TOPIC 5 BANK RECONCILIATION AND CORRECTION OF ERRORS

5.1 Bank reconciliation

The cash book and the bank statement

When a business deposits money on its account in the bank:
 The business debits its cash book and the amount is an asset of the business.
 The bank credits the customer’s bank account as the amount on the account is a liability of
the bank to the customer.

When a business pays money from its bank account by cheque or electronic transfer:
 The business credits its cash book.
 The bank debits the customer’s account in the bank.

A bank sends a bank statement to a customer showing the account balance at the beginning
of the month, payments and deposits during the period and the balance at the end of the
month.

A credit balance on the bank statement is the amount the bank owes the customer. This is a
debit balance in the customer’s cash book. A debit balance on the bank statement is the
amount the customer owes the bank. The credit balance in the customer’s cash book is a bank
overdraft.

Bank reconciliation
Bank reconciliation is the comparison of transactions in the customer’s cash book and the
bank statement. The reconciliation should be done regularly (at least monthly) as:
 It helps in the identification of errors and ensures the accuracy of the bank balance in the
financial statements.
 It reduces the risk of fraud by detecting irregularities such as unauthorized bank
withdrawals and therefore safeguards business cash.
 It assists in monitoring business cash flows.

Differences between the cash book and bank statement balances

These may be due to the following factors:
a) The cash book not updated i.e. bank transactions not yet recorded in the cash book.
These include the following:
 Bank charges like ledger fees, ATM charges and cheque clearance charges.
 Direct debits – a direct debit arises from an instruction by the payee to the bank to transfer
funds to another account.
 Standing order – this is an instruction to the bank to transfer a specific amount to another
account on a specific date on a recurring basis like payments for DSTV.
 Bank interest earned by the customer.
 Direct credits – are amounts deposited directly on the customer’s account in the bank e.g.
tax payments to URA bank accounts.
 Dishonoured cheques – are cheques deposited or paid by a business that are not cleared
by the bank due to several factors including the following:
- Insufficient funds.
- The amount in words differing from that in figures.
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 - Drawer’s signature differing from the specimen signature.
- Alterations that are not countersigned.
- Required confirmation.
- Suspected fraud
- Cheques being stale (over six months old)

b) Timing differences due to the time lag between recording deposits and payments in the
customer’s cash book and the bank statement that lead to the following:
 Unpresented cheques – are cheques paid by the entity to other parties that are not yet
banked by the payee or cleared by the bank. They are also called outstanding cheques.
 Uncredited items – are cheques and cash recorded in the cask book and deposited in the
bank that are not yet credited by the bank. They are also called outstanding deposits or
deposits in transit.

c) Errors:
 In the customer’s cash book like recording a wrong cheque amount.
 By the bank like paying the same cheque twice.

How to handle differences identified during the reconciliation

 Items not in the cash book are recorded:
- Items credited by the bank are debited in the cash book.
- Items debited by the bank are credited in the cash book.
 Errors in the cash book are corrected immediately.

Bank account (in the customer’s records)

Balance b/f* x Bank charges x
Bank interest earned x Overstatement errors x
Understatement errors x Direct debits x
Dividends paid direct to the bank x Standing orders x
Direct credits x Dishonoured deposited cheques x
Dishonoured paid cheques x Balance c/f** x
x x

*This may be on the credit side if it is an overdraft.

**The balance c/f is the adjusted cash book balance that appears in the bank
reconciliation statement and the statement of financial position.

 Unpresented cheques – as these cheques have not been debited by the bank, the
balance on the bank statement is higher than the cash book balance. Therefore, they are
added to the adjusted cash book balance.

 Uncredited items – as these items have not been credited by the bank, the balance per
bank statement is lower than the balance per cash book. Therefore, they are subtracted
from the adjusted balance per cash book.

 Bank errors are reported to the bank immediately for correction. Such errors are
reconciling items in the bank reconciliation statement. They are removed from the
subsequent bank reconciliation statements after the bank has made the necessary
corrections in the bank statements for the following months.

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 - Overstatement errors make the balance per bank statement to be higher than the
balance per cash book and therefore are added to the balance per cash book.
- Understatement errors make the balance per bank statement to be lower than the
balance cash book and therefore are subtracted from the balance as per cash book.

Bank reconciliation statement formats

a) Bank Reconciliation Statement as at ……………
Shs
Balance as per adjusted cash book x
Add: Unpresented cheques x
Overstatement bank errors x
x
Deduct: Uncredited items (x)
Understatement bank errors (x)
Balance as per Bank statement x

b) Bank Reconciliation Statement as at ………….

Shs
Balance as per bank statement x
Add: Uncredited items x
Understatement bank errors x
x
Deduct: Unpresented cheques (x)
Overstatement bank errors (x)
Balance as per adjusted cash book x

An overdraft should be in brackets as it is a negative amount.

Example 1
Below is a cash book and bank statement for A.K Ltd for the month of October 2016
CASH BOOK
Debit side Credit side
Date Particulars Shs Date Particulars Shs
Oct 1st Balance b/f 80,000,000 Oct 7th Musa 501 32,000,000
2nd Moses 984 60,000,000 8th Peter 502 40,000,000
10th BMK Ltd 614 24,000,000 11th Okurut 503 30,000,000
14th Twesi 316 10,000,000 17th Bob 504 14,000,000
16th Bwire 412 4,000,000 28th Jimmy 505 6,000,000
28th Shilla 268 34,000,000 28th Harriet 506 4,000,000
30th MAT 765 1 3,000,000 30th Martin 507 2,000,000
30th Juma 809 2,000,000 30th Monday 508 1,000,000
31st Simon 509 4,000,000
31st Balance c/f 94,000,000
227,000,000 227,000,000

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BANK STATEMENT
Date Particulars Dr Cr Balance
Shs Shs Shs
Oct 1st Balance b/d 80,000,000
5th Cheque No. 984 60,000,000 140,000,000
8th 501 32,000,000 108,000,000
10th 502 40,000,000 68,000,000
13th 503 30,000,000 38,000,000
14th 614 24,000,000 62,000,000
16th 316 10,000,000 72,000,000
18th 504 14,000,000 58,000,000
20th Credit Memo (Linda) 18,000,000 76,000,000
25th Standing order (UTL) 2,000,000 74,000,000
26th Credit Memo (Gensi) 16,000,000 90,000,000
30th Bank charges 200,000 89,800,000

The bank dishonoured Cheque No. 505 paid to Jimmy on 28.10.2016 and Cheque No. 412
received from Bwire and banked on 16.10.2016.

You are required to:

a) Reconcile the bank statement and the cash book of AK Ltd.
b) Prepare the updated cash book.
c) Prepare a bank reconciliation statement as at 31.10.2016.

Solution
Below is the adjusted cask book balance after making the above entries:
Bank a/c

Balance b/f 94,000,000 Bwire - 4,000,000

Linda 18,000,000 UTL 2,000,000
George 16,000,000 Bank charges 200,000
Jimmy 6,000,000 Balance c/f 127,800,000
134,000,000 134,000,000

Balance b/f 127,800,000

NB: The unticked items in the cash book are:

 On the debit side – the uncredited items in the bank reconciliation statement
 On the credit side – the unpresented items in the bank reconciliation statement

A.K. Ltd
Bank reconciliation statement as at 31.10.2016
Shs Shs
Balance as per adjusted cashbook 127,800,000
Add: Unpresented cheques
Cheque No. 506 4,000,000
507 2,000,000
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 508 1,000,000
509 4,000,000
11,000,000
138,800,000
Deduct: Uncredited cheques
Cheque No. 268 34,000,000
765 13,000,000
809 2,000,000
(49,000,000)
Balance as per bank statement 89,800,000

Practice question
The information below is for Nile Traders. An extract from the bank reconciliation statement for
Nile Traders for the month of July 2016 indicates the following:

Uncredited cheques: Unpresented cheques:

Cheque No.004 1,000,000 Cheque No. 10 500,000
Cheque No.623 4,500,000 Cheque No. 12 2,500,000

Cash book for the month of August 2016

Dr Cr

Balance b/f 11,000,000 Cheque No. 20 800,000

Cheque No. 2515 1,000,000 Cheque No. 21 2,100,000
Cheque No. 1119 500,000 Cheque No. 22 2,000,000
Cheque No. 990 3,000,000 Cheque No. 23 600,000
Cheque No. 224 2,400,000 Cheque No. 24 200,000
Cash 900,000 Cheque No. 26 1,400,000
Cheque No. 414 1,800,000 Cheque No. 27 2,400,000
Cheque No. 666 700,000 Cheque No. 28 700,000
Cash 1,300,000 Cheque No. 30 1,800,000
Cheque No. 804 2,100,000 S.Order – Insurance 900,000
Cheque No. 707 3,400,000 Cheque No. 31 3,100,000
Credit memo – Peter 900,000 Balance c/f 13,000,000
29,000,000 29,000,000

Bank statement for August 2016

Details Dr Cr Balance
Balance b/f 8,500,000
Cheque No. 22 2,000,000 6,500,000
24 200,000 6,300,000
623 4,500,000 10,800,000
990 3,000,000 13,800,000
Credit Memo – Peter 900,000 14,700,000
Cheque No. 21 2,100,000 12,600,000
12 2,500,000 10,100,000
20 800,000 9,300,000
2515 1,000,000 10,300,000
1119 500,000 10,800,000

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Standing Order – Insurance 900,000 9,900,000
Cheque No. 224 4,200,000 14,100,000
Cash 900,000 15,000,000
Cheque No. 26 1,400,000 13,600,000
27 2,400,000 11,200,000
6001 5,000,000 16,200,000
414 1,800,000 18,000,000
804 2,100,000 15,900,000
31 3,100,000 12,800,000
Credit memo – John 1,300,000 14,100,000
Cheque No. 28 700,000 13,400,000
Ledger fees 50,000 13,350,000
Dividends 1,500,000 14,850,000

Additional information:
i) Where the figures in the cash book and the bank statement differ, the mistakes were made
in the cash book of Nile Traders.
ii) Cheque 804 was entered on the wrong side by the bank.

You are required to:

a) Reconcile the bank statement and the cash book of Nile Traders.
b) Prepare the updated cash book.
c) Prepare a bank reconciliation statement as at 31.8 2016.

Solution
Cash book

Balance b/f 13,000,000 Ledger fees 50,000

Cheque no.224 error 1,800,000
Direct credit – cheque no. 6001 5,000,000
- John 1,300,000
- Dividends 1,500,000 Balance c/f 22,550,000
22,600,000 22,600,000

Bank reconciliation statement as at August 31st 2016

Shs Shs
Adjusted cash book balance 22,550,000
Add: Unpresented cheques:
Cheque no. 10 500,000
23 600,000
30 1,800,000
2,900,000
25,450,000
Less: Uncredited items:
Cheque no. 004 1,000,000
666 700,000
707 3,400,000
Cash 1,300,000
(6,400,000)
Bank underst. error on cheque no. 804 (4,200,000)
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Balance per bank statement 14,850,000
5.2 Correction of errors and the suspense account

A quick way of checking whether there are no errors in the accounting records before
preparing the financial statements is to prepare a trial balance. A trial balance is a list of all
ledger balances from the general ledger. Some errors are detected by the trial balance and
others are not. Errors are corrected using journal entries as shown below.

Errors not revealed by the trial balance (where the TB still balances)
These errors do not affect the TB and the total of debit balances will equal to the total of credit
balances. Such errors are corrected by the following journal entries:

Debit Account wrongly credited

Credit Correct account
OR
Debit Correct account
Credit Account wrongly debited

These errors include the following:

a) Error of omission
This is when a transaction has been completely omitted from the accounting records e.g. a
cash sale of Shs 100,000 was not recorded. The journal entry to correct the error is:
Dr Cash a/c 100,000
Cr Sales a/c 100,000

b) Error of commission
This is where the transaction is recorded correctly in a wrong account e.g. a water bill of Shs
50,000 has been debited to the electricity account. To correct the error:
Dr Water expense a/c 50,000
Cr Electricity expense a/c 50,000

c) Error of principle
Occur where a transaction is recorded in the wrong class or type of accounts e.g. recording the
purchase of an engine at Shs 900,000 for a vehicle as an expense rather as an asset. To
correct the error:
Dr Motor vehicle a/c 900,000
Cr Motor vehicle repair a/c 900,000

d) Error of original entry

This is where the double entry has been made but with the wrong amount e.g. a sales invoice
for Shs 300,000 is recorded as Shs 30,000. To correct the error:
Dr Receivables a/c 270,000
Cr Sales a/c 270,000

e) Reversal of entries

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This is where the correct amount is posted to the correct accounts but on the wrong side e.g. a
cash ale of Shs 200,000 has been debited to sales and credited to cash. To correct such
errors: Double the amount and post it on the correct side of the double entry.
Dr Cash a/c 400,000
Cr Sales a/c 400,000

f) Compensating errors
Occur where two or more errors cancel out each other e.g. the purchases account may be
overcast by Shs 500,000 and the sales account overcast by the same amount by coincidence.
To correct the error:
Dr Sales a/c 500,000
Cr Purchases a/c 500,000

Errors revealed by the TB (where the TB does not balance)

Such errors make the TB not to balance. As there is a difference on the TB, a suspense
account is used to make the total debits equal to the total credits.

A suspense account
A suspense account is an account where the difference on the TB is held temporarily until
sufficient information is available for it to be posted to the correct accounts. The two main
reasons for creating the suspense accounts are:

 When the debits and credits in the trial balance are not equal, the difference is recorded in
the suspense account as follows:
When debits exceed credits: Cr Suspense a/c
When credits exceed debits: Dr Suspense a/c

 When a bookkeeper is not sure where to post one side of the double entry, he may debit or
credit a suspense account until enough information is available. For example, when you
receive a cheque of Shs 2 m and you are not sure of the source, you record the cheque
temporarily as follows:
Dr Bank a/c 2,000,000
Cr Suspense a/c 2,000,000

The suspense account may be cleared before the final accounts are prepared.

Correction of such errors using the suspense account

The following journal entries are used to correct such errors:
Dr Respective account if omitted or understated
Cr Suspense account
OR
Dr Suspense account
Cr Respective account if omitted or understated

 Single sided entry e.g. a debit entry recorded with no corresponding credit entry or vice
versa. For example, a cheque of Shs 400,000 from a debtor was recorded in the cashbook
but no entry was made in the debtor’s account.

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 As debits exceed credits by Shs 400,000, therefore,
Cr Suspense a/c 400,000

If the debtor is later found to be Karim:

Dr Suspense a/c 400,000
Cr Karim a/c 400,000

 Debit and credit entries recorded at different values.

Example: A sales invoice for Shs 310,000 posted correctly in the Sales account but
posted as Shs 130,000 in the debtor’s account. Credits exceed debits by Shs 180,000.
Therefore, Dr Suspense a/c 180,000

Later, if it is established that the invoice is for Patel,

Dr Patel a/c 180,000
Cr Suspense a/c 180,000

This is a transposition error where there is a transposition of digits when recording figures.
The difference is always divisible by 9.

 Two entries made on the same side of the double entry.

For example, a cash sale of Shs 300,000 debited to the sales a/c.
The TB will have difference of Shs 600,000 which will be credited to the suspense account.
To correct the error: Dr Suspense a/c 600,000
Cr Sales a/c 600,000

 An incorrect addition (miscasting) in any individual account

Example: If the motor vehicles repair a/c is undercast by Shs 500,000, then the credits
exceed the debits by this amount in the TB. If the suspense a/c was debited with Shs
500,000, then,
Dr Motor vehicle a/c 500,000
Cr Suspense a/c 500,000

 Error in extracting the balance from the TB.

For example, a debit balance of Shs 75,000 on the photocopying account was
incorrectly extracted on the list of balances as Shs 750,000.
Dr Suspense a/c 675,000
Cr Photocopying a/c 675,000

Example
On extracting a trial balance, the accountant of Mamba Enterprises found that the debits
exceeded the credits by Shs. 118,000. Later he discovered the following errors:

a) A debit balance of Shs. 75,000 on the postage account had been incorrectly extracted on
the list of balances as Shs. 750,000.
b) A payment of Shs. 500,000 to a credit supplier, Kato, had been correctly entered in the
cash book, but no entry had been made in the supplier’s account.
c) When a motor vehicle was purchased during the year, the bookkeeper did not know what
to do with the debit entry. He made the following entry: Dr Suspense 1,575,000, Cr Bank
1,575,000.

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d) A credit balance of Shs. 81,000 in the sundry income account had been incorrectly
extracted on the list of balances as a debit balance.
e) A receipt of Shs. 5,000 from a credit customer, Yuda, had been correctly posted to his
account but had been entered in the cash book as Shs. 625,000.
f) The bookkeeper was not able to deal with the receipt of Shs. 500,000 from the owner’s
bank account, and he made the following entry: Dr Bank and Cr Suspense.
g) No entry has been made for a cheque of Shs. 120,000 received from a credit customer
Musa.
h) A receipt of Shs. 50,000 from a credit customer, Nina, had been entered into his account
as Shs. 5,000 and into the cash book as Shs. 5,000.

Prepare the necessary journal entries and suspense account to correct the above errors.

Correction of common errors in the cash book revealed by bank reconciliation

a) Understatement of a cheque from a debtor in the cash book, e.g. a cheque for Shs
6,500,000 from Mukasa, a debtor, was posted as Shs 5,600,000 in the cash book and
debtor’s account.
Dr Bank a/c 900,000
Cr Mukasa a/c 900,000

For an overstatement reverse the entries using appropriate accounts.

b) Understatement of a cheque paid to Mubiru, a creditor e.g. a cheque for Shs 7,000,000 was
posted as Shs 5,000,000 in the cash book and the creditor’s account.
Dr Mubiru a/c 2,000,000
Cr Bank a/c 2,000,000
For an overstatement reverse the entries using appropriate accounts.

c) Complete reversal of entries of payment by a debtor, e.g. a cheque of Shs 5,000,000 from a
debtor was credited to the cash book and debited to the receivable account as Shs
5,000,000.
Always double the amount recorded in error and post it using the correct double entry.
Dr Bank a/c 10,000,000
Cr Receivable a/c 10,000,000
For complete reversal of entries of a creditor, reverse the entries and use appropriate
accounts.

d) Complete reversal of wrong entries of payment by a debtor e.g. a cheque of Shs of

1,400,000 from a debtor was credited in the cash book and debited in the receivable
account as Shs 4,100,000. The error is Shs 5,500,000 i.e. 1,400,000 + 4,100,000,
therefore,
Dr Bank a/c 5,500,000
Cr Receivable a/c 5,500,000
For complete reversal of wrong entries of payment to a creditor, reverse the entries and use
appropriate accounts.

Common bank errors revealed by bank reconciliation and how to handle them
a) Errors overstating the bank balance but where the double entry by the bank is correct:
Always add the error to the balance as per cash book, as a separate item, in the BRS.
For example, if a cheque for Shs 8,400,000 paid to a supplier was paid by the bank as Shs
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 4,800,000, the balance on the BS is overstated by Shs 3,600,000 (8,400,000 – 4,800,000).
Add the bank overstatement error of Shs 3,600,000 to the balance as per cash book in the
BRS (format a).

b) Errors understating the bank balance on the BS but where the double entry by the bank is
correct:
Always subtract the error from the balance as per cash book in the BRS.
For example, if a cheque of Shs 2,500,000 paid to a supplier is debited as Shs 5,200,000
by the bank. The bank balance is understated by Shs 2,700,000 (5,200,000 – 2,500,000).
Deduct the bank understatement error of Shs 2,700,000 from the balance as per CB in BRS
(format a).

c) Errors overstating or understating the bank statement where there is complete reversal of
the double entry:
Add the figure in the cash book and that in the BS to get the error.
For example, if a cheque of Shs 7,900,000 banked on the account is debited as Shs
9,700,000 by the bank. This understates the bank balance by Shs 17,600,000 (7,900,000 +
9,700,000). The bank understatement error of Shs 17,600,000 is deducted from the balance
as per cash book in the BRS (format a).

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