The cash book (bank account in the general ledger) and bank statements
The cash book is a book of prime entry used
to record all receipts and payments of cash.
There are many different methods by which a
business might make payment to suppliers and receive payment from customers.
Methods include
- Cash (this is quite rare in all but the smaller businesses);
- Cheques
- Bank transfers – An amount transferred directly from a bank account holder’s account to the bank account of another party on the instruction of the first person.
- Credit and debit cards – People often use these to pay for goods and services purchased from businesses. Once a sale is made the business asks the credit (debit) card company to make the payment on behalf of the card holder. The credit (debit) card company then recovers the cash from the card holder.
- Many modern businesses now accept online payment for sales of goods and provision of services. Payment is often received through the use of credit cards and debit cards in the usual way or thorough the action of a third party (for example Pay pal).
- Standing order – An instruction a bank account holder (the payer) gives to their bank to pay a set amount at regular intervals to another party's (the payee's) account.
- Direct debit – A method of payment in which, a person (payee) instructs their bank to collect funds from another party's (payer’s) bank account. The payer must have instructed their bank to allow this before it can happen. Both standing orders and direct debits are very common methods of making monthly payments. A standing order allows for payment of the same amount on each payment date as the payer instructs the bank to pay this amount. A direct debit allows for different payments at each payment date as the payer instructs the bank to pay the amount the payee asks for.
Posting
Periodically, totals are posted from the cash
book to the general ledger accounts.
One of these accounts is the cash account.
For the purposes of this section we will describe this more specifically as the
cash at bank account. (A business usually also has a cash in hand account to
record cash amounts physically held but the majority of cash receipts and
payments are usually through the cash at bank account). The cash at bank
account in the general ledger is used to record receipts and payments of cash
through the bank account. The balance on this account is the amount that the
business believes that it has in its bank account (debit balance) or the size
of its bank overdraft (credit balance). The bank sends regular bank statements
to a business entity. A bank statement lists all the transactions that the bank
has recorded in the account for the entity since the previous statement and the
current balance on the account.
Many businesses now have on-line access to
their bank statements so can access a bank statement at any time.
Reconciliation
The term reconciliation refers to a process
that compares two sets of records (usually the balances of two accounts, in
this case the balance on the cash at bank account and the balance on the bank
statement) and explains the reason for any difference between them.
A bank reconciliation compares the balance on
the general ledger cash at bank account to the balance on the bank statement at
a given point in time. This should be done at regular intervals (say at the end
of each month). Often the balance on the cash at bank account is referred to
as the balance on the cash book. This can be confusing but remember that
the reconciliation always agrees the balance on the cash at bank account to the
balance on the bank statement. Bank reconciliations are a useful check on the
accuracy of accounting records for cash. In principle, the balance in the cash
at bank account or cash book in the general ledger and the balance shown in the
bank statement should be the same but there are often differences and some of
these might relate to transactions which the business has not yet accounted for
or errors which must be corrected.
Differences and the need for a reconciliation
The balance on the general ledger cash at
bank account and that shown for the business in its bank statement, at a point
in time, will rarely be the same.
Differences between might be caused by any of
the following:
- Items recorded in the cash at bank account are not (yet) shown in the bank statement.
- Items in the bank statement that have not been recorded in the cash at bank account.
- Errors by the bank (these are quite rare but do happen).
- Errors in the cash book.
- Each of these will be considered in turn.
Items recorded in the cash at bank account that have not (yet) shown in the bank
statement
Some transactions might have been recorded in
the cash at bank account in the general ledger, but have not yet been recorded
by the bank.
Cheques received from customers, recorded in
the cash book and paid into the bank and may not have been processed yet by the
bank. Processing payments through the banking system might take two or three
days, perhaps even longer. These are known as outstanding lodgements. Cheques
paid to suppliers are recorded as payments in accounting system of the
business but they may not yet have been
presented to the bank for payment (i.e. paid into the bank by the business’s
supplier). These are known as unpresented cheques.
Even if the cheques have been presented for
payment by our supplier the bank may not have processed the deduction form the
business’s account yet.
These are timing differences. The
transactions will eventually be processed by the bank. There are no errors or
omissions in the cash book, and no further action is needed.
Items in the bank statement that have not been recorded in the
cash at bank account.
A business might not know about some items
until they receive a bank statement.
Examples include:
- bank charges;
- bank interest on an overdrawn balance;
- a payment from a customer that has been rejected by the bank (for example, the customer’s cheque has been dishonoured).
- a bank transfer where a payment has been made directly into the business’s account;
- a bank might make a mistake either crediting or debiting an incorrect amount into an account (these are rare but they do happen).
The general ledger cash at bank account
should be amended to include these transactions.
When a cheque is dishonoured the business
must reverse the entries that were made originally when the business thought
that an amount had been received.
Illustration: Double entry for dishonoured cheque
Write back of receivable
Debit Credit
General ledger:
Receivables X
Cash at bank X
Receivables ledger:
Individual customer
accounts X
The business should also consider whether the
receivable should be written off as a bad debt or whether an allowance should
be recognised for a doubtful debt
Errors by the bank
The bank might sometimes make an error. If
so, it should be notified and asked to correct its mistake. No further action
is then needed.
Errors in the cash book
Possibly, an error has been made in the cash
book. This should be identified during the reconciliation of the bank statement
with the cash at bank account balance. Any such errors must be corrected when
discovered.
Possible cause of confusion
The bank statement presents information as
recorded in the accounting system of the bank. It always shows the banks view
of things.
When a business has a positive cash balance
that is an asset and as far as the business is concerned it is a debit balance.
From the bank’s point of view they owe the business money. Therefore they show
the business as having a credit balance on the bank statement.
Similarly a bank account is overdrawn, the
business owes money to the bank and shows this as a liability (a credit
balance) in its financial statements. However, from the bank’s point of view
they have an asset and show this as a debit balance on the bank statements.
Format of a bank reconciliation statement
The purpose of a bank reconciliation is to
show that the cash at bank account balance in the general ledger agrees with
the bank statement balance after taking account of timing differences and
making adjustments for any omissions or errors.
There is no single correct format for a bank
reconciliation.
A useful approach is to correct the cash at
bank balance for any omissions or errors and then adjust the balance per the
bank statements for uncredited lodgements and unpresented cheques. The
resultant balances should be the same.
Illustration: Bank reconciliation
The following assumes that the cash balance is positive (i.e. the
business has a debit cash balance).
Balance per general ledger cash at bank account: X
Items in bank statement not in cash book:
Bank charges (X)
Dishonoured cheques (X)
Interest received X
(X)
Error (made by business) X/(X)
Corrected cash at bank figure X1
Balance per bank statement X
Items in general ledger not in bank statement
Add: Outstanding lodgements X
Deduct: Unpresented cheques (X)
Corrected balance per bank statement X1
The balances (X1) should now agree
Alternative
presentations are possible.
Alternative format
This approach corrects the general ledger
cash at bank account and then shows
the differences between that figure and the
balance as per the bank statement.
Illustration: Bank reconciliation
The following assumes that the cash balance is positive (i.e. the
business has a
debit cash balance).
Balance per general ledger cash at bank account: X
Items in bank statement not in cash book:
Bank charges (X)
Dishonoured cheques (X)
Interest received X
(X)
Error (made by business) X/(X)
Corrected cash at bank figure X1
Items in general ledger not in bank statement
Deduct: Outstanding lodgements (X)
Add: Unpresented cheques X
Balance per bank
statement X1
Bank reconciliations and overdrawn balances
For a company with a bank account, money in
the bank is an asset and the cash balance in the cash book is a debit balance.
If there is a bank overdraft, the cash book has a credit balance, indicating
that money is owed to the bank.
For the bank, the situation is the opposite
way round.
q Money held by the bank in
a bank account for a customer is money that belongs to the customer. For the
bank, deposits are therefore liabilities and an account is said to be in credit
when there is money in it.
q If a bank allows an
overdraft to a customer, the customer owes the bank.
The amount of the overdraft is a form of
receivable for the bank, and is an asset. To the bank, an overdraft balance on
a customer’s account is therefore a debit balance (= asset).
A bank statement might therefore indicate
that a customer’s account has a ‘debit balance’, such as Rs. 5,250 Dr.
This debit balance means ‘overdraft’ and for the customer it is a liability and
credit balance item in their financial records.
Preparing a bank reconciliation with an overdraft balance
If you are given a question in which there is
an overdraft balance in the bank statement, it is useful to make the negative
balance clear by putting brackets around the balance.
Illustration: Bank reconciliation
The following assumes that the cash balance is negative (i.e, the
business has a
credit cash balance).
Balance per general ledger cash at bank account: (X)
Items in bank statement not in cash book:
Bank charges (X)
Dishonoured cheques (X)
Interest received X
(X)
Error (made by business) X/(X)
Corrected cash at bank figure (X1)
Balance per bank statement (X)
Items in general ledger not in bank statement
Add: Outstanding lodgements X
Deduct: Unpresented cheques (X)
Corrected balance per bank statement (X1)
The balances (X1 should now agree)
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