RELEVANT TO CAT PAPER 3
A question on bank reconciliation has frequently been included in past CAT Paper 3 exam papers and
this can be expected to continue. While many candidates pick up a high number of marks on this
topic, a number of candidates do not perform wel . This could easily be corrected by applying clear
thinking to the question. This article sets out the key issues to be considered in the context of the
Study Guide outcomes for CAT Paper 3, Maintaining Financial Records.
PURPOSE OF A BANK RECONCILIATION
To understand the purpose of a bank reconciliation, it is necessary to consider
These are the most straightforward differences, as they are simply
the overall purpose of CAT Paper 3. Financial records are maintained so that
transactions which are recorded in each set of records in different periods.
final accounts can be prepared. Given that the overriding requirement of final
They arise because the entity will record the issue of cheques or lodgements
accounts is that they should fairly present the financial position and income
to the bank at the point at which the transaction is initiated. However, the
and expenses of the entity, it follows that the underlying financial records must nature of the banking system may lead to a delay in a cheque being presented
be reliable. This means that all transactions should be recorded accurately.
at, or a lodgement being processed by, the bank.
Therefore, the purpose of a bank reconciliation is to ensure that the
These differences are simply reconciling items. Therefore, no entry
underlying records relating to bank transactions are reliable. This means that
is required in the ledger, but such items should be included on the
the completion of a bank reconciliation is more than a matter of arithmetical
accuracy. It is not sufficient to provide a statement which reconciles the
balance on the bank account in the entity’s ledger and the bank statement.
Transactions initiated by the bank
Rather, it is important to ensure that the ledger balance is correctly stated,
There are a number of reasons why the bank may initiate a transaction. The
by making any correcting entries in the ledger, so that the corrected ledger
most obvious is that the bank may have charged fees or interest, or may have
balance is reconciled to the bank statement balance. This is emphasised in
paid interest to the entity.
the Study Guide for CAT Paper 3. Outcome 12 (e) is deliberately worded as
A less obvious type of transaction initiated by the bank occurs when
follows: ‘Prepare a reconciliation between the statement balance and the
a cheque lodged by the entity is not honoured by the paying bank. In
corrected ledger balance’.
such circumstances, the bank will initiate a debit on the bank statement
Thus, the purpose of a bank reconciliation is to check the accuracy of
to cancel the lodgement, and a further debit charge for costs incurred by
the bank balance in the entity’s ledger and to ensure that the bank balance is the bank.
correctly reported in the final accounts.
Usually, the entity will not be aware that such transactions have
occurred until the bank statement is received. If the final accounts
REPORTING THE BANK BALANCE
are to be reliable, it is essential that these transactions are recorded
From the discussion above, it follows that the bank balance to be reported in
in the entity’s ledger, and are included in the corrected bank balance.
the final accounts is the corrected ledger balance. If the corrected balance is
Therefore any transaction initiated by the bank will require an entry in the
a debit balance, then the entity will have funds at the bank which should be
reported on the balance sheet as a current asset. If the corrected balance is a
It is worth remembering that the bank statement is actually a copy
credit balance, then the bank account is overdrawn. This should be reported
of the record of transactions maintained by the bank. This means that
on the balance sheet as a current liability.
transactions are recorded from the perspective of the bank. Therefore
a lodgement will appear on the bank statement as a credit entry, as it
increases the liability of the bank to the account holder. In the books of the
The process of carrying out a bank reconciliation is to compare the two
account holder, a lodgement will be a debit entry in the bank account on
sets of records (the entity’s ledger and the bank statement) and to identify
the general ledger. In the same way, cheques issued, bank charges, and
any differences. The vast majority of transactions will be present in both
bank fees will appear on the bank statement as debit entries, and will be
sets of records, but inevitably there will be differences. These differences
recoded in the bank account in the general ledger of the account holder as
will typically be the starting point for an exam question. The exam task is
credit entries. As a result, a balance at the bank will be a credit balance
therefore to decide how to treat each difference. Perhaps the easiest way to
on the bank statement, and a debit balance on the bank account in the
do this is to consider the reasons for differences.
account holder’s general ledger.
Transactions omitted by the entity
Before starting the question, it is worth considering the significance of the
Obviously, if a transaction has been omitted, then an entry must be made in
note included in requirement (a). As this paper tests candidates’ ability to
the ledger to ensure it remains reliable. The nature of the entry will depend
maintain accurate financial records, it is not appropriate for ledger information
on the type of transaction which has been omitted.
to be presented without clearly identifying whether a debit entry or a credit
entry is being made. This can be done in a number of ways, but the use of
Transactions incorrectly recorded
‘plus’ and ‘minus’ is NOT acceptable within a ledger account.
These are probably the most difficult matters to deal with. The first question
to be considered is whether the error has been made by the entity or by the
bank. If the error has been made by the entity, an entry must be made in
To complete the question, it is necessary to decide how each of the
the ledger. If the error has been made by the bank, an adjustment will be
differences noted in the question should be treated.
included on the reconciliation statement.
In both cases, the value will be the net effect of cancelling the incorrect
entry and establishing the correct entry.
The charges made by the bank need to be included in the ledger.
A credit entry for $129 is required in the bank account (the
PAST PAPER QUESTION
corresponding debit will be in the expense account for
Perhaps the best way to illustrate how to handle a bank reconciliation is to
consider a question from a past paper. The following question was in the June ii
This is an example of a transaction omitted from the ledger.
2007 CAT Paper 3 exam:
As the transaction was to transfer the sum of $2,500 into
the business bank account, a debit entry is required in the
At the end of each month, Sarah prepares a bank reconciliation statement for
bank account (the corresponding credit will be in Sarah’s
her business bank account. At 31 May 2007 her ledger balance was $2,759
capital account, to reflect the funds introduced to
(credit) and her bank statement showed that she had funds of $131 at the
bank. She has the following information:
This is another transaction omitted from the ledger. In this case,
(i) The bank debited Sarah’s account with charges of $129 during May.
funds have been withdrawn, so a credit entry for $100 must
Sarah has not recorded these charges.
be made in the bank account (the corresponding debit will be in
(ii) Sarah arranged for $2,500 to be transferred from her personal bank
Sarah’s drawings account).
account into the business bank account. The bank made the transfer on
The information confirms that the cheque has been incorrectly
30 May, but Sarah has not made any entry for it in her records.
recorded in the ledger. Therefore, the value is understated by
(iii) On 22 May, Sarah withdrew $100 cash which she did not record.
$90. This means that the value of the cheque issued must
(iv) Cheque number 543987, which Sarah issued to a supplier, appears
be increased by $90, leading to a credit entry in the ledger
on the bank statement as $650. Sarah incorrectly recorded the cheque
account (the corresponding debit will be in the trade
(v) On 31 May, Sarah lodged $457. On the bank statement, this amount is
This is a timing difference. The lodgement is correctly recorded
dated 3 June.
in Sarah’s ledger, but the banking system means that it
(vi) Sarah was advised by the bank that she earned $52 interest for the
has not yet appeared on the bank statement. This will be an
period in May that her account was in credit. Sarah recorded this in May,
item on the reconciliation statement. It will lead to an increase
but the bank did not credit her account until June.
in the funds at the bank.
(vii) Three of the cheques issued in May, with a total value of $942, were not vi
As the interest was earned during May, it has been correctly
debited on the bank statement until after 31 May.
recorded in the ledger account in May. Therefore, it is another
(viii) A cheque for $276, issued to a supplier, was cancelled but Sarah has
timing difference, and as such, should be included in the
not recorded the cancellation of the cheque.
Cheques which have not yet been processed by the bank are
timing differences, and will appear on the reconciliation
(a) Show the bank account in Sarah’s general ledger, including any
statement. The effect is to reduce the funds at the bank.
adjusting entries required due to the information given in points (i) to
This is a transaction omitted from the ledger. When the cheque
(viii). Note: You MUST present your answer in a format which clearly
was originally issued, a credit entry would have been made in
indicates whether each entry is a debit or a credit. (7 marks)
the ledger account. Therefore, to cancel the cheque a debit
(b) Prepare a reconciliation of the bank statement balance to the corrected
entry is required for $276 (the corresponding credit entry will be
balance on the bank account in Sarah’s general ledger. (5 marks)
in the trade payables account).
(c) Indicate how the bank balance will be reported in Sarah’s final
accounts, and the value to be reported. (3 marks)
Having identified how to treat each item, the ledger account and the
(15 marks) reconciliation statement can now be prepared. (Note, the explanations given
are not required in an exam. They are provided here to assist candidates’
The reconciliation statement provides assurance that the ledger account is
understanding of how the various items should be treated.)
correctly stated. The only reasons for the difference between the corrected
The question states that the balance on the ledger account before the
balance on the ledger account and the balance on the bank statement will
necessary adjustments is a credit balance of $2,759. This is the starting
be timing differences. The question states that the balance on the bank
point for the ledger account. When each of the adjustments noted above are
statement is $131 at the bank. With timing differences for unpresented
included, the corrected ledger balance is $302. As the balance is brought
cheques, and lodgement and interest to be credited, the reconciliation
down on the credit side, it represents an overdraft. This provides the answer to
statement is as follows:
Part (c), as it is the corrected balance of $302 which wil be reported on the
balance sheet. As it is a credit balance, it wil be reported as a current liability.
Balance per statement
Balance as given
Balance (corrected) 302 (iv)
90 The negative balance confirms that the bank account is overdrawn.
302 Ronnie Patton is examiner for CAT Paper 3