Bank Reconciliation Statement

Definition and Explanation:

From time to time the balance shown by the bank and cash column of the cash book required to be checked. The balance shown by the cash column of the cash book must agree with amount of cash in hand on that date. Thus reconciliation of the cash column is simple matter. If it does not agree it means that either some cash transactions have been omitted from the cash book or an amount of cash has been stolen or lost. The reason for the difference is ascertained and cash book can be corrected. So for as bank balance is concerned, its reconciliation is not so simple. The balance shown by the bank column of the cash book should always agree with the balance shown by the bank statement, because the bank statement is a copy of the customer's account in the banks ledger. But the bank balance as shown by the cash book and bank balance as shown by the bank statement seldom agree. Periodically, therefore, a statement is prepared called bank reconciliation statement to find out the reasons for disagreement between the bank statement balance and the cash book balance of the bank, and to test whether the apparently conflicting balance do really agree.

Causes of Disagreement Between Bank statement and Cash book:

Usually the reasons for the disagreement are:

1. That our banker might have allowed interest which have not yet been entered in our cash book.
2. That our banker might have debited our account for any such item as interest on overdraft, commission for collecting cheque, incidental charges etc., which we have not entered in the cash book.
3. That some of the cheque which we drew and for which we credited our bank account prior to the date of closing, were not presented at the bank and therefore, not debited in the bank statement.
4. That some cheques or drafts which we have paid into bank for collection and for which we debited our bank account, were not realised within the due date of closing and therefore, not credited by the bank.
5. The banker might have credited our account with amount of a bill of exchange or any other direct payment into bank and the same may not have been entered in the cash book.
6. That cheques dishonoured might have been debited in the bank statement but have not been given effect to in our books.

How to Prepare a Bank Reconciliation Statement:

To prepare the bank reconciliation statement, the following rules may be useful for the students:

1. Check the cash book receipts and payments against the bank statement.
2. Items not ticked on either side of the cash book will represent those which have not yet passed through the bank statement.
3. Make a list of these items.
4. Items not ticked on either side of the bank statement will represent those which have not yet been passed through the cash book.
5. Make a list of these items.
6. Adjust the cash book by recording therein those items which do not appear in it but which are found in the bank statement, thus computing the correct balance of the cash book.
7. Prepare the bank reconciliation statement reconciling the bank statement balance with the correct cash book balance in either of the following two ways:
   
   (i)  First method (Starting with the cash book balance)
   (ii) Second method (Starting with the bank statement balance)

First Method (Starting With the Cash Book Balance):

(a)	If the cash balance is a debit balance, deduct from it all cheques, drafts etc., paid into the bank but not collected and credited by the bank and added to it all cheques drawn on the bank but not yet presented for payment. The new balance will agree with bank statement.
(b)	If the bank balance of the cash book is a credit balance (overdraft), add to it all cheques, drafts, etc., paid into the bank but not collected by the bank and deduct from it all cheques drawn on the bank but not yet presented for payment. The new balance will then agree with the balance of the bank statement.

Second Method (Starting With the Bank Statement Balance):

(a)	If the bank statement balance is a debit balance (an overdraft), deduct from it all cheques, drafts, etc., paid into bank but not collected and credited by the bank and add to it all cheques drawn on the bank but not yet presented for payment. The new balance will then be agree with the balance of the cash book.
(b)	If the bank statement balance is a credit balance (in favor of the depositor), add to it all cheques, drafts, etc., paid into the bank but not collected and credited by the bank and deduct from it all cheques drawn on the bank but not yet presented for payment. The new balance will agree with the balance of the cash book.

Alternatively:

Information	Cash book shows debit balance i.e., bank statement shows credit balance		Cash book shows credit balance i.e., bank statement shows debit balance
	CB to BS	BS to CB	CB to BS	BS to CB
Cheques issued but not presented in the bank	Add	Less	Less	Add
Cheques paid into bank but not collected and credited by the bank	Less	Add	Add	Less
Credit, if any in the bank statement	Add	Less	Less	Add
Debit, if any in the bank statement	less	Add	Add	Less

Example 1:

On December 31 1991 the balance of the cash at bank as shown by the cash book of a trader was $1,401 and the balance as shown by the bank statement was 2,253.

On checking the bank statement with the cash book it was found that a cheque for $116 paid in on the 31st December was not credited until the 1st January, 1992 and the following cheques drawn prior to 31 December were not presented at the bank for payment until the 5th January 1992. Rashid & Sons $29, Bashir & Co. $801, MA Jalil $6, Khalid Bros., $132.

Prepare a statement recording the two balances:

Solution:

Bank Reconciliation Statement on 31st December 1991
First Method:
Balance as per cash book - Dr.		1,401
Less cheques paid in but not collected		116
		1,285
Add cheques drawn but not presented:
Rashid & Sons	29
Bashir & Co.	801
MA Jalil	6
Khalid Bros.	132	968
Balance as per bank statement - Cr.		2,253
Second Method:
Balance as per bank statement - Cr.		2,253
Less cheques drawn but not presented		968
		1,285
Add cheques paid in but not collected		116
Balance as per cash book - Dr.		1,401

Example 2:

On 31st March, 1991 the bank statement showed the credit balance of $10,500. Cheque amounting to $2,750 were deposited into the bank but only cheque of $750 had not been cleared up to 31st March. Cheques amounting to $3,500 were issued, but cheque for $1,200 had not been presented for payment in the bank up to 31st March. Bank had given the debit of $35 for sundry charges and also bank had received directly from customers $800 and dividend of $130 up to 31st March. Find out the balance as per cash book.

Solution:

Bank Reconciliation Statement as on 31st March, 1991

Balance as per bank statement - Cr.	10,500
Add cheques deposited but not credited	750
	11,250
Less cheques issued but not presented	1,200
	10,050
Add bank charges made by the bank	35
	10,085
Less omission in cash book ($800 + $130)	930
Balance as per cash book	9,155

Note:

1. Charges made by the bank $35 have not been recorded in the cash book, therefore, the balance in cash book is more. Add to bank statement balance also.
2. Dividend and amount from customers received by the bank have not been recorded in the cash book. Therefore, in the cash book there is no entry of $930 (800 + 130). Deduct from the bank statement balance to adjust it according to cash book balance.

Inventories basics and methods

Inventory Valuation Methods

First-in First-out (FIFO)    Last-in First-out (LIFO)    Moving Average Method    Weighted Average Method    Dollar Value LIFO

FIFO, LIFO, Perpetual, Periodic

Under FIFO, it is assumed that items purchased first are sold first.

Under LIFO, it is assumed that items purchased last are sold first.

Perpetual inventory system updates inventory accounts after each purchase or sale.

Periodic inventory system records inventory purchase or sale in "Purchases" account.       "Purchases" account is updated continuously, however, "Inventory" account is updated on a periodic basis, at the end of each accounting period (e.g., monthly, quarterly)

Example 1 (Company A)

Inventory transactions in May 2010. Date Transactions Units Purchased (Sold) Unit Cost Inventory Units May 1 Beginning Inventory 700 $10 700 May 3 Purchase 100 $12 800 May 8 Sale (500) ?? 300 May 15 Purchase 600 $14 900 May 19 Purchase 200 $15 1,100 May 25 Sale (400) ?? 700 May 27 Sale (100) ?? 600 May 31 Ending Inventory   ??      Ending Inventory = Beginning Inventory + Units Purchased - Units Sold    = 700 + 900 - 1,000 = 600 comparison of FIFO and LIFO    FIFO vs. LIFO   Cost of goods sold Cost of ending inventory Beginning inventory + Purchases FIFO, Perpetual $11,000 $8,600 $19,600 LIFO, Perpetual $12,400 $7,200 $19,600 FIFO, Periodic $11,000 $8,600 $19,600 LIFO, Periodic $13,600 $6,000 $19,600 Moving average, Perpetual $11,705 $7,895 $19,600 Weighted average, Periodic $12,250 $7,350 $19,600    Example 1 shows that per unit purchase cost increases continuously throughout the period ($10 --> $12 --> $14 --> $15).    FIFO assumes that items purchased FIRST are sold FIRST.       --> Cost of old purchase is recorded as cost of goods sold.       --> Cost of recent purchases is recorded as cost of ending inventory.       --> When price goes up, old price is lower than recent price.       --> Cost of goods sold is lower for FIFO. ($11,000 < $12,400)       --> Cost of ending inventory is higher for FIFO. ($8,600 > $7,200)    LIFO assumes that items purchased LAST are sold FIRST.       --> Cost of recent purchase is recorded as cost of goods sold.       --> Cost of old purchases is recorded as cost of ending inventory.       --> When price goes up, recent price is higher than old price.       --> Cost of goods sold is higher for LIFO. ($12,400 > $11,000)       --> Cost of ending inventory is lower for LIFO. ($7,200 < $8,600)     FIFO, Perpetual Cost of Goods Sold = FIFO, Periodic Cost of Goods Sold             ($11,000 = $11,000)     FIFO, Perpetual Inventory Cost = FIFO, Periodic Inventory Cost             ($8,600 = $8,600)     LIFO, Perpetual Cost of Goods Sold < LIFO, Periodic Cost of Goods Sold             ($12,400 < $13,600)     LIFO, Perpetual Inventory Cost > LIFO, Periodic Inventory Cost             ($7,200 > $6,000)     Moving average, Perpetual Cost of Goods Sold          < Weighted average, Periodic Cost of Goods Sold             ($11,750 < $12,250)     Moving average, Perpetual Inventory Cost           > Weighted average, Periodic Inventory Cost             ($7,895 > $7,350)

basic concepts of inventories

First-in First-out (FIFO)
Under FIFO, it is assumed that items purchased first are sold first.
Last-in First-out (LIFO)
Under LIFO, it is assumed that items purchased last are sold first.
Perpetual Inventory System
Perpetual inventory system updates inventory accounts after each purchase or sale.       Inventory subsidiary ledger is updated after each transaction.       Inventory quantities are updated continuously.
Periodic Inventory System
Periodic inventory system records inventory purchase or sale in "Purchases" account.       "Purchases" account is updated continuously, however, "Inventory" account is updated on a periodic basis, at the end of each accounting period (e.g., monthly, quarterly)       Inventory subsidiary ledger is not updated after each purchase or sale of inventory.       Inventory quantities are not updated continuously.       Inventory quantities are updated on a periodic basis.

Why does LIFO usually produce a lower gross profit than FIFO?

LIFO usually produces a lower gross profit than FIFO only because the costs of the goods purchased or produced have been increasing over the past decades. Since LIFO assigns the latest costs of the goods purchased or produced to the cost of goods sold, the rising costs mean a higher amount of cost of goods sold on the income statement. That in turn means a lower gross profit than assigning the first or oldest costs to the cost of goods sold under FIFO.
If costs were to steadily decrease over several years, LIFO would result in a higher gross profit than FIFO. The reason is that LIFO would be assigning the latest costs (which will be lower costs than the first or oldest costs) to the cost of goods sold on the income statement. That in turn means a higher gross profit than under the FIFO cost flow assumption

what is depreciation?

Depreciation is the assigning or allocating of a plant asset’s cost to expense over the accounting periods that the asset is likely to be used. For example, if a business purchases a delivery truck with a cost of $100,000 and it is expected to be used for 5 years, the business might have depreciation expense of $20,000 in each of the five years. (The amounts can vary depending on the method and assumptions.)

In our example, each year there will be an adjusting entry with a debit to Depreciation Expense for $20,000 and a credit to Accumulated Depreciation for $20,000. Since the adjusting entries do not involve cash, depreciation expense is referred to as a noncash expense.

Why does LIFO usually produce a lower gross profit than FIFO?

LIFO usually produces a lower gross profit than FIFO only because the costs of the goods purchased or produced have been increasing over the past decades. Since LIFO assigns the latest costs of the goods purchased or produced to the cost of goods sold, the rising costs mean a higher amount of cost of goods sold on the income statement. That in turn means a lower gross profit than assigning the first or oldest costs to the cost of goods sold under FIFO.
If costs were to steadily decrease over several years, LIFO would result in a higher gross profit than FIFO. The reason is that LIFO would be assigning the latest costs (which will be lower costs than the first or oldest costs) to the cost of goods sold on the income statement. That in turn means a higher gross profit than under the FIFO cost flow assumption.

Calculating a Missing Amount within Owner’s Equity

The income statement for the calendar year 2010 will explain a portion of the change in the owner’s equity between the balance sheets of December 31, 2009 and December 31, 2010. The other items that account for the change in owner’s equity are the owner’s investments into the sole proprietorship and the owner’s draws (or withdrawals). A recap of these changes is the statement of changes in owner’s equity. Here is a statement of changes in owner’s equity for the year 2010 assuming that the Accounting Software Co. had only the eight transactions that we covered earlier.

Accounting Software Co.
Statement of Changes in Owner’s Equity
For the Year Ended December 31, 2010
Owner’s Equity at December 31, 2009	$	0
Add: Owner’s Investment		10,000
Net Income		180
Subtotal		10,180
Deduct: Owner’s Draws		100
Owner’s Equity at December 31, 2010	$	10,080

Example of Calculating a Missing Amount
The format of the statement of changes in owner’s equity can be used to determine one of these components if it is unknown. For example, if the net income for the year 2010 is unknown, but you know the amount of the draws and the beginning and ending balances of owner’s equity, you can calculate the net income. (This might be necessary if a company does not have complete records of its revenues and expenses.) Let’s demonstrate this by using the following amounts.

Assets as of December 31, 2009	$100,000
Liabilities as of December 31, 2009	40,000
Assets as of December 31, 2010	128,000
Liabilities as of December 31, 2010	34,000
Owner investment in business in 2010	10,000
Owner draws in 2010	40,000

Step 1.
The owner’s equity at December 31, 2009 can be computed using the accounting equation:

Assets	=	Liabilities + Owner’s Equity
$100,000	=	$40,000 + Owner’s Equity
$100,000–$40,000	=	Owner’s Equity
$60,000	=	Owner’s Equity at Dec. 31, 2009

Step 2.
The owner’s equity at December 31, 2010 can be computed as well:

Assets	=	Liabilities + Owner’s Equity
$128,000	=	$34,000 + Owner’s Equity
$128,000–$34,000	=	Owner’s Equity
$94,000	=	Owner’s Equity at Dec. 31, 2010

Step 3.
Insert into the statement of changes in owner’s equity the information that was given and the amounts calculated in Step 1 and Step 2:

Owner’s Equity at December 31, 2009	$	60,000	(Step 1)
Add: Owner’s Investment	+	10,000	(given)
Net Income	+	?
Subtotal		?
Deduct: Owner’s Draws	–	40,000	(given)
Owner’s Equity at December 31, 2010	$	94,000	(Step 2)

Step 4.
The “Subtotal” can be calculated by adding the last two numbers on the statement: $94,000 + $40,000 = $134,000. After this calculation we have:

Owner’s Equity at December 31, 2009	$	60,000	(Step 1)
Add: Owner’s Investment	+	10,000	(given)
Net Income	+	?
Subtotal		134,000	(Step 4)
Deduct: Owner’s Draws	–	40,000	(given)
Owner’s Equity at December 31, 2010	$	94,000	(Step 2)

Step 5.
Starting at the top of the statement we know that the owner’s equity before the start of 2010 was $60,000 and in 2010 the owner invested an additional $10,000. As a result we have $70,000 before considering the amount of Net Income. We also know that after the amount of Net Income is added, the Subtotal has to be $134,000 (the Subtotal calculated in Step 4). The Net Income is the difference between $70,000 and $134,000. Net income must have been $64,000.



Step 6.
Insert the previously missing amount (in this case it is the $64,000 of net income) into the statement of changes in owner’s equity and recheck the math:

Owner’s Equity at December 31, 2009	$	60,000	(Step 1)
Add: Owner’s Investment	+	10,000	(given)
Net Income	+	64,000	(Step 5)
Subtotal		134,000	(Step 4)
Deduct: Owner’s Draws	–	40,000	(given)
Owner’s Equity at December 31, 2010	$	94,000	(Step 2)

Since the statement is mathematically correct, we are confident that the net income was $64,000.