day or two for the banks to process it and for the money to be deducted from your account.

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15: BANK RECONCILIATIONS

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If you do keep a personal record of your cash position at the bank, and if you do check your periodic bank statements against what you think you should have in your account, you are doing exactly the same thing that the bookkeepers of a business do when they make a bank reconciliation.

A bank reconciliation is a comparison of a bank statement (sent monthly, weekly or even daily by the bank) with the cash book. Differences between the balance on the bank statement and the balance in the cash book will be errors or timing differences, and they should be identified and satisfactorily explained.

2 The bank reconciliation

Differences between the cash book and the bank statement arise for three reasons:

• Errors – usually in the cash book • Omissions – such as bank charges not posted in the cash book • Timing differences – such as unpresented cheques

2.1 The bank statement It is a common practice for a business to issue a monthly statement to each credit customer, itemising:

(a) The balance he owed on his account at the beginning of the month (b) New debts incurred by the customer during the month (c) Payments made by him during the month (d) The balance he owes on his account at the end of the month.

In the same way, a bank statement is sent by a bank to its short-term debtors and creditors - ie customers with bank overdrafts and customers with money in their account - itemising the balance on the account at the beginning of the period, receipts into the account and payments from the account during the period, and the balance at the end of the period.

However, remember that if a customer has money in his account, the bank owes him that money, and the customer is therefore a creditor of the bank (hence the phrase 'to be in credit' means to have money in your account). If a business has £8,000 cash in the bank, it will have a debit balance in its own cash book, but the bank statement will show a credit balance of £8,000. (Think of sales and purchases: in the customer's books, the supplier is a creditor; in the supplier's books, the customer is a debtor.)

2.2 Why is a bank reconciliation necessary? A bank reconciliation is needed to identify and account for the differences between the cash book and the bank statement.

Question Differences

These differences fall into three categories. What are they?

Answer

Error, bank charges or interest, time differences

Key term

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2.3 What to look for when doing a bank reconciliation The cash book and bank statement will rarely agree at a given date. If you are doing a bank reconciliation, you may have to look for the following items.

(a) Corrections and adjustments to the cash book:

(i) Payments made into the account or from the account by way of standing order, which have not yet been entered in the cash book.

(ii) Dividends received (on investments held by the business), paid direct into the bank account but not yet entered in the cash book.

(iii) Bank interest and bank charges, not yet entered in the cash book.

(b) Items reconciling the correct cash book balance to the bank statement:

(i) Cheques drawn (ie paid) by the business and credited in the cash book, which have not yet been presented to the bank, or 'cleared' and so do not yet appear on the bank statement.

(ii) Cheques received by the business, paid into the bank and debited in the cash book, but which have not yet been cleared and entered in the account by the bank, and so do not yet appear on the bank statement.

You are likely to have a bank reconciliation question. You may have to adjust the cash book, the bank balance or both.

3 Worked examples When the differences between the bank statement and the cash book are identified, the cash book must be corrected for any errors or omissions. Any remaining difference can then be shown to be due to timing differences.

3.1 Example: Bank reconciliation At 30 September 20X6, the balance in the cash book of Wordsworth Ltd was £805.15 debit. A bank statement on 30 September 20X6 showed Wordsworth Ltd to be in credit by £1,112.30.

On investigation of the difference between the two sums, it was established that:

(a) The cash book had been undercast by £90.00 on the debit side*. (b) Cheques paid in not yet credited by the bank amounted to £208.20. (c) Cheques drawn not yet presented to the bank amounted to £425.35.

* Note. 'Casting' is an accountant's term for adding up.

Required

(a) Show the correction to the cash book. (b) Prepare a statement reconciling the balance per bank statement to the balance per cash book.

Solution (a) £

Cash book balance brought forward 805.15 Add Correction of undercast 90.00 Corrected balance 895.15

Exam focus point

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(b) £ £ Balance per bank statement 1,112.30 Add Cheques paid in, recorded in the cash book, but not yet credited to the account by the bank 208.20 Less Cheques paid by the company but not yet presented to the company's bank for settlement 425.35 (217.15) Balance per cash book 895.15

Question Original balance

On 31 January 20X8 a company's cash book showed a credit balance of £150 on its current account which did not agree with the bank statement balance. In performing the reconciliation the following points come to light. £ Not recorded in the cash book Bank charges 36 Transfer from deposit account to current account 500

Not recorded on the bank statement Unpresented cheques 116 Outstanding lodgements 630

It was also discovered that the bank had debited the company's account with a cheque for £400 in error. What was the original balance on the bank statement?

Answer

CASH ACCOUNT

£ £ Balance b/f 150 Transfer from deposit a/c 500 Charges 36 Balance c/f 314 500 500

£ Balance per cash book 314 Add unpresented cheques 116 Less uncleared lodgements (630) Less error by bank (400) Balance per bank statement (600)

Note that on the bank statement Dr is overdrawn

Question Closing balance

A company's bank statement shows £715 direct debits and £353 investment income not recorded in the cash book. The bank statement does not show a customer's cheque for £875 entered in the cash book on the last day of the accounting period. If the cash book shows a credit balance of £610 what balance appears on the bank statement?


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A £1,847 debit B £1,847 credit C £972 credit D £972 debit

Answer

B £ £ Balance per cash book (610) Items on statement, not in cash book Direct debits (715) Investment income 353 (362) Corrected balance per cash book (972) Item in cash book not on statement: Customer's cheque (875) Balance per bank statement (1,847)

Question Bank balance

Given the facts in the question above, what is the figure for the bank balance to be reported in the final accounts?

A £1,847 credit B £972 credit C £972 debit D £1,847 debit

Answer

B The figure to go in the balance sheet is the corrected cash book figure. This is £972 credit (or overdrawn). So the bank figure will appear in liabilities.

3.2 Example: More complicated bank reconciliation On 30 June 20X0, Cook's cash book showed that he had an overdraft of £300 on his current account at the bank. A bank statement as at the end of June 20X0 showed that Cook was in credit with the bank by £65.

On checking the cash book with the bank statement you find the following.

(a) Cheques drawn, amounting to £500, had been entered in the cash book but had not been presented.

(b) Cheques received, amounting to £400, had been entered in the cash book, but had not been credited by the bank.

(c) On instructions from Cook the bank had transferred interest received on his deposit account amounting to £60 to his current account, recording the transfer on 5 July 20X0. This amount had, however, been credited in the cash book as on 30 June 20X0.

(d) Bank charges of £35 shown in the bank statement had not been entered in the cash book.

(e) The payments side of the cash book had been undercast by £10.


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(f) Dividends received amounting to £200 had been paid direct to the bank and not entered in the cash book.

(g) A cheque for £50 drawn on deposit account had been shown in the cash book as drawn on current account.

(h) A cheque issued to Jones for £25 was replaced when out of date. It was entered again in the cash book, no other entry being made. Both cheques were included in the total of unpresented cheques shown above.

Required

(a) Indicate the appropriate adjustments in the cash book. (b) Prepare a statement reconciling the amended balance with that shown in the bank statement.

Solution (a) The errors to correct are given in notes (c) (e) (f) (g) and (h) of the problem. Bank charges (note

(d)) also call for an adjustment. CASH BOOK

£ £ 20X0 20X0 Jun 30 Bank interest - reversal of Jun 30 Balance brought down 300 incorrect entry (c) 60 Bank charges (d) 35 Bank interest account (c)(Note 1) 60 Correction of undercast (e) 10 Dividends paid direct to bank (f) 200 Balance carried down 50 Cheque drawn on deposit account written back (g) 50 Cheque issued to Jones Cancelled (h) (Note 2) 25 395 395 Notes

1 Item (c) is rather complicated. The transfer of interest from the deposit to the current account was presumably given as an instruction to the bank on or before 30 June 20X0. Since the correct entry is to debit the current account (and credit the deposit account) the correction in the cash book should be to debit the current account with 2 × £60 = £120 - ie to cancel out the incorrect credit entry in the cash book and then to make the correct debit entry. However, the bank does not record the transfer until 5 July, and so it will not appear in the bank statement.

2 Item (h). Two cheques have been paid to Jones, but one is now cancelled. Since the cash book is credited whenever a cheque is paid, it should be debited whenever a cheque is cancelled. The amount of cheques paid but not yet presented should be reduced by the amount of the cancelled cheque.

(b) BANK RECONCILIATION STATEMENT AT 30 JUNE 20X0 £ £ Balance per bank statement 65 Add: outstanding lodgements (ie cheques paid in but not yet credited) (b) 400 deposit interest not yet credited (c) 60 460 525 Less: unpresented cheques (a) 500 less cheque to Jones cancelled (h) (25) 475 Balance per corrected cash book 50


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Notice that in preparing a bank reconciliation it is good practice to begin with the balance shown by the bank statement and end with the balance shown by the cash book. It is this corrected cash book balance which will appear in the balance sheet as 'cash at bank'. But examination questions sometimes ask for the reverse order: as always, read the question carefully.

Question Bank reconciliation

From the information given below relating to PWW Ltd you are required:

(a) To make such additional entries in the cash at bank account of PWW Ltd as you consider necessary to show the correct balance at 31 October 20X2.

(b) To prepare a statement reconciling the correct balance in the cash at bank account as shown in (a) above with the balance at 31 October 20X2 that is shown on the bank statement from Z Bank plc.

CASH AT BANK ACCOUNT IN THE LEDGER OF PWW LIMITED

20X2 20X2 October £ October £

1 Balance b/f 274 1 Wages 3,146 8 Q Manufacturing 3,443 1 Petty Cash 55 8 R Cement 1,146 8 Wages 3,106 11 S Limited 638 8 Petty Cash 39 11 T & Sons 512 15 Wages 3,029 11 U & Co 4,174 15 Petty Cash 78 15 V plc 1,426 22 A & Sons 929 15 W Electrical 887 22 B Limited 134 22 X and Associates 1,202 22 C & Company 77 26 Y Limited 2,875 22 D & E 263 26 Z Limited 982 22 F Limited 1,782 29 ABC plc 1,003 22 G Associates 230 29 DEE Corporation 722 22 Wages 3,217 29 GHI Limited 2,461 22 Petty Cash 91 31 Balance c/f 14 25 H & Partners 26

26 J Sons & Co Ltd 868 26 K & Co 107 26 L, M & N 666 28 O Limited 112 29 Wages 3,191 29 Petty Cash 52 29 P & Sons 561 21,759 21,759

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Z BANK PLC - STATEMENT OF ACCOUNT WITH PWW LIMITED

20X2 Payments Receipts Balance October £ £ £

1 1,135 1 cheque 55 1 cheque 3,146 1 cheque 421 O/D 2,487 2 cheque 73 2 cheque 155 O/D 2,715 6 cheque 212 O/D 2,927 8 sundry credit 4,589 8 cheque 3,106 8 cheque 39 O/D 1,483

11 sundry credit 5,324 3,841 15 sundry credit 2,313 15 cheque 78 15 cheque 3,029 3,047 22 sundry credit 1,202 22 cheque 3,217 22 cheque 91 941 25 cheque 1,782 25 cheque 134 O/D 975 26 cheque 929 26 sundry credit 3,857 26 cheque 230 1,723 27 cheque 263 27 cheque 77 1,383 29 sundry credit 4,186 29 cheque 52 29 cheque 3,191 29 cheque 26 29 dividends on

investments 2,728 29 cheque 666 4,362 31 bank charges 936 3,426

Answer

(a) CASH BOOK

£ £ 31 Oct Dividends received 2,728 31 Oct Unadjusted balance b/f (overdraft) 14 31 Oct Bank charges 936 31 Oct Adjusted balance c/f 1,778 2,728 2,728

(b) BANK RECONCILIATION STATEMENT AT 31 OCTOBER 20X2 £ £ Corrected balance as per cash book 1,778 Cheques paid out but not yet presented 1,648 Cheques paid in but not yet cleared by bank 0 1,648 Balance as per bank statement 3,426


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Workings

1 Payments shown on bank statement but not in cash book* £(421 + 73 + 155 + 212)

£861

* Presumably recorded in cash book before 1 October 20X2 but not yet presented for payment as at 30 September 20X2

2 Payments in the cash book and on the bank statement £(3,146 + 55 + 3,106 + 39 + 78 + 3,029 + 3,217 + 91 + 1,782 + 134 + 929 + 230 + 263 + 77 + 52 + 3,191 + 26 + 666)

£20,111

3 Payments in the cash book but not on the bank statement = Total payments in cash book £21,759 minus £20,111 =

£1,648

£ (Alternatively J & Sons 868 K & Co 107 O Ltd 112 P & Sons 561 1,648

4 Bank charges, not in the cash book £936

5 Receipts recorded by bank statement but not in cash book: dividends on investments

£2,728

6 Receipts in the cash book and also bank statement (8 Oct £4,589; 11 Oct £5,324; 15 Oct £2,313; 22 Oct £1,202; 26 Oct £3,857; 29 Oct £4,186)

£21,471

7 Receipts recorded in cash book but not bank statement None

Chapter Roundup

• In theory, the entries appearing on a business's bank statement should be exactly the same as those in the business cash book. The balance shown by the bank statement should be the same as the cash book balance on the same date.

• Differences between the cash book and the bank statement arise for three reasons:

– Errors – usually in the cash book – Omissions – such as bank charges not posted in the cash book – Timing differences – such as unpresented cheques

• When the differences between the bank statement and the cash book are identified, the cash book must be corrected for any errors or omissions. Any remaining difference can then be shown to be due to timing differences.


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Quick Quiz 1 Which of the following are common reasons for differences between the cash book and the bank

statements?

(i) Timing differences (ii) Errors (iii) Omissions (iv) Contra entries

A (i) and (ii) B (i) and (iv) C (ii), (iii) and (iv) D (i), (ii) and (iii)

2 A cash book and a bank statement will never agree.

Is this statement?

A True B False

3 A bank statement shows a balance of £1,200 in credit. An examination of the statement shows a £500 cheque paid in per the cash book but not yet on the bank statement and a £1,250 cheque paid out but not yet on the statement. In addition the cash book shows deposit interest received of £50 but this is not yet on the statement. What is the balance per the cash book?

A £1,900 overdrawn B £500 overdrawn C £1,900 in hand D £500 in hand

Answers to Quick Quiz 1 D Contra entries only occur between the debtors and creditors control accounts.

2 B False. In very small businesses, with few transactions, the cash book and bank statement could well agree.

3 D £ £ Balance per bank statement 1,200 Add: outstanding lodgements 500 deposit interest not yet credited 50 550 1,750 Less: unpresented cheques (1,250) Balance per cash book 500

Now try the questions below from the Exam Question Bank

Number Level Marks Time

Q5 Examination 2 2 mins

Q28 Examination 2 2 mins


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Documents

Bank Recons