Bank Reconciliation Statement — Study Notes

1. Introduction

A business maintains a bank account and keeps a record of all its bank transactions in the bank column of its cash book. At the same time, the bank also maintains an account for the business and sends a statement or pass book to the business showing the balance of its account. In an ideal situation, the balance shown by the cash book and the balance shown by the pass book should be identical. In practice, however, the two balances usually differ, and the statement prepared to explain this difference is called the Bank Reconciliation Statement (BRS).

The BRS is not an account but a statement which reconciles the cash book balance with the pass book balance as on a particular date. It is prepared to identify the causes of the difference and to verify that both records are correct. A favourable balance means the bank balance in the cash book is a debit balance and the pass book shows a credit balance. An unfavourable balance, called an overdraft, appears as a credit balance in the cash book and a debit balance in the pass book.

2. Causes of Difference between Cash Book and Pass Book

The difference between the two balances arises mainly because of two reasons: (a) timing differences in the recording of transactions, and (b) errors in the cash book or the pass book. The major causes are:

1. Cheques issued but not presented for payment: When the business issues a cheque, it immediately credits the bank column of the cash book. The bank, however, reduces the balance only when the cheque is presented for payment. Until then the pass book balance is higher.

2. Cheques deposited but not collected: When a cheque is deposited into the bank, the business debits the bank column at once, but the bank credits the account only when the cheque is cleared. Until then the cash book balance is higher.

3. Amount directly credited by the bank: Interest on the bank deposit, dividends collected by the bank, and amounts collected by the bank on behalf of the business are credited in the pass book without the knowledge of the business, making the pass book balance higher.

4. Amount directly debited by the bank: Bank charges, interest on overdraft and insurance premium paid by the bank are debited in the pass book without being recorded in the cash book, making the pass book balance lower.

5. Cheques dishonoured: A cheque deposited earlier may be dishonoured, and the bank debits the account. The business may not have recorded the dishonour.

6. Errors in the cash book or pass book: Wrong entries, omission of entries or wrong balancing may create differences.

3. Favourable and Unfavourable Balances

• A favourable balance is the normal bank balance which appears as a debit balance in the cash book and as a credit balance in the pass book. It means the business has money in the bank.
• An unfavourable balance is the overdraft, which appears as a credit balance in the cash book and as a debit balance in the pass book. It means the business has withdrawn more money than it had in the bank, and the bank is financing the deficit.

4. Preparation of the Bank Reconciliation Statement

There are two main methods of preparing the BRS:

Method 1: Starting from the Cash Book Balance

Adjust the cash book balance by adding items that increase the pass book balance and deducting items that decrease it. A correct BRS must give the same answer as the pass book balance.

Method 2: Starting from the Pass Book Balance

Adjust the pass book balance in the reverse manner to arrive at the cash book balance.

Rules to Remember

Worked Example

The cash book of a business shows a debit balance of Rs 50,000 on 31 March. - Cheques issued but not presented: Rs 8,000 - Cheques deposited but not collected: Rs 12,000 - Interest credited by the bank: Rs 500

Bank Reconciliation Statement as on 31 March:

5. Advantages of the Bank Reconciliation Statement

1. It brings out the causes of difference between the cash book and pass book balances.
2. It helps in verifying the accuracy of both the cash book and the pass book.
3. It helps in detecting errors, frauds and embezzlements by the cashier.
4. It gives a correct picture of the bank balance for financial planning.
5. It helps in detecting any delay in the collection of cheques or the presentation of cheques for payment.
6. It checks the working of the cashier and provides an internal check on cash transactions.

6. Points to Note in BRS

• If the cash book shows a credit balance, it is an overdraft and the BRS should be prepared starting from the overdraft.
• Interest allowed by the bank increases the pass book balance.
• Interest charged by the bank decreases the pass book balance.
• Cheques issued earlier but still outstanding reduce the cash book balance but not the pass book balance.
• A BRS is prepared on a specific date and is not an account.

Quick Revision Tables

Table 1: Items that Increase or Decrease the Pass Book Balance

Table 2: Starting from Cash Book Balance

Table 3: Favourable vs Unfavourable Balance

Mind Map

Important Diagrams (SVG)

Diagram 1: Causes of Difference between Cash Book and Pass Book

Diagram 2: Adjusting the Cash Book Balance

Common Mistakes

1. Students add cheques deposited but not collected when starting from the cash book balance; they must be deducted because the cash book already includes them.
2. Direct credits by the bank such as interest are deducted instead of being added to the cash book balance.
3. A cash book credit balance (overdraft) is treated like a debit balance, giving a wrong final figure.
4. Bank charges are added when they should be deducted from the cash book balance.
5. Students treat the BRS as an account and balance it, while it is only a statement and needs no balancing.
6. Dishonoured cheques are ignored altogether, while they reduce the balance in the pass book.
7. The favourable and unfavourable balance positions in the cash book and pass book are interchanged; a debit in the cash book is a credit in the pass book.

Exam Tips

1. Always write the opening sentence naming the date of the BRS and the starting balance clearly.
2. State the rules in one line: "Add items that increase the pass book balance and deduct items that decrease it when starting from the cash book balance."
3. Show the working of at least two items, such as cheques issued and direct credits, to demonstrate the logic.
4. Prepare the BRS in a table format with Particulars and Amount columns.
5. If the starting balance is an overdraft, clearly mention it and adjust the items with the opposite treatment.
6. Give the advantage that the BRS acts as an internal check and helps in detecting frauds.
7. Practise both methods, starting from the cash book balance and from the pass book balance, for the same data.

Conclusion

The Bank Reconciliation Statement is an important tool for verifying the accuracy of the bank records of a business. The difference between the cash book and the pass book arises mainly because of the timing of recording and direct entries made by the bank. By adding and deducting the appropriate items, the BRS reconciles the two balances and provides a correct picture of the bank position. It also acts as an internal check, helping in the detection of errors and frauds and in the efficient management of cash.