ACCOUNTS & FINANCIAL MANAGEMENT

COURSE CODE: 20UCS607N

UNIT 3: FINAL ACCOUNTS AND BANK RECONCILIATION STATEMENT

BANK RECONCILIATION
We have studied the Cash Book which has two columns viz. Cash and Bank. The majority of
transactions get settled through cash or Bank. For cash received or paid, the effect in the cash
box is instant. The transactions settled through the medium of Bank (i.e. by way of cheque, pay
order, draft etc) take a little longer time. If customer pays by cheque, it is deposited in the Bank
who will sent it for clearance and then only it will be credited by the Bank into the A/c of
business entity. This may take about a week. Similarly, when a cheque is issued to supplier, he
will deposit in his Bank which in turn will clear it. Because of such time lag, there would be
difference in the records.

The records here would mean Cash Book (in books of business entity) and Pass Book
(maintained by the Bank). The contents of Bank Pass Book (or Bank statement) are exactly the
same as that of Cash Book with a mirror image effect. When cheques is received the entry in
books of accounts of business is

Bank A/c Dr
To customer A/c

For the Bank, this amount is collected through the clearing system and payable to the Business
Entity’s A/c. The entry in their books will be

Clearing A/c Dr
To Business Entity’s A/c

Hence they will show it as payable i.e. as a credit. Thus all debits in the Bank column of the
Cash Book will correspond to the credit entries in the Bank Passbook and all credits in the
Bank column of the Cash Book will correspond to the debit entries in the Bank Passbook. Due
to the time differences, these entries may not exactly match at a given point of time. This
necessitates that these two statements are reconciled regularly:

1) To identify differences
2) To know reasons for differences
3) To ensure the required entries are made in the books of accounts
4) To ensure that entries are made by the Bank in time.
A statement which is prepared to reconcile the causes of difference between Bank Balance as
per Cash Book and Bank Balance as per Pass Book/ Bank Statement is known as a Bank
Reconciliation statement.

It may be noted that before the final accounts are prepared, Bank Reconciliation is a must. It is
a very important preparatory step. If an entity has A/c with more than one Bank, all such A/cs
must be reconciled regularly i.e. weekly or monthly. In these days of internet Banking where
the Bank statements are available online, the reconciliation also can be an online activity. In
fact, modern accounting packages are equipped with automatic reconciliations. A Bank
statement is entered in the computer system (or a soft copy is uploaded) and then a programme
is run which will throw up the transactions leading to the differences.
Features of a Bank Reconciliation statement:
1. It is a statement.
2. It is not a part of the process of Accounts.
3. It is prepared to reconcile the causes of difference between the Bank balance as per Cash
Book and the Bank balance as per Pass Book.
4. It can be prepared at any time during the financial year, as and when it is required.
5. Since it is prepared on a particular date, it is written as Bank Reconciliation statement as at/
as on ……………………

It is necessary for a beginner to understand the mechanism of how to prepare the Bank
Reconciliation statement. The first milestone on this journey is to understand the various
reasons for differences between the two records.

Reasons for Differences between Cash Book and Pass Book

The differences are basically of two types:
(A) Items appear in Cash Book but not appearing in Pass Book and
(B) Items appear in Pass Book but not appearing in the Cash Book

Let us understand these reasons:

(A) Items not appearing in Bank Pass Book
(1) Cheques issued by business entity not debited by the Bank - This may be because they
might not have been Banked by the payee or it may still be under clearance. The entry in Cash
Book will be made immediately when the cheque is issued thereby reducing the Bank balance
in the books of entity’s books of A/cs. Here, Bank balance as per Cash Book will be less, but
as per Bank Pass Book it will be more. This is also termed as unpresented cheques.
(2) Cheques deposited but not credited by the Bank - The business entity may receive cheques
or draft which is deposited into the Bank for collecting the payment. Again entry in Cash Book
will be instant thereby increasing the balance. Here, Bank balance as per Cash Book will be
more than the balance as per Bank passbook. This is also called as outstanding cheques.
(3) Errors - The Bank may by mistake miss out entering the debit or credit which results in the
difference.
(4) Standing Instructions - The entity may give standing instruction to the Bank for certain
regular payments like loan repayment installment, transfer of funds etc. This may get entered
in the Cash Book immediately, but Pass Book entry may be delayed.

(B) Items not appearing in the Cash Book

(1) Bank interest, Bank charges etc. - The Bank will charge interest on overdraft or also charges
for services, issue of demand draft, pay orders etc. Here, being the source of transaction, the
Bank will record in the Pass Book immediately and send the debit advice slips to the business
entity. The entry in the Cash Book may be delayed. Similarly the Bank could credit interest on
fixed deposits, which may get entered in business books at a later date.
(2) Direct deposits in Bank account - Sometimes customers or others may directly deposit an
amount in the Bank for goods or services rendered. The Bank will enter it immediately, but
entry in Cash Book will appear later.
(3) Bills for collection - The Business Entity may send bills of exchange for collection. The
Bank will collect the payment and credit the same in the passbook. The entry in Cash Book
will be made only after receipt of information from the Bank.
(4) Errors - The records may be missed out by the book-keeper of the Business Entity.
Need of Bank Reconciliation Statement
1. It helps to understand the actual Bank balance.
2. It helps to identify the mistakes in the Cash Book and the Pass Book.
3. It helps to detect and prevent frauds and errors in recording the Banking transactions.
4. It helps to incorporate certain expenditures/income debited/credited by Bank in the books of
accounts.

Methods of preparation of Bank Reconciliation Statement

1. Rules of Addition and Subtraction.
2. Debit and Credit Method.

Steps in Preparing Bank Reconciliation Statement

One has to have a systematic approach towards the preparation of the reconciliation. To avoid
a lengthy reconciliation, one must ensure that the entries in the Cash Book are absolutely
online. One also must obtain the Bank statements at regular intervals. Once this checking is
done, Bank reconciliation could be done by following these steps:
(a) Identify the balances and the character thereof. Remember, a debit balance in Cash Book
means asset where as a credit balance means a Bank overdraft. In Bank passbook, it’s the
reverse. A debit balance in Pass Book means an overdraft and a credit balance is a favourable
balance. This must be carefully understood.
(b) Based on the above, start with the balance (or overdraft) as per one book and arrive at the
balance (or overdraft) as per the other book. The items of differences will be added to or
deducted from the balance (or overdraft) with which the reconciliation is started.
(c) The end result should be the balance (or overdraft) as per the other book e. g. if you start
with balance as per Cash Book, then after adding or deducting items of differences, you should
arrive at the balance (or overdraft) as per the Pass Book.
(d) One has to make sure that all the items of differences from the Cash Book as well as the
Bank Book are taken into account in the reconciliation statement.
(e) Whether the items of differences should be added or deducted will depend on the sequence
you follow. This is shown in the following table:

When reconciliation is started with Bal. as OD as Bal. as OD as

per CB per CB per PB per PB
Cheques deposited in Bank, but not cleared Less Add Add Less
Cheques issued, but not presented in Bank Add Less Less Add
Bank charges debited in PB only Less Add Add Less
Interest debited in PB only Less Add Add Less
Payments by Bank debited in PB only Less Add Add Less
Direct payment by customer shown in PB only Add Less Less Add
Bills discounted & dishonoured in PB only Less Add Add Less
Cheques deposited, dishonoured in PB only Less Add Add Less
Interest, Dividend, Commission collected by Add Less Less Add
Bank not recorded in the Cash book
Overcasting of payment side of Cash Book or Add Less Less Add
Undercasting of Receipt side of Cash Book
Undercasting of payment side of Cash Book or Less Add Add Less
Overcasting of Receipt side of Cash Book
Deposits recorded twice in the Cash Book or Less Add Add Less
excess amount recorded in the Cash Book
Undercasting of credit side of the Pass Book or Less Add Add Less
 overcasting of the debit side of the Pass Book
Cheques deposited into Bank and credited Add Less Less Add
without recording in the Cash Book
Wrong debit in the Pass Book for issue of Less Add Add Less
cheque, Bank charges, etc.
Wrong credit in the Pass Book for deposit of Add Less Less Add
cheque, interest, etc.
Cheques drawn but not actually issued to the Add Less Less Add
suppliers/ creditors
Bank charges recorded twice in the Cash Book Add Less Less Add
Amount withdrawn from Bank not recorded in Less Add Add Less
the Cash Book
Please note the abbreviations CB - Cash Book, PB - Pass Book, OD - Overdraft

PREPARATION OF FINAL ACCOUNTS

The most important function of an accounting system is to provide information about the
profitability of the business. A sole trader furnishes a Trading and Profit and Loss Account
which depicts the result of the business transactions of the sole trader. Along with the Trading
and Profit and Loss Account he also prepares a Balance Sheet which shows the financial
position of the business.

Steps in the Process of Finalization of Accounts for a Trading Concern:

1. Trading Account.
2. Profit and Loss Account.
3. Balance Sheet.

Trading Account:
It is an account which is prepared by a merchandising concern which purchases goods and sells
the same during a particular period. The purpose of it to find out the gross profit or gross loss,
which is an important indicator of business efficiency.

The following items will appear in the debit side of the Trading Account:
(i) Opening Stock:
In case of trading concern, the opening stock means the finished goods only. The amount of
opening stock should be taken from Trial Balance.
(ii) Purchases:
The amount of purchases made during the year. Purchases include cash as well as credit
purchase. The deductions can be made from purchases, such as, purchase return, goods
withdrawn by the proprietor, goods distributed as free sample etc.
(iii) Direct expenses:
It means all those expenses which are incurred from the time of purchases to making the goods
in suitable condition. This expenses includes freight inward, octroi, wages etc.
(iv) Gross profit:
If the credit side of Trading A/c is greater than debit side of Trading A/c gross profit will arise.

The following items will appear in the credit side of Trading Account:
(i) Sales Revenue:
The sales revenue denotes income earned from the main business activity or activities. The
income is earned when goods or services are sold to customers. If there is any return, it should
be deducted from the sales value. As per the accrual concept, income should be recognized as
soon as it is accrued and not necessarily only when the cash is paid for.
(ii) Closing Stocks:
In case of trading business, there will be closing stocks of finished goods only. According to
convention of conservatism, stock is valued at cost or net realizable value whichever is lower.
(iii) Gross Loss:
When debit side of Trading A/c is greater than credit side of Trading A/c, gross loss will appear.

Profit and Loss Account:

The following items will appear in the debit side of the Profit & Loss A/c:
(i) Cost of Sales:
This term refers to the cost of goods sold. The goods can be manufactured and sold or can be
directly purchased and sold.
(ii) Other Expenses:
All expenses which are not directly related to main business activity will be reflected in the
P&L component. These are mainly the Administrative, Selling and distribution expenses.
Examples are salary to office staff, salesmen commission, insurance, legal charges, audit fees,
advertising, free samples, bad debts etc. It will also include items like loss on sale of fixed
assets, interest and provisions. Students should be careful to include accrued expenses as well.

The following items will appear in the credit side of Profit & Loss A/c:
(i) Revenue Incomes:
These incomes arise in the ordinary course of business, which includes commission received,
discount received etc.
(ii) Other Incomes:
The business will generate incomes other than from its main activity. These are purely
incidental. It will include items like interest received, dividend received, etc .The end result of
one component of the P&L A/c is transferred over to the next component and the net result will
be transferred to the balance sheet as addition in owners’ equity. The profits actually belong to
owners of business. In case of company organizations, where ownership is widely distributed,
the profit figure is separately shown in balance sheet.
Balance Sheet:
Horizontal format of Balance Sheet is also used by the business other than company
A. Liabilities
(a) Capital:
This indicates the initial amount the owner or owners of the business contributed. This
contribution could be at the time of starting business or even at a later stage to satisfy
requirements of funds for expansion, diversification etc. As per business entity concept, owners
and business are distinct entities, and thus, any contribution by owners by way of capital is a
liability.
(b) Reserves and Surplus:
The business is a going concern and will keep making profit or loss year by year. The
accumulation of these profit or loss figures (called as surpluses) will keep on increasing or
decreasing owners’ equity. In case of non-corporate forms of business, the profits or losses are
added to the capital A/c and not shown separately in the balance sheet of the business.
(c) Long Term or Non-Current Liabilities:
These are obligations which are to be settled over a longer period of time say 5-10 years. These
funds are raised by way of loans from banks and financial institutions. Such borrowed funds
are to be repaid in installments during the tenure of the loan as agreed. Such funds are usually
raised to meet financial requirements to procure fixed assets. These funds should not be
generally used for day-to-day business activities. Such loan are normally given on the basis of
some security from the business e.g. against a charge on the fixed assets. So, long term loan
are called as “Secured Loan” also.
(d) Short Term or Current Liabilities:
A liability shall be classified as Current when it satisfies any of the following:
• It is expected to be settled in the organisation’s normal Operating Cycle,
• It is held primarily for the purpose of being traded,
• It is due to be settled within 12 months after the Reporting Date, or
• The organization does not have an unconditional right to defer settlement of the liability for
at least 12 months after the reporting date (Terms of a Liability that could, at the option of the
counterparty, result in its settlement by the issue of Equity Instruments do not affect its
classification)
Current liabilities comprise of :
(i) Sundry Creditors –
Amounts payable to suppliers against purchase of goods. This is usually settled within 30-180
days.
(ii) Advances from customers –
At times customer may pay advance i.e. before they get delivery of goods. Till the business
supplies goods to them, it has an obligation to pay back the advance in case of failure to supply.
Hence, such advances are treated as liability till the time they get converted to sales.
(iii) Outstanding Expenses:
These represent services procured but not paid for. These are usually settled within 30–60 days
e.g. phone bill of Sept is normally paid in Oct.
(iv) Bills Payable:
There are times when suppliers do not give clean credit. They supply goods against a
promissory note to be signed as a promise to pay after or on a particular date. These are called
as bills payable or notes payable.
(v) Bank Overdrafts:
Banks may give fund facilities like overdraft whereby, business is permitted to issue cheques
up to a certain limit. The bank will honour these cheques and will recover this money from
business. This is a short term obligation.
B. Assets
In accounting language, all debit balances in personal and real accounts are called assets.

Assets are broadly classified into fixed assets and current assets.
(a) Fixed Assets:
These represent the facilities or resources owned by the business for a longer period of time.
The basic purpose of these resources is not to buy and sell them, but to use for future earnings.
The benefit from use of these assets is spread over a very long period. The fixed assets could
be in tangible form such as buildings, machinery, vehicles, computers etc, whereas some could
be in intangible form viz. patents, trademarks, goodwill etc. The fixed assets are subject to wear
and tear which is called as depreciation. In the balance sheet, fixed assets are always shown as
“original cost less depreciation”.
(b) Investments:
These are funds invested outside the business on a temporary basis. At times, when the business
has surplus funds, and they are not immediately required for business purpose, it is prudent to
invest it outside business e.g. in mutual funds or fixed deposit. The purpose is to earn a
reasonable return on this money instead of keeping them idle. These are assets shown
separately in balance sheet. Investments can be classified into Current Investments and Non-
current Investments.
Non-current Investments are investments which are restricted beyond the current period
as to sale or disposal. Whereas, current investments are investments that are by their nature
readily realizable and is intended to be held for not more than one year from the date on which
such investment is made.
(c) Current Assets:
An asset shall be classified as Current when it satisfies any of the following :
• It is expected to be realised in, or is intended for sale or consumption in the organisation’s
normal Operating Cycle,
• It is held primarily for the purpose of being traded,
• It is due to be realised within 12 months after the Reporting Date, or
• It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a
liability for at least 12 months after the Reporting Date.

Current assets comprise of:

(i) Stocks:
This includes stock of raw material, semi-finished goods or WIP, and finished goods. Stocks
are shown at lesser of the cost or market price. Provision for obsolescence, if any, is also
reduced. Generally, stocks are physically counted and compared with book stocks to ensure
that there are no discrepancies. In case of discrepancies, the same are adjusted to P & L A/c
and stock figures are shown as net of this adjustment.
(ii) Debtors:
They represent customer balances which are not paid. The bad debts or a provision for bad debt
is reduced from debtors and net figure is shown in balance sheet.
(iii) Bills receivables:
Credit to customers may be given based on a bill to be signed by them and payable to the
business at an agreed date in future. At the end of accounting period, the bills accepted but not
yet paid are shown as bills receivables.
(iv) Cash in Hand:
This represents cash actually held by the business on the balance sheet date. This cash may be
held at various offices, locations or sites from where the business activity is carried out. Cash
at all locations is physically counted and verified with the book balance. Discrepancies if any
are adjusted.
(v) Cash at Bank:
Dealing through banks is quite common. Funds held as balances with bank are also treated as
current asset, as it is to be applied for paying to suppliers. The balance at bank as per books of
accounts is always reconciled with the balance as per bank statement, the reasons for
differences are identified and required entries are passed.
(vi) Prepaid Expenses:
They represent payments made against which services are expected to be received in a very
short period.
(vii) Advances to suppliers:
When amounts are paid to suppliers in advance and goods or services are not received till the
balance sheet date, they are to be shown as current assets. This is because advances paid are
like right to claim the business gets.

Please note that both current assets and current liabilities are used in day-to-day business
activities. The current assets minus current liabilities are called as working capital or net current
assets. The following report is usual horizontal form of balance sheet. Please note that the assets
are normally shown in descending order of their liquidity. Also, capital, long term liabilities
and short term liabilities are shown in that order.