Chapter Notes

Bank Reconciliation Statement

A Bank Reconciliation Statement (BRS) is a report prepared by a business to compare and match the bank balance recorded in its own Cash Book with the balance shown in the Bank Statement (or Passbook) provided by the bank.

Think of it like this: your business keeps a diary of all its bank transactions (the Cash Book), and the bank also keeps its own diary of your transactions (the Passbook). Ideally, both diaries should tell the same story and show the same final balance. In reality, they often don't match perfectly on any given day. The BRS is the tool used to figure out exactly why they are different and to "reconcile" them.

Need for Reconciliation

It is very common for the bank balance in a firm's Cash Book and the balance in the Passbook to not tally. A Bank Reconciliation Statement is prepared to:

• Identify the specific reasons for the difference between the two balances.
• Correct any errors made either by the business or the bank.
• Ensure the accuracy of the bank balance recorded in the company's financial records.
• Provide a clear explanation for the discrepancy, which is important for internal control and auditing.

To prepare a BRS, you need the Cash Book and the Bank Statement for the same period and must compare the entries in both to find the items that appear in one but not the other.

The main causes for these differences fall into two categories: timing differences and errors.

Timing Differences

A timing difference occurs when a transaction is recorded by the business and the bank at different times. This time lag is the most common reason for discrepancies.

Cheques issued by the bank but not yet presented for payment

When a business issues a cheque to a supplier, it immediately records the payment on the credit side of its Cash Book, reducing the bank balance. However, the bank only reduces the account balance when the supplier actually presents that cheque for payment, which could be days or even weeks later.

Cheques paid into the bank but not yet collected

When a business receives a cheque from a customer, it immediately records it on the debit side of the Cash Book, increasing its bank balance. However, the bank only credits the account after the cheque has gone through the clearing process and the funds are actually received, which can take a few days.

Direct debits made by the bank on behalf of the customer

The bank may automatically deduct certain payments from a customer's account based on standing instructions or for its own charges. The business only finds out about these deductions when it receives the bank statement.

• Examples: Bank charges, cheque collection fees, interest on an overdraft, or payments for insurance premiums or telephone bills set up as standing orders.
• Effect: The balance in the Passbook will be lower than the balance in the Cash Book until the business records these expenses.

Amounts directly deposited in the bank account

Sometimes, customers or debtors deposit money directly into the firm's bank account. The bank will credit the account immediately, but the business might not know about this deposit until it sees the bank statement.

• Effect: The balance in the Passbook will be higher than the balance in the Cash Book.

Interest and dividends collected by the bank

If a business has investments, the bank may collect interest or dividends on its behalf and credit them directly to the account. The business will only record this income after seeing the bank statement.

• Effect: The balance in the Passbook will be higher than the balance in the Cash Book.

Direct payments made by the bank on behalf of the customers

Similar to direct debits, a business may give the bank standing instructions to make regular payments like rent, taxes, or insurance premiums. The bank makes the payment and debits the account, but the business may not have recorded it yet.

• Effect: The Passbook balance will be lower than the Cash Book balance.

Cheques deposited/bills discounted dishonoured

If a cheque deposited by the firm is dishonoured (bounces), the bank will reverse the credit entry by debiting the account. The business is often unaware of this until it receives notification or the bank statement.

• Effect: The Passbook balance will be lower than the Cash Book balance because the business still assumes the money was collected.

Differences Caused by Errors

Sometimes, the difference isn't due to timing but is caused by a simple mistake made by either the firm or the bank.

Errors committed in recording transaction by the firm

These are mistakes made in the company's Cash Book.

• Examples: Forgetting to record a cheque issued or deposited, recording a transaction with the wrong amount, or making a calculation error when balancing the account.

Errors committed in recording transactions by the bank

Although less common, banks can also make mistakes.

• Examples: Crediting or debiting the wrong amount, or posting a transaction to the wrong customer's account.

Preparation of Bank Reconciliation Statement

A BRS can be prepared in two ways:

1. Preparation of BRS without adjusting the Cash Book balance.
2. Preparation of BRS after adjusting the Cash Book balance.

This guide focuses on the first method.

Preparation of Bank Reconciliation Statement without adjusting Cash Book Balance

In this method, we start with the balance from either the Cash Book or the Passbook and make a series of additions and subtractions for all the reconciling items to arrive at the balance of the other book.

There are four possible starting points:

1. Favourable balance (debit) as per Cash Book.
2. Favourable balance (credit) as per Passbook.
3. Unfavourable balance/Overdraft (credit) as per Cash Book.
4. Unfavourable balance/Overdraft (debit) as per Passbook.

Dealing with favourable balances

A favourable balance means there is money in the bank account.

Steps to prepare the BRS (starting with Cash Book balance):

1. Start with the Balance as per Cash Book.
2. Add items that have increased the Passbook balance or decreased the Cash Book balance but are not yet reflected in the other.
   • Cheques issued but not yet presented for payment.
   • Interest and dividends collected directly by the bank.
   • Amounts directly deposited by customers into the bank.
3. Less (Deduct) items that have decreased the Passbook balance or increased the Cash Book balance but are not yet reflected in the other.
   • Cheques deposited but not yet collected or credited by the bank.
   • Bank charges, interest on overdraft, and other direct debits by the bank.
   • Direct payments made by the bank on standing instructions.
   • Cheques deposited that were dishonoured.
4. The final result should be the Balance as per Passbook.

Dealing with overdrafts

An overdraft occurs when a bank account has a negative balance, meaning the business has borrowed money from the bank. It is treated as a negative figure in the BRS.

• An overdraft is a credit balance in the Cash Book.
• An overdraft is a debit balance in the Passbook.

When preparing a BRS starting with an overdraft, the logic remains the same, but you are working with negative numbers. The goal is still to reconcile the two balances by accounting for all the differences.