Effect of Dishonoured Cheque in Journal Entry

When a cheque given by us is dishonoured, it means that the bank has refused to honor the payment due to various reasons such as insufficient funds, a mismatch in signatures, or a stopped payment request. This has significant implications on the financial records of a business, and the following journal entries need to be recorded to reflect the dishonoured cheque:

1. Initial journal entry for issuing the cheque:
- Debit: Accounts Payable (or the relevant expense or liability account)
- Credit: Bank (or Cash) account

2. Journal entry to record the dishonoured cheque:
- Debit: Accounts Payable (or the relevant expense or liability account)
- Credit: Bank (or Cash) account

Explanation:

When a cheque is issued, it is recorded as a decrease in the bank account and an increase in the accounts payable (or the relevant expense or liability account). This reflects the intention to make a payment and the liability of the business to the recipient.

However, when the cheque is dishonoured, the bank account needs to be adjusted back to its original amount, and the liability of the business to the recipient needs to be reinstated. This is done by reversing the initial journal entry through a debit to the accounts payable (or the relevant expense or liability account) and a credit to the bank account.

Impact on Financial Statements:

The dishonoured cheque has the following impacts on the financial statements:

1. Balance Sheet:
- The bank account balance will decrease by the amount of the dishonoured cheque, reducing the overall liquidity of the business.
- The accounts payable (or the relevant expense or liability account) will decrease by the same amount, reflecting the reversal of the liability.

2. Income Statement:
- If the dishonoured cheque was related to an expense, such as a supplier payment, the expense will need to be adjusted accordingly. This will decrease the net income of the business.

3. Cash Flow Statement:
- The dishonoured cheque will affect the cash flow from operating activities section, as it represents a reduction in the cash inflow that was initially recorded.

Conclusion:

The dishonoured cheque has a significant impact on the financial records of a business. By recording the necessary journal entries, the company can accurately reflect the reversal of the payment and its impact on the financial statements. This ensures the accuracy of the financial records and provides transparency in the company's financial position.