Methods of Preparing Bank Reconciliation statement

Method 1: Bank reconciliation statement by Debit balance of Bank Column of Cash Book.

Method 2: Bank reconciliation statement by Credit balance as Cash Book (Overdraft).

Method 3: Bank reconciliation statement by Credit balance as per Bank Statement

Method 4: Bank reconciliation statement by Debit balance as per Bank Statement (Overdraft).

Bank Reconciliation Statement

"Bank reconciliation statement is a statement prepared mainly to reconcile the difference between the ‘Bank Balance’ shown by the Cash book and Bank statement."

A company's cash balance at bank and its cash balance according to its accounting records usually do not match. This is due to the fact that, at any particular date, checks may be outstanding, deposits may be in transit to the bank, errors may have occurred etc. Therefore companies have to carry out bank reconciliation process which prepares a statement accounting for the difference between the cash balance in company's cash account and the cash balance according to its bank statement.

  Reasons For Differences between a bank statement and cash accounting records

1	Items recorded in cash book, but not on the bank statement (timing differences)
1.1	Checks issued, but have not cleared the bank	After a check is issued, it may take some time before its holder presents it to the bank. Therefore, a bank statement would not show such checks until they are presented to the bank, but the company has already recorded such checks as cash deductions in their cash account(s).
1.2	Deposits in transit	Checks or amounts received and deposited into the bank account, but not yet processed and recorded by the bank. Similar to checks, such deposits have been recorded by the company, but are not yet reflected on a bank statement.
2	Items on the bank statement, but not in cash book
2.1	Bank interest / charges	Interest or charges already recorded by the bank, but not by the company as the company didn't know about them until the company received the bank statement.
2.2	Standing orders	A bank has a right to pay fixed amounts at regular intervals to another account. Such orders are given to the bank by the bank customer (the company). Usually the company may not know or record such amounts until a bank statement is received.
2.3	Direct debits / ACH	An instruction / permission that a bank account holder gives to another company to deduct amounts directly from its bank account. Direct debits are primarily used in Europe. In the United States, an equivalent is an ACH transfer initiated by a withdrawing party (biller). Again, the company may not know or record such amounts transferred until a bank statement is received.
2.4	Credit / wire transfers	An incoming transfer of money from one bank account to another. For example, a company returns goods purchased from its suppliers and receives the money back from them directly into the company's bank account.
2.5	Dishonored check	For example, a company's payer does not have enough money to cover the payment by check or the check is post-dated. The company has already recorded the check as a cash receipt in the cash register and ledger, but no cash was deposited into the company's bank account and is shown on a bank statement.
3	Cash book errors or bank errors
3.1	Cast errors	A transaction is recorded to an incorrect account.
3.2	Transposition	A figure in the amount is transposed by mistake.
3.3	Omissions	A transaction is not recorded.
3.4	Duplications	A transaction is posted twice.

Preparation of Bank Reconciliation statement

A bank reconciliation statement can be prepared by taking the balance either as per cash book or as per pass book as a starting point.

If the statement is started with the balance as per bank column of the cash book, the answer arrived at the end will be balance as per pass book.

Alternatively, if the statement is started with the balance as per pass book, the answer arrived at in the end will be the balance as per cash book.

A debit balance as per cash book shows the amount of the money in the bank, whereas, a credit balance means that the business has taken an overdraft. In the same way, a credit balance as per pass book shows a positive bank balance whereas debit balance as per pass book shows an Overdraft.

ADJUSTMENTS OF FINAL ACCOUNTS

In mercantile system of accounting, it is essential to adjust different accounts before the preparation of final accounts. It is quite common to adjust expenses paid in advance, incomes received in advance, income accrued but not received, bad debts, provision for bad debts depreciation on assets and soon. Journal entries are passed to effect the required adjustments; these entries are known as adjusting entries. There are many adjustments because earlier we have not passed any journal entry, so at the time of making final account we have to adjust them. 

Name of items	Adjustment entry	Effect on trading and profit and loss account	Effect on balance sheet
1. Closing stock	Closing stock a/c dr. xxx   To trading account xxx	Closing stock will write on the credit side of trading account	It will show as asset in the Balance sheet
2. outstanding expenses or expenses payable or expenses due but not paid	Expenses account dr. xxx   To outstanding exp. xxx	Outstanding expenses will add in respective expenses.  If it is direct it will go to trading account’s debit side , if it is indirect in nature then it will go to the debit side of profit and loss account	It will be the current liability so it will go to the liability side of balance sheet.
3. Advance or Prepaid expenses	Advance expenses a/c dr.    To expenses account xxx	It will deduct from respective expenses paid.	It will be the current asset so it will go to assets side of balance sheet
4. Accrued Income	Outstanding income dr. xx      To income account xxx	It will add in the income and go to credit side of profit and loss account	It will show as asset in the assets side of balance sheet
5. Income received in advance	Income account dr. xxx  To advance income a/c xx	It will deduct from the income received	It will shown as liability in the liabilities side of balance sheet
6 Goods use for personal use	Drawing account dr. xxx       To purchase account	It will deduct from purchase in the debit side of trading account =purchase –drawing in goods	It will deduct from capital in the liabilities side of balance sheet =capital- drawing in goods
7. Loss of goods by Fire or Accident	loss by fire a/c   Dr. xx To trading a/c If there is no insurance It will also go to profit and loss account Profit and loss a/c  dr. xxx     To loss by fire / accident	It will show on credit side of trading account. And also in profit and loss account’s debit side	It will not go to balance sheet
8. Depreciation	Depreciation account dr.xx  To respective asset a/c xxx	It will go to the debit side of profit and loss account	It will deduct from fixed asset. Because it decrease the value of an asset =fixed asset -depreciation
9. provisional for doubtful debts	If you have make any provision for doubt ful debts, its journal entry will passed: Provision for doubtful debts a/c                   dr. xx    To Bad debts account xx ( New bad debts which is not shown in trial balance will transfer to provision for doubtful debt account )	Net value of provision for doubtful debt account transfer to profit and loss account’s debit side =total bad debt + closing balance or provision of doubtful debt or this year provision - opening balance of provision for doubtful debts	Deduct from debtor = debtor – new bad debts – this year provision or closing balance of provision for bad debts
10. Prov. for discount on debtors	Profit and loss a/c  dr. xxx To Prov. for discount on Debtors a/c   xxx	The amount of provision for discount is calculated after deducting the provision for bad debts from sundry debtors. The amount should be debited to the profit and loss account of that year in which sales are made.	Deduct from Debtors = debtor – new bad debts – this year provision or closing balance of provision for bad debts – Prov. for discount on debtors.
11. Prov. for discount on creditors	Provision for discount on Creditor’s a/c Dr.        xxx   To Profit and loss a/c  xxx	Amount should be credited to the profit and loss account of that year in which purchases are made.	Deduct from Creditors. The amount of prov. for discount on creditors is calculated on total creditors.
12. Interest on Capital	Intt. on capital a/c dr. xx            To Capital a/c xxx	Interest on capital being an expense is debited to profit and loss account	Same amount of interest on capital is added to Capital.
13. Interest on Drawings	Capital a/c Dr.  To Interest on drawings a/c	The interest on drawings being an income is credited to profit and loss account	Same amount is shown as a deduction from the capital.
14. Goods given as charity or distributed as free samples.	Charity or Advertisement expenses a/c    dr.       xxx        To Purchase a/c   xxx	It will deduct from purchases in trading account and It will go to the debit side of P/L a/c as Charity or Advertisement expenses.
15. Commission to manager	Commission a/c  dr. xxx   To outstanding commission	It will shown in the debit side of profit and loss account as o/s commission to manager If it charge on the amount after charging such commission then we will calculate = profit before comm.*Rate/ 100+rate	It will shown as liability

ACCOUNTING ERRORS

ACCOUNTING ERRORS

The statement of Trial Balance is not a final and conclusive proof of the complete correctness of books. This is because, there are certain errors in the books of accounts which may be committed while recording, classifying or summarizing the financial transactions which are not disclosed by the trial balance. The following are some of the errors which will not affect the agreement of Trial Balance:

·         Classification of Errors

Errors can be classified on the basis of its nature:

I. Errors of Omission.  

II. Errors of Commission.

III. Errors of Principles.

IV. Compensating Errors.

I.       Errors of Omission: When business transaction is either completely or partly omitted to be recorded in the books of prime entry it is called an ‘error of omission’. When a business transaction is omitted completely, it is called a ‘complete error of omission”, and when a business transaction is partly omitted, it is called a “partial error of omission”. A complete error of omission does not affect the agreement of trial balance whereas a partial error of omission may or may not affect the agreement of trial balance.

An example of a complete error of omission is goods purchased or sold may not be recorded in the purchase book or sales book at all. This error will not affect the trial balance. An example of a partial error of omission is goods purchased for Rs. 5,500 recorded in Purchase Book for Rs. 550. This is a partial error of omission.

II.    Errors of Commission: Errors of Commission may be occurred by wrong recording in the books of original entry. The committed errors arise due to the negligence of the Accountant while recording, totaling, carrying forward and balancing the accounting process. The errors of commission may arise due to the following ways :

(1) Entering the wrong amount to the correct side of correct subsidiary books

(2) Entering the correct amount to the wrong side of correct subsidiary books

(3) Entering the correct amount to the correct side of wrong subsidiary books

(4) Posting wrong amount to the correct side of the accounts

(5) Posting correct amount to the wrong side of the accounts

(6) Posting to the correct side of the account but making double posting.

III. Errors of Principles: When a business transaction is recorded in the books of original entries by ignoring the basic/fundamental principles of accountancy it is called an error of principle. Some examples of these errors are:

(a)    When revenue expenditure is treated as capital expenditure or vice-versa, e.g. building purchased is debited to the purchase account instead of the building account.

(b)   Revenue expenses debited to the personal account instead of the expenses account, e.g. salary paid to Mr. Ashok, a clerk, for the month of June, debited to Ashok’s account instead of salary account.

IV. Compensating Errors: Compensating errors refer to those errors which are compensated by each other. In other words, the effect of one error is compensated by the other. Such errors which do not affect the agreement of the trial balance. For example, if wage paid Rs. 1,000 is debited in the Wage Account at Rs. 1,500 and dividend received Rs. 1,500 is credited in the Dividend Account at Rs. 2,000, the excess debit in Wage Account is compensated by an excess credit of Rs. 500 in Dividend Account.

Difference between Fund Flow & Cash Flow statement

Distinction between Cash Flow Statement & Fund Flow Statement

Followings are the main differences between cash flow statement and funds flow statement.

1. Concept
Cash flow statement is based on narrow concept of funds, which considers changes in cash. Funds flow statement is based on the changes in working capital which considers both the changes in cash as well as other components of current assets and current liabilities.

2. Basis Of Preparation
Cash flow statement is prepared on cash basis. Funds flow statement is prepared on accrual basis.

3. Working capital
Cash flow statement does not require use of changes in working capital because all the changes in assets and liabilities are summarizes in cash flow statement. Funds flow statement requires to use of separate statement of changes in net working capital.

4. Link
The preparation of cash flow statement considers only those transactions that are linked with flow of cash. The preparation of funds flow statement considers those transactions that are linked with flow of funds along with actual cash.

5. Usefulness
Cash flow statement is more useful in short term analysis and cash planning. Funds flow statement is more useful in long-term analysis of financial planning.

Fund Flow Statement

FUND FLOW STATEMENT

The term of ‘Funds Flow’ has made up with the two words – Funds and Flow of funds. Let us first we understand these meaning and then we see how funds flow statement is prepared.

Meaning of Funds:

The term ‘fund’ has different meanings:

CASH -

In narrow sense, the term ‘fund’ is used to mean only the cash and bank balance. Therefore, in this sense, funds flow statement is a statement reflecting the changes in cash and bank balances only. This concept is better for the preparing of ‘Cash Flow Statement’ Therefore, this term is not used in this sense.

TOTAL RESOURCES -

In broader sense it includes all resources used in the business whether in the form of men, material, machinery, money and methods etc.

Working Capital –

In popular sense, the term ‘Fund’ is used to mean working capital i.e. the excess of current assets over current liabilities. Therefore, in this sense, fund flow statement includes all the transactions affecting current assets and current liabilities.

q  Hence, Fund means Working Capital.

Working Capital = Current Assets - Current Liabilities.

MEANING OF FLOW 

The term ‘Flow’ means changes – incoming and outgoing. When this term is used with funds, it means the changes taking place in funds during a certain period. Whenever there is change in the funds, it is presume that flow in funds has taken place. Transactions that bring working capital into the firm are sources of funds and on the contrary, if the working capital decreases, it is an application of funds.

THEREFORE THE TERM FLOW OF FUNDS MEANS “CHANGES IN FUNDS” OR “CHANGES IN WORKING CAPITAL”. IN OTHER WORDS, ANY INCREASE OR DECREASE IN WORKING CAPITAL MEANS “FLOW OF FUNDS”.

MEANING OF FUNDS FLOW STATEMENT

The Funds flow statement (FFS) is a financial statement which reveals the methods by which the business has been financed and how it has used its funds between the opening and closing Balance-Sheet dates. It studies – from where the funds have been received and where the funds have been used.

Fund flow statement is the statement prepared for the purpose of studying the changes in the funds of an organization between the two balance sheet dates.

“A statement of sources and application of fund is a technical device designed to analyse the changes in the financial condition of a business enterprise between two dates.”      -Foulke

“Fund flow statement is a statement prepared to indicate the increase in the cash resources and the utilization of such resources of business during the accounting period.”    - Robert N. Anthony

A fund flow statement is:

ü   a statement shows the changes in funds

ü   b/w two balance sheet of two different dates.

Other Cognate Names of Fund Flow statement:

Fund flow statement bears the following names as well:

(1)   Application of Funds statement;

(2)   Statement of Sources & Application of Funds;

(3)   Statement of sources and uses of funds;

(4)   Statement of Funds Supplied and applied.

 Flow of Funds Chart

Transaction Involves between

 No Flow of Funds Chart

Uses / advantages of Fund Flow Statement :

1. Fund flow statement helps the management in the assessment of long range forecasts of a cash requirements and availability of liquid resources. The manager can judge the quality of management decisions.

 2. With the help of Fund Flow Statement, the investors are able to measure as to how the company has utilized the funds supplied by them and its financial strength. Also, the investors can judge the company’s capacity to generate funds from operations.

 3. It serves as effective tools to the Management for economic analysis as it supplies additional information which cannot be provided by financial statement based on historical data.

 4. Fund flow statement explains the relationship between changes in working capital and net profits. 

5. Fund flow statement helps the management in making planning process of a company. It is also useful in assessing the resources available and the manner of utilization of the resources. 6. It explains the financial consequences of business activities. It also provides explicit and clean answer to questions regarding liquid and solvency position of the company.

6. Fund Flow Statement provides clues to the creditors and financial institutions as to the ability of a company to use funds effectively in the best interest of the investors, creditors and owners of the company.

Limitations of Fund Flow Statements

 1. It should not be overlooked that Fund Statements ignore non-cash transactions, therefore it is considered as cruder device than the financial statement.

 2. Fund Flow Statements merely rearrange a part of the information contained in financial statements. They do not serve as original evidence of financial status.

 3. Though changes in cash resources are more significant, they are not highlighted by Fund Statements except being shown by them as a part of working capital.

 4. As Fund Flow Statements are prepared from information provided by financial statements, they are essentially historical in nature.

Preparation of Fund Flow Statement

Example:- The Balance Sheet of ABC Ltd. at the end of 2006 and 2007 are as follows:

	31 March 2006	31 March 2007
Liabilities:
Accounts Payable	15,000	20,000
Notes Payable	25,000	10,000
Other Current Liabilities	10,000	15,000
6 % Bonds	------	20,000
Retained Earning	80,000	1,10,000
Mortgage	------	10,000
Shares	50,000	50,000
TOTAL	1,80,000	2,35,000
Assets:
Cash	10,000	5,000
Marketable Security	10,000	-------
Inventory	70,000	1,05,000
Receivables	30,000	40,000
Fixed Assets	1,00,000	1,40,000
Accumulated Depreciation	(-)40,000	(-)55,000
TOTAL	1,80,000	2,35,000

You are required to prepare a Statement of Changes in Working Capital and Fund Flow Statement.

Solution: 

Statement of Changes in Working Capital

Particular	2006	2007	Effect on Working Capital
			Increase	Decrease
Current Assets:	Rs.	Rs.	Rs.	Rs.
Cash	10,000	5,000	-----	5,000
Marketable Security	10,000	-----	-----	10,000
Inventory	70,000	1,05,000	35,000	-----
Receivable	30,000	40,000	10,000	-----
	1,20,000	1,50,000
Current Liabilities:
Accounts Payable	15,000	20,000	-----	5,000
Notes Payable	25,000	10,000	15,000	-----
Other Current Liabilities	10,000	15,000	-----	5,000
	50,000	45,000
Net Increase in Working Capital(Balance)			-----	35,000
TOTAL			60,000	60,000

Adjusted Profit & Loss Account

Particular	Amount	Particular	Amount
To Depreciation  (55,000 – 40,000)	15,000	By Opening Balance of P & L A/c	80,000
To Closing Balance of P & L A/c	1,10,000	By Fund from Operation (Balance)	45,000
	1,25,000		1,25,000

Fund Flow Statement
( As on 31 march 2007)

Sources	Amount	Application	Amount
Mortgage	10,000	Purchase of Fixed Assets	40,000
6 % Bonds	20,000	Net Increase in Working Capital	35,000
Funds from Operation	45,000
	75,000		75,000

IMPORTANT QUESTIONS

Short answer questions

1. State the meaning of Funds flow statement
2. How  is the  schedule of changes in working capital prepared?
3. Discuss the importance  of funds flow statement .
4. Explain the  terms ‘funds items‘ and ‘non funds items. Give examples.
5. Write short notes on application of funds.
6. How are the funds from operations calculated?
7. Distinguish between the funds flow statement and Balance-Sheet.

Long Answer questions 

1. Explain the terms ‘Funds’ and ‘Flow in funds ’ in respect of funds flow statement
2. What is a ‘Funds Flows statement’? How is it prepared? What are the various sources and uses of funds ?
3. How is a funds flow statement prepared ?Give a Performa of schedule of changes in working capital and funds flow statement. 

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