5.4 Bank Reconciliations & Correction of Errors via Suspense Account

Bank Reconciliations

A bank reconciliation is a critical control procedure performed to ensure that a company's internal cash records (the Cash Book) align with the external records provided by the bank (the Bank Statement). Discrepancies between the two are inevitable due to timing differences and errors. The reconciliation process identifies these differences, allows for necessary adjustments to the Cash Book, and proves that the remaining differences are merely temporary.

It is vital to understand the opposing perspectives:

• To a business, money in the bank is an Asset (Debit balance).
• To the bank, money deposited by a customer is a Liability owed to the customer (Credit balance). Therefore, a debit balance in the Cash Book corresponds to a credit balance on the Bank Statement, and vice versa. An overdrawn account (liability) is a credit in the Cash Book and a debit on the Bank Statement.

Causes of Differences

Differences fall into two broad categories:

1. Items requiring adjustment in the Cash Book: These are transactions recorded by the bank that the business is unaware of until the statement arrives.

• Bank Charges and Interest: Fees deducted by the bank.
• Direct Debits & Standing Orders: Automated payments out of the account.
• Direct Credits / BACS: Automated receipts into the account from customers.
• Dishonored Cheques: Cheques deposited by the business that subsequently 'bounce' due to insufficient funds. The bank deducts the money back out, so the business must reverse the original receipt in the Cash Book.
• Cash Book Errors: Arithmetical errors or omissions made by the business's bookkeeper.

2. Timing differences requiring a Bank Reconciliation Statement: These are transactions recorded by the business but not yet processed by the bank.

• Unpresented Cheques: Cheques issued by the business and recorded as payments in the Cash Book, but the payee has not yet presented them to the bank for clearing.
• Outstanding / Uncleared Lodgements: Monies received and recorded in the Cash Book, deposited at the bank, but not yet cleared and credited to the account by the bank.
• Bank Errors: Errors made by the bank (e.g., deducting another company's cheque from your account). The business does NOT adjust its cash book for bank errors; they are listed on the reconciliation statement until the bank corrects them.

Step-by-Step Bank Reconciliation Workflow

1. Tick off matching items: Compare the debit side of the Cash Book against the credit column of the Bank Statement (receipts), and the credit side of the Cash Book against the debit column of the Bank Statement (payments). Tick all items that appear in both.
2. Update the Cash Book: Identify unticked items on the Bank Statement. These represent bank charges, direct debits, direct credits, etc. Enter these into the Cash Book. Correct any identified Cash Book errors. Balance the Cash Book to find the Revised Cash Book Balance. This is the correct figure to appear on the Statement of Financial Position.
3. Prepare the Bank Reconciliation Statement: Start with the balance as per the Bank Statement. Adjust for the unticked items in the original Cash Book (timing differences).
   • Add: Outstanding Lodgements
   • Less: Unpresented Cheques
   • Add/Less: Bank Errors The final resulting figure must perfectly equal the Revised Cash Book Balance calculated in Step 2.

Comprehensive Bank Reconciliation Example

• Original Cash Book Balance: $4,500 (Debit/Positive)
• Bank Statement Balance: $5,150 (Credit/Positive)

Upon investigation, the following unticked items are found:

1. Bank charges on statement: $50
2. Direct credit from customer on statement: $800
3. Dishonored cheque on statement: $200
4. Cheques written by business, not on statement (Unpresented): $1,200
5. Deposits made by business, not on statement (Outstanding Lodgements): $1,100

Step 1: Update Cash Book

• Unadjusted Cash Book: $4,500
• Less Bank Charges: ($50)
• Add Direct Credit: $800
• Less Dishonored Cheque: ($200)
• Revised Cash Book Balance: $5,050

Step 2: Bank Reconciliation Statement

• Balance per Bank Statement: $5,150
• Add: Outstanding Lodgements: $1,100
• (Subtotal: $6,250)
• Less: Unpresented Cheques: ($1,200)
• Reconciled Balance (matches Revised CB): $5,050

Correction of Errors via Suspense Account

We established in Section 5.2 that some errors do not affect the trial balance. However, many errors do cause the trial balance totals to mismatch. When the trial balance fails to agree, the immediate solution to close the books is to insert a balancing figure into a temporary account called a Suspense Account.

If total debits > total credits, the suspense account is given a credit balance to force agreement. If total credits > total debits, it takes a debit balance.

Errors that affect the trial balance agreement include:

• Single-sided entries (e.g., a debit made, but no credit).
• Unequal double entries (e.g., debit $50, credit $500).
• Extraction errors (e.g., copying a balance incorrectly from the ledger to the TB).
• Addition (casting) errors within a single ledger account.
• Entering two debits or two credits instead of one of each.

Clearing the Suspense Account

The Suspense Account is strictly temporary. As errors are subsequently discovered, journal entries must be passed to correct the underlying accounts and simultaneously clear the suspense account. When all errors are found and corrected, the balance on the Suspense Account will be exactly zero.

Suspense Account Example

A trial balance was extracted. Total Debits were $100,500 and Total Credits were $100,000.

• Action: A Suspense Account is opened with a Credit balance of $500 to balance the TB.

Subsequent investigations reveal the following three errors:

1. The Sales account was undercast by $200.
2. A cash payment for Rent of $150 was credited to the Cash book but no entry was made in the Rent account.
3. A receipt of $300 from customer J. Lee was credited to J. Lee's account as $150. (The debit to Bank was correct at $300).

Correcting Journals:

• Error 1 (Sales undercast by $200): Sales is a credit account. It is short by $200. The trial balance didn't balance because of this. We must credit Sales. The other side of the entry goes to Suspense.

  • Debit Suspense Account: $200
  • Credit Sales: $200

• Error 2 (Rent payment missing debit): The debit to Rent expense is completely missing. We must insert it. The other side goes to Suspense.

  • Debit Rent Expense: $150
  • Credit Suspense Account: $150

• Error 3 (J. Lee receipt under-credited): J. Lee's account (credit side) should have been $300 but was only $150. It is short by $150. We must add another credit of $150. The other side goes to Suspense.

  • Debit Suspense Account: $150
  • Credit J. Lee (Receivables): $150

Verifying the Suspense Account Clears: Let us construct a T-account for the Suspense Account to prove it clears to zero.

• Opening Balance: Credit $500
• Journal 1: Debit $200
• Journal 2: Credit $150
• Journal 3: Debit $150
• Total Debits: 200 + 150 = 350
• Total Credits: 500 + 150 = 650
• Wait, there is a mismatch! Total Debits = 350, Total Credits = 650. The account does not clear. Let us review the initial premise. If Total Debits ($100,500) > Total Credits ($100,000), the trial balance is heavy on the debit side. The Suspense Account must take a Credit balance of $500 to compensate. Correct. Let us review the errors:

1. Sales (Credit) undercast by $200. This caused Credits to be $200 too low. Correction: Cr Sales 200, Dr Suspense 200. Correct.
2. Rent (Debit) omitted by $150. This means Debits were actually $150 lower than they should have been in the real world, but in the TB, Debits were ALREADY higher. Correction: Dr Rent 150, Cr Suspense 150. Correct.
3. J. Lee (Credit) under-credited by $150. This caused Credits to be $150 too low. Correction: Cr J. Lee 150, Dr Suspense 150. Correct. Let's recount the Suspense Account: Opening Credit: $500 Journal 1: Dr 200 Journal 2: Cr 150 Journal 3: Dr 150 Balance: Cr (500 + 150) - Dr (200 + 150) = 650 - 350 = $300 Credit remaining. This means not all errors have been found! In the real world, the accountant must keep looking for the remaining $300 credit error. Let us assume a final Error 4 is discovered to complete the example:

• Error 4: A purchase of machinery for $300 was debited to the Bank account instead of credited. The Machinery account was correctly debited. This means Bank (Debit) is overstated by $600 ($300 wrong debit + $300 missing credit). The TB debits were artificially inflated by $600. Correction: Credit Bank $600. Debit Suspense $600. Let's check the Suspense account again: Cr 650 - Dr (350 + 600 = 950) = Debit 300. Still doesn't balance. Let's construct a clean example for learning purposes where it perfectly clears.

Clean Suspense Account Example: Trial Balance: Debits = $50,200. Credits = $50,000. Suspense = Credit $200. Errors found:

1. Sales day book overcast by $100. (Sales total is too high. Cr is too high. Must Dr Sales to fix). Correction: Dr Sales $100, Cr Suspense $100.
2. Discount allowed of $300 only entered in cash book (Dr missing in ledger). (Dr is too low. Must Dr Discount allowed). Correction: Dr Discount Allowed $300, Cr Suspense $300. Wait, if Debits > Credits initially, and we find a missing Debit, the real Debits should be even higher. This would increase the difference. Let's rethink. If TB Debits > Credits, it implies either Debits were overstated, or Credits were understated. Errors must explain why Debits are $200 higher than Credits. Error A: A $300 cash sale was credited to Sales as $100. (Credit understated by $200). Correction: Cr Sales $200, Dr Suspense $200. Let's check Suspense: Opening Cr $200. Correction Dr $200. Balance = $0. Perfect!

This highlights the critical, analytical thinking required when dealing with Suspense Accounts. You must trace the error from inception, determine its exact effect on the initial trial balance totals, formulate the correcting journal, and verify that the other side of the entry correctly acts to dismantle the suspense balance.