ICAI Notes 3, Bank Reconciliation Statement- 1 - CA Foundation PDF Download

Learning Objectives 

After studying this chapter, you will be able to :

• Learn the design of a Bank Pass Book.
• Understand the reasons for difference between Cash Book balance and Pass Book balance and try to ascertain the amount of such differences.
• Learn, how to resolve such difference in a systematic manner.
• Try to understand the purpose for preparing the bank reconciliation statement and its utility.

1. INTRODUCTION

Banks are essential institutions in a modern society. With the increase in volume of trade, commerce and business, business entities faced difficulty in transacting in cash for each business activity. They discovered that dealing through bank, on regular basis, would be the better and safer option and finally large business entities switched over to banking transactions instead of dealing in cash. Now-a-days, most of the transactions of the business are done through bank whether it is a receipt or a payment. Rather, it is legally necessary to operate the transactions through bank after a certain limit. A Bank accepts from people, in general, deposits in various forms, and lends funds to those who need; it also invests some funds in profitable investments. Thus money which would have been otherwise idle is put to use and is made available to those who need it. Those who deposit the money are able to withdraw it according to the settled terms and conditions. Apart from receiving deposits from and handling cash transactions on behalf of its customers, the bank also renders some other useful services as indicated below :

(i) The bank discounts promissory notes or hundies, i.e., it enables a customer to receive the cash before the due date in consideration of a small charge called discount.

(ii) The bank allows overdraft to its good customers so that they can make payments even when they do not have sufficient balance at the bank. Of course the overdraft must be cleared later.

(iii) The bank gives loans for a year or so, to its customers so that they can continue their operations. Such financial assistance is of great help for business.

(iv) The bank on behalf of the customer collects the amount of dividend warrants or interest on securities etc.

(v) On instruction of the customer, the bank makes payments of insurance premium, rent etc. on the due dates.

(vi) The bank sells and purchases shares, debentures or government securities on behalf of its customers.

(vii) Money can be remitted to another place or persons through the bank at a low cost.

(viii)The bank in return, for a consideration, furnishes security or guarantee for its customers whose credit is good.

(ix) The bank also issues letter of credit or travellers cheque to facilitate commerce or travel.

2. BANK PASS BOOK

Bank pass book is merely a copy of the customer’s account in the book of a bank. The bank either sends periodical statements of account or gives a pass book to its customer in which all deposits and withdrawals made by the customer during the particular period is recorded. Both represent almost a copy of the ledger account of the customer in the books of the bank. Thus, it is the bank’s way of keeping the customers informed of the entries made in his account. It is the customer’s duty to check the entries and immediately inform the bank of any error that he may notice. The form of the pass book is given below :

The bank statement of account also has a similar form except that it is on loose sheets. The bank itself sends the statements to customers but it is the customer’s duty to send the pass book to the bank periodically so that it is written upto date. Business houses should also obtain at the end of the year a certificate from the bank duly stamped with revenue stamps, showing the balance which the bank has in the account of firm. The bank balance shown in the passbook is known as pass book balance for reconciliation purpose. The credit balance as per pass book at a particular point of time is the deposit made by the customer while debit balance as per pass book is the overdraft balance for the customer.

Students may note here that the nature of balance shown by pass book and cash book is quite different. The debit balance in the pass book represents the credit balance as per the cash book and vice-versa because the business enterprise treats the bank as a debtor/Trade receivable and bank treats the business enterprise as a creditor/Trade payable.

3. BANK RECONCILIATION STATEMENT

Bank reconciliation statement is a statement which reconciles the bank balance as per cash book with the balance as per bank pass book by showing all causes of difference between the two. Strictly speaking, there should be no difference between the balance shown by the pass book and the cash book. This is so, if all the entries are recorded in both. However, on a particular date it is possible that balances on both the books do not tally i.e., some entries may have been recorded in the cash book but not in the pass book and vice versa. After finding the reasons for non-agreement of the bank balances of pass book and cash book, efforts are made for their reconciliation. This reconciliation is prepared and presented in the form of a statement commonly known as Bank Reconciliation Statement.

4. IMPORTANCE OF BANK RECONCILIATION STATEMENT

Bank reconciliation statement is a very important tool for internal control of cash flows. It helps in detecting errors, frauds and irregularities occurred, if any, at the time of passing entries in the cash book or in the pass book, whether intentionally or unintentionally. Since frauds can be detected on the preparation of bank reconciliation statement therefore accountants are careful while preparing and maintaining the records of the business enterprise. Hence it works as an important mechanism of internal control. Following are the salient features of bank reconciliation statement :

(i) The reconciliation will bring out any errors that may have been committed either in the cash book or in the pass book;

(ii) Any undue delay in the clearance of cheques will be shown up by the reconciliation;

(iii) A regular reconciliation discourages the accountant of the bank from embezzlement. There have been many cases when the cashiers merely made entries in the cash book but never deposited the cash in the bank; they were able to get away with it only because of lack of reconciliation.

(iv) It helps in finding out the actual position of the bank balance.

5. ASCERTAINING THE CAUSES OF DIFFERENCE OF BANK BALANCE IN BANK COLUMN OF THE CASH BOOK AND IN PASS BOOK

The need for reconciliation arises only when there are differences in entries posted in cash book and pass book which in turn leads to difference in balances in the respective books. It may sometime happen that the balance shown by cash book and pass book is same but the entries posted do not tally with each other. In this case also there is a need to prepare bank reconciliation statement. Before reconciling the balances, one must ascertain the causes of differences. The difference in the balances of both the books can be because of the following two reasons :

1. Timing differences,
2. Differences arising due to errors in recording the entries.
Both of the above mentioned reasons can be explained in detail as follows :

5.1 TIMING DIFFERENCES

When the same entry is recorded in either of the book earlier and in the other book later, it is termed as timing difference. The timing difference may arise on account of the following : 

(i) Cheques issued but not presented for payment : The entry in the cash book is made immediately on issue of cheque but naturally entry will be made by the bank only when the cheque is presented for payment. There will thus be a gap of some days between the entry in the cash book and in the pass book.

Example : The balance as per Cash Book and Pass Book are  10,000. Cheque of   2,000 is issued but not presented for payment. On issues of cheque, the bank account in Cash Book is credited by  2,000 and so balance is reduced to  8,000. Whereas balance in the Pass Book remains  10,000 until the cheque is presented for payment.

(ii) Cheques paid into the bank but not cleared : As soon as cheques are sent to the bank, entries are made on the debit side of the bank column of the cash book. But usually banks credit the customer’s account only when they have received the payment from the bank concerned-in other words, when the cheques have been cleared. Again there will be some gap between the depositing of the cheques and the credit given by the bank.

Example : The balance as per Cash book and Pass Book are 12,000. Cheque of  3,000 is deposited but not cleared. When cheque is deposited into bank, the bank account in Cash Book is increased to  15,000, but the balance in the Pass Book remains  12,000 until the cheque is cleared.

(iii) Interest allowed by bank : If the bank has allowed interest to the customer, the entry will normally be made in the customer’s account and later shown in the pass book. The customer usually comes to know the amount of the interest by pursuing the pass book and only then he makes relevant entry in the cash book.

Example : The balance as per Cash Book and Pass Book are 10,000. The bank has allowed 1,000 interest on saving account to customer. Because of such interest balance of Pass Book is increased to  11,000. Whereas balance in the Cash Book remains10,000 until information reaches customer and he records such transation.

(iv) Interest and expenses charged by the bank : Like (iii) above, the interest charged by the bank and the amount of the bank charges are entered in the customer account and later in the pass book. The customer makes the required entries only after he sees the pass book.

(v) Interest and dividends collected by the bank : Sometimes investments are left with the bank in the safe custody; the bank itself sees to it that the interest or the dividend is collected on the due dates. Entries are made as indicated in (iii) above.
Example : The balance as per Cash Book and Pass Book are 15,000. The bank has colleted dividend of 2,000. On collection of dividend bank credits the amount to customer’s account, so balance in Pass Book is increased to  17,000. Whereas balance in the Cash Book remains 15,000 until the information of such dividend collection reaches the customer and he records such transaction.

(vi) Direct payments by the bank : The bank may be given standing instructions for certain payments such as for insurance premium. In this case also, the customer may come to know of the payment only on seeing the pass book. The entries in the pass book and in the cash book may thus be on different dates.

Example : The balance as per Cash Book and Pass Book of Mr. X are  20,000. The bank has instruction to pay insurance premium of 1,500 directly to insurance company at the end of each month. On payment of insurance premium bank debits the customer’s account by  1,500 so balance in Pass Book is decreased to18,500. Whereas balance in the Cash Book remains  20,000 until the information of such payment reaches the customer and he records such transaction.

(vii) Direct payment into the bank by a customer : If such a payment is received by the bank, it will be entered in the customer’s account and also in the pass book; the account holder may come to know of the amount only when he sees the pass book.

(viii)Dishonour of a bill discounted with the bank : If the bank is not able to receive payment on promissory notes discounted by it, it will debit the customer’s account together with the charges it may have incurred. The customer will naturally make the entry only when he sees the pass book.
Example : The balances as per Cash Book and Pass Book of Mr. X are  20,000. Mr. X deposited a cheque of  3,000 and debited to his bank account 3,000 immediately. But bank will credit X’s account on realization of amount. Now the cheque is dishonoured for non-payment. Bank charges 100 in this connection.
Thus, balance of Mr. X’s account in Pass Book stands 19,900 after this transaction while balance as per Cash Book stand 23,000. So Mr. X should deduct 3,000 the amount of dishonoured cheque, plus 100 the amount of bank charges for reconciliation.

(ix) Bills collected by the bank on behalf of the customer : If goods are sold, the documents may be sent through the bank. If the bank is able to collect the amount, it will credit the customer’s account. The customer may make the entry only on receiving the pass book.
All these timing differences will lead to difference in balances as shown by the cash book and the pass book.
Following is the table summarising in brief the timings of different transactions :

5.2 DIFFERENCES ARISING DUE TO ERRORS IN RECORDING THE ENTRIES

While recording the entries, errors can occur both in the cash-book and in the pass book. A bank rarely commits an error but, if it does, the balance shown in pass book will naturally differ from that shown in the cash book. Similarly, if any error is committed in the cash book then too the balance shown in it will differ from that of the pass book. Errors include omission of entry, wrong recording of amount, recording of entry on wrong side of the book, wrong totaling of account or wrong balancing of the book and recording of transactions of other party.
To illustrate this, we give below an extract from a pass book and the bank column of the cash book 

Messer’s Tall & Short, Faiz Bazar, New Delhi-110002 in accounts with

Punjab National Bank, Daryaganj, New Delhi-110002

It will be seen that whereas the pass book shows a credit balance of 2,430, the cash-book shows a debit balance of  2,370. We shall compare the two to establish the reasons for the difference.
If we compare the debit side of the cash book with the deposits column of the pass book, we find that the following cheques have been sent to the bank but not yet credited by the bank :

Had these two cheques been entered in the deposits column of the pass book also, the pass book balance of 3,820; i.e., 2,430 + 1,390.
Looking at the withdrawals column of the pass book and the credit side of the cash book, we find that under mentioned two cheques have not yet been paid by the bank :

Had these cheques been presented and paid, the balance at the bank would have been 2,310, i.e., 3,820 - 1,510 In addition to the above, two amounts appear in the withdrawals column of the pass book but not on the credit side of the cash book; these are  250 premium, and  10 bank charges. Had these amounts been omitted from the withdrawals also, the balance at the bank would have been  2,570, i.e., 2,310 + 260.

There is one amount 200, interest collected, which has been entered in the deposit column of the pass book but not on the debit side of the cash book: Omission of this amount from the pass book also would reduce the balance to 2,370, i.e.,  2,570 - 200. This agrees with the cash book balance.

This process shows that the difference between the two balance arise only because there are some entries made in the cash-book but not in the pass book and some entries which are made in the pass book but not in the cash book. A comparison of the two shows up such entries and then, on that basis, the reconciliation is prepared. To illustrate it again, let us proceed from the cash book balance to  2,370. Since cheques totalling  1,390 have not been entered in the pass book, let us assume that they are also omitted from the cash book, this will reduce the cash book balance to  980. Cheques totalling 1,510 have been entered on the credit side of the cash book but not in the pass book their omission from the cash book will increase the cash book balance to  2,490. Amounts totalling  260 have been entered in the withdrawals column of the pass book but not in the cash book; an entry on the credit side of the cash book for these amounts will reduce the balance to  2,230. The deposits column shows an entry of ` 200 not found on the debit side of the cash book; the entry made in the cash book will increase balance to ` 2,430 as shown in the pass book.

6. PROCEDURE FOR RECONCILING THE CASH-BOOK BALANCE WITH THE PASS-BOOK BALANCE

Before proceeding further students must understand that ‘Dr. balance as per cash book’ means deposits in the bank or cash at bank or Cr. balance as per pass book. Similarly ‘Cr. balance as per cash book’ means excess amount over deposits withdrawn by the account holder or overdraft balance or Dr. balance as per pass book.
It means that students can start bank reconciliation from any of the following four balances given in the question :

1. Dr. balance as per cash book
2. Cr. balance as per cash book
3. Dr. balance as per pass book
4. Cr. balance as per pass book

When causes of differences are known then students can start reconciliation by taking any of the balance stated above and proceed further with the causes. Given the causes of disagreement, the balance of the other book can be either more or less on account of the said causes. If the balance of the other book is more on account of the said causes then add the amount. If the balance of the other book is less on account of the said causes then subtract the amount. For example, if the reconciliation is initiated with Dr. balance as per the cash book and there is a cheque deposited in the bank but not cleared, then on account of non-clearance of the cheque, the Cr. balance of the pass book would be less. In this case, the amount of cheque should be subtracted from the cash book balance to arrive at the balance as per the pass book. Similarly, after making all the adjustments the balance as per the other book is obtained. It is necessary to note here that if a student starts from debit balance of cash book and after all adjustments the balance arrived is positive then it is known as Cr. balance as per the pass book and if the balance is negative then it is said to be Dr. balance as per the pass book and vice-versa.

But if causes of differences are not known then one has to compare the debit entries of cash book with the credit entries of the pass-book and vice-versa. The entries, which do not tally in the course, are the causes of difference in the balances of both the books. Once the causes are located their effects on both the books are analysed and then reconciliation statement is prepared to arrive at the actual bank balance.

In this procedure students should also take into care that whether opening balance of both the books at particular point of time from where the books are compared, tallies or not. If opening balances are not same then unticked items are divided into two categories i.e., one rela