1.0
INTRODUCTION
Whenever a
businessman in an organization opens a current account with a bank, the
services that are rendered by the bank include receiving deposits from his
debtors and paying money to his creditor on his behalf. Periodically, a bank
issues a bank statement to the business man, showing the transactions
undertaken so far by the bank on his behalf. More often than not, the bank balance
in the cash book
disagrees with that in the bank statement. Before drawing up a
trial balance at the end of an accounting period, however, there is a need to
reconcile the two balances. The Statement prepared to bring the bank balance in
the cash book into agreement with that in the bank statement is called Bank
reconciliation statement. In this note you will learn how to prepare that
statement and the adjustment required in the cash book.
2.0
OBJECTIVES.
At
the end of this note, you should be able to:
• Prepare a bank
reconciliation statement
• Adjust the cash
book balance
• Appreciate Bank
reconciliation statement.
3.0
MAIN CONTENT
3.1
Causes of Difference
The main causes that
lead to disagreement in the balances of the cash book and the pass book or the
bank statement are as follows:
3.1.1
Cheques Issued but not yet Presented for Payment
Whenever a payment is
made by cheque, the businessmen immediately records it in his cash book. But,
the bank debit's the firm's account only when the cheques are presented for
payments. You know that there is always a time lag between the issue of cheques
and its presentation for payment and so the date on which it will be recorded
by the bank will always be later than the date of its recording in the cash
book. It is quite possible that on a particular date when the bank submits the
statement of account, there may be some cheques which have been issued but not
yet presented for payment and so not recorded by the bank. Consequently, the
balance shown by the pass book or bank statement will be higher than the
balance shown by the cash book. For example, a firm issued a cheque for
N3000.00 in favor of a creditor on December 28, 1987 which is presented to the
bank for payment on January, 2, 1988. the firm would record it in the cash book
on December 28, 1987 whereas the bank would record it on January, 2 1988. When
the firm would receive the pass book or the bank statement completed up to
December 31, 1987 they would find the balance shown by the pass book or bank
statement is different from the balance shown by the cash book. The pass book
or bank balance statement would be higher by N3000.
3.1.2
Cheques Deposited into the Bank but not yet collected
When payment is
received by cheque, the firm sends it to the bank for collection and records it
immediately on the debit side of the cash book. This increases the bank balance
as per cash book. But the bank will not credit the firm's account till the
cheque is actually collected. So the balance in the pass book or bank statement
remains unaffected till the proceeds of the cheque are collected and credited.
Thus, on a particular
date, it is possible that certain cheques which were sent for collection might
not have been collected by the bank and so not shown in the pass book or the
bank statement. All such cheques pending collection would make the cash book or
bank statement balances different from that of the cash book. For example the
firm sends a cheque of 442000 on June 28 to bank for collection. The cheque is
collected on July 6, now if the balance as on June 30 are compared, they will
be different because the credit of 442000 will not appear in the pass book or
bank statement.
3.1.3
Bank Charges
The bank usually
charges some amount from their customers for various services provided by them.
They may charge for collection of outstanding cheques, for making or collecting
payments on standing instructions, and so on. The bank debits the customers
account for such charges from time to time. However, the firm will know about
these charges only when it goes through the pass book or bank statement. So, on
the date of reconciliation the pass book or statement may differs from the
balance as per cash book.
3.1.4
Interest Allowed by the Bank
The banks normally do
not allow any interest on the current account balances. But if such interest is
allowed, the bank credits it to the customer's account. This increases the
balance in the pass book. The bank would pass the corresponding entry in the
pass book only when it receives the instruction from the bank or when it
notices it in the pass book or the bank statement. Hence, the cash book balance
will be lower till such entry is made or pass.
3.1.5
Interest on Overdraft
When the businessman
requires more funds he may request the bank for overdraft facility which means
permitting him to draw more than the amount available in his account. When the
businessman actually withdraws more than the available amount, he is said to
have utilized the overdraft facility.
The bank charges
interest on the amount overdrawn and debits the same to his account
periodically. The firm records the corresponding entry on overdraft only when
the pass book is received. Hence, the balance in the two books would differ
till the entry is passed in the cash book.
3.1.6
Amount Collected by Bank on Standing Instructions
The businessman often
issues standing instructions authorizing his banker to collect on his behalf
certain amount due to him such as interest, dividends, etc. the bank credits
the customer's account as at when he collect such amounts and sends the
necessary instructions to him. The firm will pass the corresponding entry in
the cash book when it receives such instructions or when it notices it in the
pass book. Thus, as on the date of reconciliation, the balance as per cash book
may be lower than the balance as per pass book.
3.1.7
Payments Made by the Bank as Per Standing Instructions
The businessman may
also issue standing instructions to his banker to make certain payments on his behalf
such as insurance premium, rent, etc. When the banker makes such payments, he
would immediately debit the customer’s account. So, the balance in the pass
book would get reduced. If the corresponding entries for such payments have not
been recorded in the cash book, the balance as per cash book would remain
unchanged.
3.1.8
Direct Payments into the Bank Made by Firm's Customers
Sometimes, a customer
may directly deposit an amount into the firm's account. The firm shall record
it in the cash book only when it learns about such deposit. But, the pass book
would show the entry on the date of deposit itself if by the date of
reconciliation, such entry has not been passed in the cash book, the balance
shown by pass book will be higher than the balance as per cash book.
3.1.9
Dishonor of Cheques or Bills
As already stated
when cheques are sent to the bank for collection, they are entered in the cash
book immediately. But no entry appears in the pass book, till they are
collected by the bank. Sometimes, for one reason or the other, the cheques are dishonored.
In that case the bank will not make any entry in its books and returns such
cheques to the firm. The same thing applies to the bills receivable sent for
collection to the bank. On receiving the dishonored cheques or bills the firm
has to pass reverse entry in the cash book. But, till such entry is passed the
balance show by the cash book and the pass book would differ.
3.1.10
Errors
It is quite possible
that while recording the transactions in the cash book some errors might have
been committed by the firm. For example, a cheque deposited in the bank may not
be recorded at all, or is recorded on the wrong side in the cash book.
Similarly, the bank may also commit some errors while recording entries in the
customer's account. For example, a cheque collected on behalf of a customer is
entered in some other account. Such errors would also lead to the disagreement
of the balances in the cash book and the pass book.
3.2
What is Bank Reconciliation Statement?
By comparing the
entries in the cash book with those in the pass book you can easily ascertain
the exact causes of difference between the balance as per cash book and the
balance as per pass book. In order to reconcile these balances every firm prepares
a statement showing all the causes of differences. This statement is called
bank Reconciliation Statement and is prepared periodically. The main objective
of preparing such a statement is to account for the difference between the cash
book and the pass book balances and pass the necessary correcting entries in
the books of the firm.
Thus, Bank
Reconciliation Statement can be defined as a statement which reconciles the
balance as per cash book and the balance as per pass book showing all causes of
difference between the two.
3.3
Preparation of Bank Reconciliation Statement
The Bank
Reconciliation Statement is prepared at the end of a quarter, half year or a
year as the firm may consider desirable and convenient. It can be prepared in
two ways.
(i) take the balance
as per cash book as the starting point, adjust the effect of each item causing
the difference, and arrive at the balance as per pass book or Bank statement.
(ii) Take the balance
as per pass book as the starting point, adjust the effect of each item causing
the difference, and arrive at the balance as per cash book.
Whatever be the
method. First of all you must analyze the effect of each item on the balance of
the book which you are using the starting point. In order words, whether it has
led to a higher balance or a lower balance in that book. This helps you to
decide whether a particular item is to be added to or subtracted from such a
balance.
Suppose you start
with cash book balance as the base and the item causing the difference is the
bank charges of N100. This item appears in the pas book but not in the cash
book. The bank charges would appear in the withdrawals column of the pass book
which means that the pass book balance had decreased by NI00. Since it has not
been shown in the cash book, the cash book balance remained unaffected, it did
not decrease. Hence the cash book balance would be higher than the pass book
balance by 4100. If we now subtract this amount from the cash .117
book
balance it will reconcile with the pass book balance. Take another example; the
bank collected 4500 as interest on securities on behalf of the firm. But, the
same had not been recorded in the cash book. This item would appear in the
deposit column of the pass book which means the pass book balance had increased
by 4500.
Since it had not been
shown in the cash book, the cash balance remained unaffected, it did not
increase. Hence the cash book balance would be lower than the pass book balance
by N500. If we now add this amount to the cash book balance it will reconcile
with the pass book balance.
If you were to start
with pass book balance as the base you would do just the reverse of what you
did when you started with cash book balance as the base. You will add N100
relating to the item of bank charges because it leads to a lower balance in the
pass book and subtract N500 relating to interest on securities collected by the
bank because it had increase the pass book balances.
Generally, the firms
adopt the first method because the bank Reconciliation statement is prepared
primarily for the verification of the bank balance as shown by the cash book.
From the above examples it should be clear to you that in case you start with
cash book balance you should add all those items which have been responsible for
lower balance in the cash book and subtract those which have been responsible
for a higher balance. Let us, for convenience lists the items which would
generally be added and subtracted when cash balance is used as the starting
point to be added.
1. Cheques issued but
not yet presented
2. Interest allowed
by the bank
3. Interest and
dividends collected but not recorded in the cash book
4. Direct deposits by
customers in the firm's bank account.
To
be Subtracted
1. Cheques deposited
but not yet collected
2. Bank Charges
3. Interest on
overdraft
4. Amounts paid by
the bank understanding instructions but not recorded in the cash book.
5. Cheques dishonored
but no entry made in the cash book for the dishonor.
If the pass book/bank
balance is taken as the starting point, just reverse the above process. Add
those which are to be subtracted from the cash .
book
balance as per the above list and subtract those which are to be added to the
cash book balance as per the above list.
The above analysis
will help you to prepare Bank Reconciliation Statement correctly. Look at
illustration 1 and study how a Bank Reconciliation Statement is prepared with
cash book balance as the starting point. On December 31, 1990 Deola's book
showed a debit balance of 47, 800. The balance as per pass book was 410, 300.
On comparing the cash book with the pass book, the following discrepancies were
found:
1. Two cheques for
N1, 600 and 42, 000 issued on December 23 have not been presented to the bank
for payment.
2. A cheque for N1,
200 was deposited in the bank on December, 29, but it was credited by the bank
on January 5, 1988.
3. There was a credit
entry in the pass book for 4520 in respect of dividend received by the bank on
behalf of Deola. This had not been recorded in the cash book.
4. N300 was deposited
by a customer directly into the bank.
5. The bank charged
460 as their commission for collecting an outstanding cheque. No entry for this
appear in the cash book.
6. A cheque for N500
received from Gbenga and deposited in the bank was dishonored but no entry was
recorded in the cash book for the dishonor.
7. A cheque for N160
was entered in the cash book but it was not sent to the bank for collection.
Solution
Note:
The statement bears a heading "Bank Reconciliation
Statement" and mentions the date for which reconciliation is done. So,
whenever you prepare a Bank Reconciliation Statement, make sure that it bears
this heading along with the date of reconciliation.
The Bank
Reconciliation Statement can also be prepared by 'plus and minus method'. In
that case you will have two separate amount columns, one for additions and the
other for subtraction. The first column is called 'plus column' and the second
column is called 'minus column'. The bank
Reconciliation
Statement prepared according to this method will appear as follows:
Bank Reconciliation
Statement as on December 31, 1990
Now, look at
illustration 2 and study how a Bank Reconciliation Statement will be prepared
with pass book balance as the starting point. 
Illustration
2:
From the following,
prepare a Bank Reconciliation Statement of Laide Adeosun as on March 31, 1988.
Balance as per pass book as on March 31, 1988 was N22, 000.
1. Cheques amounting
to N9,000 were deposited in the bank during March, but credit was given only
for N7,000.
2. The bank paid
insurance premium of N300 on March 20, but it was not entered in the cash book.
3. A discounted bill
receivable for N1, 500 was returned dishnoured to the bank on March 27, but the
corresponding entry in the cash book was made in April.
4. A cheque for N800
received on March 29 was entered in the cash book, but it was sent to bank on
April
5. The cheques
amounting to N3, 000 issued to creditors, the cheques for N1, 800 only were
presented for payment.
6. The bank charges
debited in the pass book amounted to N50.
7. The interest on
securities collected and credited by the bank
amounting to Ni, 000
was not entered in the cash book. 
You have learnt the
method of preparing a Bank Reconciliation Statement when the firm has a favorable
balance in the bank. Let us now study how Bank Reconciliation Statement will be
prepared when the firm has an unfavorable balance (an overdraft).
You know when the
firm has a favorable balance the cash book shows a debit balance. But when the
firm has an overdraft, it will show a credit balance because, in such a
situation, the bank is a creditor for the firm. As for the pass book, when the
firm has favorable balance it shows a credit balance and when the firm has an
overdraft it will show a debit balance, because for the bank, the firm is a
debtor when there is an overdraft. In other words it can be stated that when
cash. book shows a credit balance or, when pass book shows a debit balance, the
firm has an overdraft.
The preparation of
the Bank Reconciliation Statement does not differ much whether there is a favorable
balance or an overdraft. Especially, if you follow the 'plus and minus method'.
You know when the firm has a
favorable
balance, it is shown in plus column of the Bank Reconciliation Statement. But,
if there is an overdraft it will be shown in the minus column. This is the main
point you have to remember while preparing a Bank Reconciliation Statement when
there is an overdraft. The treatment with regard to causing difference between
the balances of two books remains the same.
If however, you do
not follow the plus and minus method you will have to analyzes first the effect
of each discrepancy on the overdraft and then decide whether the amount involved
is to be added or subtracted. When you make such analysis you will observe that
the effect of each discrepancy on overdraft will be just the reverse of what it
would be on a favorable balance. For example, if bank charges are found to be
unrecorded in the cash book which shows a favorable balance, this omission is
considered responsible for a higher balance in the cash book and so, while
preparing Bank Reconciliation subtracted from the balance. But in case of an
overdraft omitting to record the bank charges would mean lower amount of
overdraft in the cash book and so, while preparing the bank Reconciliation
Statement it will have to be added. Thus, you will find that when you prepare a
Bank Reconciliation Statement with an overdraft as per cash book as the
starting point you will have to add all items which were subtracted when you
started with a favorable balance as per cash book and vice-versa. This makes
the preparation of the bank Reconciliation quite complicated. Hence you are
advised to follow plus and minus method.
In that case by
simply showing the overdraft in the minus column you will automatically have
the desired effect of each item duly adjusted in the overdraft.
3.4
Adjusting the Cash Book Balance
When you look at the
various items that normally cause the difference between the cash book balance
and the pass book balance, you will find a number of items which appear only in
the pass book. Why not record such items in the cash book before preparing the
Bank Reconciliation Statement. This shall reduce the number of items
responsible for the difference. So, as soon as the pass book is received, the
firm may record all those items in the cash book which appear only in pass book
and work out a fresh balance of the cash book. This is called 'adjusted
balance' or 'corrected balance' as per cash book. Similarly, it may also pass
correcting entries for the errors committed in the cash book and adjust the
cash book balance. When you work out an adjusted balance of the cash book as
above, the Bank Reconciliation Statement may be prepared with the adjusted
balance. This would reduce the number of items shown in the Bank Reconciliation
Statement. As a matter of fact this is exactly what is done in practice.
The items which can
usually be adjusted in the cash book are:
(1) Interest allowed
by Bank
(2) Amounts collected
by bank as per standing instruction
(3) Payments made by
bank as per standing instruction
(4) Bank charges
(5) Interest on
overdraft
(6) Direct deposits
by customers.
(7) Dishonored
cheques or bills receivable
(8) Errors committed
in the cash book.
3.5
Advantages of Bank Reconciliation Statement
The main purpose of
preparing Bank Reconciliation Statement is to account for the difference
between the cash book and the pass book balances. This would ensure that
accuracy of entries made in the cash book as well as those in the pass book.
Regular comparison of these two books is necessary for preparing the Bank
Reconciliation Statement. This helps in the detection of errors and taking
timely action to correct them. It is quite possible that the bank wrongly
debits firm's account for cheques drawn by someone else. If reconciliation is
not done, such mistakes will not be detected. Preparation of Bank
Reconciliation Statement also help in preventing frauds in banking
transactions. The cashier, for example, may omit to deposit some bearer cheques
in the bank and encash them himself such fraud is sure to be detected at the
time of reconciliation when it is investigated as to why certain cheques
remained uncollected. Thus, it acts as a moral check on the staff to refrain
from indulging in such activities.
Bank Reconciliation
Statement is also required for audit purposes. The auditor has to verify the
bank balance before he would certify the accounts. For this he would insist on
the Bank Reconciliation Statement and ensure that the bank balance shown in the
cash book is correct.
4.0
CONCLUSION
When the businessman
receives the Bank Statement or the pass book from the bank, he compares it with
the cash book. Normally, entries in the cash book would tally with those in the
pass book and the balances shown by both the book should also be the same. But
in practice they generally differ. This happens if there are some entries which
have been recorded in the cash book but they do not appear in the pass book.
Similarly, there may be some entries which have been recorded in the pass book
but they do not appear in the cash book. The difference can also arise on
account of errors committed either by the firm or by the Bank in recording of
various transactions.
5.0
SUMMARY
When cash book and the pass book or bank
Statement are compared, it is often found that the balances shown by these two
books differs. There may be many causes leading to difference. A Bank
Reconciliation Statement is prepared to explain the causes of difference and
take the necessary follow up action. It can be prepared either by taking cash
book balances as the starting point or by taking pass book balance to the
starting point. It can also be prepared by taking the adjusted balance of the
cash book as the starting point. The adjusted balance of the cash book is
arrived at by passing corresponding entries in the cash book for items which
appeared in the pass book or bank statement only.
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