Bank Reconciliation Statement and the Adjusted Cash Book: Step-by-Step Method

A business keeps its own record of its bank account in the cash book. The bank keeps another record and sends it as a statement. The two should agree, but they almost never do on the same day. Some differences are only timing, and some are items one side has not yet recorded, and some are mistakes. A bank reconciliation explains every difference and shows that the two records agree.

It is one of the most reliable ways to catch errors in the cash records and to find items the business did not know about, such as bank charges and bounced cheques.

Bank reconciliation is the highest-scoring topic in the past papers. A full bank reconciliation question appeared in nine of the 20 diets reviewed, usually for 20 marks with an adjusted cash book and a reconciliation statement, plus several Section A items. Read the cash book and banking procedures first.

This topic then covers the methods of payment that create the differences, why the balances differ, the adjusted cash book, both formats of the reconciliation statement, and overdrawn accounts. The next topic covers control accounts, which apply the same idea of reconciliation to receivables and payables.

Methods of payment behind the differences

A business can pay suppliers and receive money from customers in several ways. The methods matter because each reaches the bank at a different time and by a different route.

• Cash. Quite rare, except in smaller businesses.
• Cheques.
• Bank transfers. An amount transferred directly from the account of the payer to the account of another party on the payer’s instruction.
• Credit and debit cards. Once a sale is made, the business asks the card company to make the payment on behalf of the cardholder, and the card company then recovers the money from the cardholder.
• Online payments. Many businesses accept online payment for goods and services, usually by credit or debit card or through a third party such as PayPal.
• Standing order. An instruction that the account holder, the payer, gives to the bank to pay a set amount at regular intervals to the account of another party, the payee.
• Direct debit. A method in which the payee instructs its bank to collect funds from the payer’s account. The payer must first have told the bank to allow this.
• Banker’s draft. A cheque issued by a bank. The payer transfers funds to the bank, from its account or in cash, and the bank issues the draft, which the third party presents to a bank and is paid at once.

A standing order and a direct debit are both common for monthly payments. A Standing order pays the same amount on each date, because the payer tells the bank the amount. A Direct debit can collect a different amount each time, because the payer allows the bank to pay whatever the payee asks for.

Banker’s drafts have advantages for the payee: payment is immediate, so there is no wait for a cheque to clear, and the risk is lower because a bank will pay. They remain useful for large commercial purchases, especially in new trading relationships, although electronic transfers are reducing their importance.

The cash at bank account and the bank statement

Periodically the totals from the cash book are posted to the general ledger. One of these accounts is the cash account, which for this topic is the Cash at bank account (a business usually also has a cash in hand account for cash it physically holds, but most receipts and payments go through the bank).

The balance on this account is the amount the business believes it has in the bank, a debit balance, or the size of its overdraft, a credit balance. Often it is called the balance on the cash book. That label can confuse, but the reconciliation always agrees the balance on the cash at bank account with the balance on the bank statement.

The bank sends regular Statements. A statement lists every transaction the bank has recorded in the account since the previous statement, and the current balance. Many businesses now have online access, so they can see the statement at any time. A reconciliation compares two sets of records, here the two balances, and explains the reason for any difference.

A bank reconciliation does this at regular intervals, for example at the end of each month. It is a useful check on the accuracy of the cash records, because some differences are transactions the business has not yet accounted for, or errors that must be corrected.

Why the balances differ

The balance in the cash at bank account and the balance on the statement will rarely be the same on a given date. Four causes are possible.

1. Items in the cash book but not yet on the statement

These are timing differences. They arise when a transaction has been recorded in the cash book but the bank has not yet processed it.

• Outstanding lodgements, also called uncredited or uncleared lodgements or cheques. Cheques from customers were recorded in the cash book and paid into the bank, but the bank has not yet processed them. Clearing can take two or three days or longer.
• Unpresented cheques. Cheques paid to suppliers were recorded as payments, but the supplier has not yet presented them to its bank, or the bank has not yet deducted the amount.

There is no error or omission in the cash book, and no entry is needed. The bank will process the items in time.

2. Items on the statement not in the cash book

A business may not know of some items until the statement arrives. Examples are Bank charges, Interest on an overdrawn balance, a Customer’s cheque that the bank rejected (dishonoured), and a Bank transfer paid directly into the account. Background: examiners also set standing orders and direct debits paid by the bank, direct credits and dividends received by the bank, and interest received on a credit balance. The cash book must be amended for each of these.

When a cheque is dishonoured, the business reverses the entry it made when it thought it had been paid: Dr Receivables, Cr Cash at bank, and the customer’s account in the receivables ledger is debited. The business should then consider whether the receivable should be written off as a bad debt or covered by an allowance for doubtful debts.

3. Errors by the bank

Banks sometimes make mistakes. For example, the bank may credit or debit the wrong amount or the wrong account. The bank is told and asked to correct it. No entry is needed in the cash book.

4. Errors in the cash book

The reconciliation can reveal errors in the cash book, such as an amount wrongly entered, a column wrongly added, or a payment recorded on the wrong side. They must be corrected when found.

The bank’s point of view

The statement shows the bank’s view, which is the opposite of yours. When the business has money in the bank, that is an asset and a debit balance in its own books. The bank owes the money to the customer, so on the statement it is a Credit balance.

When the account is overdrawn, the business owes the bank, which is a liability and a credit balance in the business’s books. For the bank the overdraft is a receivable, an asset, so the statement shows a Debit balance, for example ₦5,250 Dr. A “debit balance” on a statement therefore means an overdraft.

The same reversal applies to the entries: a cash deposit appears as a credit entry on the statement and a payment out as a debit.

The adjusted cash book

The learning outcomes of the chapter include posting journal entries to correct cash book errors found by the reconciliation. Background: the examiner asks for this as an Adjusted cash book, which starts with the balance in the cash book, makes every correction needed, and ends with the corrected balance.

Every item that appears on the statement but not in the cash book, and every error in the cash book, goes in it. Timing differences and bank errors do not.

If a cheque was stale, that is, issued over six months before and now out of date. Has been replaced, the original payment is reversed in the cash book and the cheque is dropped from the list of unpresented cheques.

The bank reconciliation statement

The purpose of the bank reconciliation statement is to show that the balance in the cash at bank account agrees with the balance on the statement after allowing for timing differences and after correcting omissions and errors. There is no single correct format. A useful approach is to correct the cash book balance for omissions and errors, then adjust the balance on the statement for uncredited lodgements and unpresented cheques. The two results must agree.

Background: the steps. November 2017 asked for the steps. They are:

1. Compare the cash book with the statement, line by line, and tick the items that appear in both.
2. List the items that appear in only one of them.
3. Correct the cash book for items on the statement that are not in the cash book, and for errors, to get the adjusted cash book balance.
4. Take the bank statement balance, add the outstanding lodgements, deduct the unpresented cheques and correct any bank error. The result must equal the adjusted cash book balance.

Format 1: adjust the cash book, then reconcile to the statement

One illustration has a cash at bank debit balance of ₦4,500. Outstanding lodgements are ₦2,000, unpresented payments are ₦6,200, bank charges are ₦700, a customer’s cheque of ₦300 is dishonoured, and the statement balance is ₦7,700. The corrected cash at bank figure is ₦4,500 − ₦700 − ₦300 = ₦3,500. From the statement: ₦7,700 + ₦2,000 − ₦6,200 = ₦3,500. The two agree.

Format 2: start from the adjusted cash book

This approach corrects the cash book and then shows the differences between that figure and the statement balance. The corrected figure is ₦3,500 as above. Deduct outstanding lodgements (₦2,000) and add unpresented cheques (₦6,200) to reach the statement balance: ₦3,500 − ₦2,000 + ₦6,200 = ₦7,700. Either format is acceptable, but follow the starting point the question gives. When a question says “starting with the balance as per the bank statement”, use Format 1.

Reconciliation when the account is overdrawn

When there is an overdraft, the cash book balance is a credit and the statement shows a debit. Make a negative balance clear by putting brackets around it. The layout is the same, and the signs follow.

Another example has a statement overdraft of ₦20,000 and a cash book credit balance of ₦12,100. Lodgements not yet cleared are ₦24,300, cheques not yet presented are ₦18,900, bank charges are ₦1,300, and a customer’s cheque of ₦1,200 was dishonoured. The charges and the dishonoured cheque are not yet in the cash book. Corrected cash at bank: (₦12,100) − ₦1,300 − ₦1,200 = (₦14,600). From the statement: (₦20,000) + ₦24,300 − ₦18,900 = (₦14,600). The two agree.

Alternatively, from the corrected figure (₦14,600), deduct the lodgements (₦24,300) and add the unpresented cheques (₦18,900) to reach (₦20,000).

The ideas in more depth

Which items change the cash book and which do not

This is the most common point of confusion, and the examiner tests it in Section A. Ask whether the business already knows about the item. If it was recorded in the cash book and is waiting for the bank (outstanding lodgements, unpresented cheques), the item is a timing difference and appears only in the reconciliation.

If the bank recorded it and the business did not (charges, standing orders, direct credits, dishonoured cheques), the cash book must be corrected. A bank error is corrected by the bank. A cash book error is corrected in the cash book.

Why the signs flip for the bank

The bank is a separate business with its own books. For it, your deposit is a liability and your overdraft an asset. If you remember that a statement always shows what the bank is thinking, the debit and credit signs of the statement stop being confusing.

Adding and deducting in the right direction

From the statement balance, Add outstanding lodgements and Deduct unpresented cheques. The lodgements are money the bank will credit, and the cheques are money it will pay out. From the cash book balance to the statement, the directions are reversed.

Where the corrected balance goes

The adjusted cash book balance is the figure for the statement of financial position, as cash at bank or, if negative, as a bank overdraft within current liabilities. The unpresented cheques and lodgements are already in it.

Why do it regularly

Regular reconciliation shows errors early, makes sure the business knows about charges and bounced cheques, helps detect fraud, and keeps the cash balance used in the accounts reliable. November 2021 and November 2022 each asked for two reasons.

Sources and references

• The adjusted cash book, the table of entries, the steps and the reasons for regular reconciliation are background taken from the past-paper questions listed below.

Worked example: Garba Enterprises

1. Sort the items. Items 1 to 7 correct the cash book. Item 8 is a bank error. Items 9 and 10 are timing differences.
2. Adjusted cash book. Start with the balance of ₦185,000. Less bank charges 6,500 gives 178,500. Less the standing order 24,000 gives 154,500. Add the direct credit 38,000 gives 192,500. Add the dividend 12,000 gives 204,500. Less the dishonoured cheque 15,000 gives 189,500.
   The payment was overstated by 81,000 − 18,000 = 63,000, so add 63,000 to give 252,500.
   Add the undercast receipts 20,000 to give ₦272,500.
3. Journals. Dr Bank charges 6,500, Cr Bank. Dr Insurance 24,000, Cr Bank. Dr Bank 38,000, Cr Receivables. Dr Bank 12,000, Cr Dividend income. Dr Receivables 15,000, Cr Bank. Dr Bank 63,000, Cr Payables or the supplier account (or the account debited). Dr Bank 20,000, Cr the account that should have received the receipts total.
4. Reconciliation from the statement. Balance per bank statement 262,500. Deduct the bank error 25,000, which the bank must reverse, giving 237,500.
   Add outstanding lodgements 90,000 and deduct unpresented cheques 55,000: 237,500 + 90,000 − 55,000 = 272,500.
5. Check. The adjusted cash book of ₦272,500 equals the corrected statement balance of ₦272,500.
6. Overdraft version. A cash book shows an overdraft of (₦82,000). Bank charges of ₦3,500 and a standing order of ₦9,000 have not been entered.
   Adjusted: (82,000) − 3,500 − 9,000 = (₦94,500).
   Lodgements not cleared are ₦28,000 and unpresented cheques ₦40,000.
   The statement balance is S, where S + 28,000 − 40,000 = (94,500), so S = (₦82,500), an overdraft of ₦82,500 which the statement shows as a debit.

Common mistakes in the exam

• Adjusting the cash book for outstanding lodgements and unpresented cheques. They are timing differences and appear only in the reconciliation.
• Adding the unpresented cheques and deducting the outstanding lodgements when starting from the statement. The directions are the opposite.
• Adding items such as bank charges to the statement balance. Bank charges are corrected in the cash book.
• Forgetting that a dishonoured cheque reduces the cash book balance.
• Mixing up the bank’s debit and credit. A credit balance on the statement means money in the bank.
• Correcting a bank error in the cash book. The bank corrects it.
• Failing to show the adjusted cash book balance when the question asks for it, or not agreeing the final balances.
• Losing track of signs when the account is overdrawn. Use brackets for negative balances.

Quick revision

• Four causes of difference: timing, items on the statement not in the cash book, bank errors, cash book errors.
• Timing differences: outstanding lodgements and unpresented cheques. No entry.
• Adjust the cash book for charges, interest, standing orders, direct debits and credits, dishonoured cheques, dividends and cash book errors.
• From the statement: add outstanding lodgements, deduct unpresented cheques, correct bank errors. The result equals the adjusted cash book.
• Bank statement credit balance: money in the bank. Debit balance: overdraft.
• Dishonoured cheque: Dr Receivables, Cr Bank.
• Standing order: same amount, payer instructs. Direct debit: payee collects, amounts vary.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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