Bank Reconciliations
A bank reconciliation explains why the balance in the cash book differs from the balance on the bank statement. First correct the cash book for everything the bank has recorded that the business has not (bank charges, standing orders, direct debits, credit transfers, dishonoured cheques) and for any errors in it. Then prepare a statement that starts with the bank statement balance, adjusts for any bank errors and the timing differences (add lodgements not yet credited, deduct unpresented cheques) and ends with the corrected cash book balance — the figure that goes in the statement of financial position.
1 Introduction
There are many errors that can be made in the bookkeeping – for example, it is very easy to enter a number incorrectly – and it is therefore important to carry out as many checks as possible on the accuracy.
One of the most obvious checks is to compare the cash book with the bank statement. The balance on both should be the same. If there are any errors then this check should discover that they exist.
In principle this check is very simple, but it can be a little more involved due, mainly, to the use of cheques in many countries.
2 Terminology
Before we explain the nature of bank reconciliations, it is important to make sure that you are familiar with the terminology related to bank transactions.
Balance on bank statement
One important aspect to be aware of is that if you put money into the bank, the bank statement will show a credit balance. This is despite the fact that in the books of the business we will debit the cash account and say that we have a debit balance. The reason for this is that the bank statement is a reflection of the balance on your account in the books of the bank. As far as the bank is concerned, they owe you money – hence the credit balance.
It is very easy to get confused in an exam question, and so be very careful. A credit balance on the bank statement means that you have money, whereas a debit balance on the bank statement means that you are overdrawn.
The other terms you need are these:
Term | Meaning |
Cheque | A written instruction by the account holder to their bank to pay a stated sum to the person named on it. Writing a cheque is a payment; receiving one is a receipt. Both are entered in the cash book when the cheque is written or received. |
Drawer (of cheque) | The person who writes (draws) the cheque and from whose account the money will be paid. The person to whom it is paid is the payee. |
Unpresented cheques (or outstanding cheques) | Cheques the business has written and entered in its cash book as payments, which have not yet been paid by the bank and so do not yet appear on the bank statement. |
Deposits/Lodgements not yet credited | Money (cash or cheques) received and paid into the bank and entered in the cash book as receipts, which the bank has not yet credited to the account, so they do not yet appear on the bank statement. Also called outstanding lodgements. |
Dishonoured cheques | A cheque received from a customer that the customer’s bank refuses to pay, usually because there is not enough money in the customer’s account. The receipt already entered in the cash book must be cancelled (Cr Cash) and the customer again owes the money (Dr Receivables). |
Credit transfers | Money transferred directly from one bank account to another, without a cheque (for example a customer paying by internet transfer). A transfer received from a customer is a direct credit to the business’s account; the business often first learns of it from the bank statement. |
Standing orders | An instruction by the account holder to the bank to pay a fixed amount to the same person at regular intervals (for example rent of $100 every month) until told to stop. |
Direct debits | An authority given by the account holder allowing a supplier to collect whatever amount is due from the account at regular intervals (for example a telephone bill that differs every month). Like a standing order it is a payment, but the amount can vary. |
Bank charges and interest | Fees and interest the bank takes from (or interest it pays into) the account. The bank does not send a bill first, so the business learns of them from the bank statement. |
3 Reasons why the balance on the bank statement may differ from the balance in the cash account
If there is a difference between the balance on the bank statement and the balance in the cash account, then clearly we need to find out why.
There are three types of situations that can result in a difference:
cash book errors and omissions
Examples:
bank charges and overdraft interest taken by the bank, not yet entered in the cash book
standing orders and direct debits paid by the bank, not yet entered
credit transfers (direct credits) received from customers, and interest received, not yet entered
customers’ cheques that have been dishonoured
mistakes in the cash book itself — an amount entered wrongly (for example a payment of $1,200 entered as $2,100), entered on the wrong side, or a column added up wrongly
If there are any cash book errors or omissions, then these must be corrected
bank mistakes
Examples:
a cheque drawn by another customer of the bank charged to the business’s account by mistake
a lodgement credited to the wrong account, or recorded by the bank at the wrong amount
If there are any errors by the bank, then the bank must be informed and these errors corrected by the bank
‘timing differences’
Even if all the entries in the bank statement and the cash book are correct, the two balances are unlikely to agree. This is because of unpresented cheques and lodgements not yet credited. The receipts and payments have been correctly entered in the cash book, but because of the time delay they have not yet appeared in the bank statement. This is not a mistake on the bank’s part – the transactions will appear at some time in the future – and so no correction is necessary. However, if we list the unpresented cheques and lodgements not yet credited, we should be able to explain (or reconcile) the difference between the balances. If we cannot reconcile the two then there must be errors remaining which we must find.
The statement reconciling the balances is called a bank reconciliation statement.
The first group is corrected in the cash book, because the bank statement is right and the cash book is not up to date. The second and third groups do not change the cash book: they are the items that appear on the bank reconciliation statement.
4 The preparation of a bank reconciliation statement
compare the cash account to the bank statement and tick off all items that agree
any remaining items must be either errors or timing differences
correct any errors in the cash account by putting through the necessary debits or credits (in the examination write up a t-account, starting with the balance given in the question and ending with the correct balance)
prepare a bank reconciliation statement. This is always a statement (not a t-account), starting with the balance on the bank statement, listing any bank errors and timing differences, and ending with what should be the corrected balance in the cash account.
The corrected cash account balance is the figure for cash at bank (or the bank overdraft) in the statement of financial position. The bank statement balance is never used there, because it leaves out the timing differences.
Pro-forma bank reconciliation statement:
$ | |
Balance per bank statement | x |
Add/Less bank errors | x |
x | |
Add: Lodgements not credited | x |
Less: Unpresented cheques | (x) |
Balance as per (corrected) cash account | x |
Lodgements not yet credited are added, because when the bank does credit them the bank balance will go up. Unpresented cheques are deducted, because when the bank pays them the bank balance will go down. Remember that the bank statement shows money in the bank as a credit balance: if the statement shows the account overdrawn (a debit balance), start the statement with a negative figure in brackets and make the same additions and deductions.
A question may instead give the corrected cash book balance and ask for the bank statement balance. Work the same statement backwards: start from the cash book balance, add back the unpresented cheques and deduct the lodgements not yet credited.
At 31 December 2007, the balance on the cash account was $11,820 (DR), but the balance appearing on the bank statement was $15,000 (CR).
The reasons for the difference were as follows:
Bank charges of $20
A payment of $1,200 had been entered in the cash account as $2,100
A cheque for $200 had been dishonoured
There were unpresented cheques totalling $6,500
Lodgements of $4,000 had not yet appeared on the bank statement
Calculate the correct balance on the cash account, and prepare a bank reconciliation statement.
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At 30 June 2019 the cash book of Zainab Traders in Lagos shows an overdraft of $1,460 (a credit balance). The bank statement at the same date shows a balance of $575 (CR). On comparing the two, the following are found:
A standing order for insurance of $250 has not been entered in the cash book.
A credit transfer of $1,800 received from a customer appears only on the bank statement.
Bank charges of $35 have not been entered in the cash book.
The receipts side of the cash book was undercast by $100.
A cheque for $300 received from a customer has been dishonoured.
The bank has charged to the business’s account a cheque for $520 drawn by another of its customers.
Cheques written totalling $2,180 have not yet been presented.
Lodgements of $940 made on 30 June do not appear on the bank statement.
Required: Prepare the corrected cash account and a bank reconciliation statement at 30 June 2019.
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5 Test your knowledge
Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.
Bank Reconciliations
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