Chapter 3: Accounting for Cash and Bank Flashcards
Recording cash and bank transactions
- In a cash sale or purchase, goods and services are bought and PAID IMMEDIATELY using cash
Remittance advice accompanies a cash receipt or payment transaction.
These transactions are reflected in a business’s accounting system by transferring information from the remittance advice (source document) into the relevant ledger accounts (general ledgers) using double entries.
Cash and bank transactions and their double entries
Transactions that may impact the cash or bank account are:
- Cash sales (receipt)
- Cash purchases (payment)
- Expense payments (payment)
- Income received (receipt)
- Trade payables settlements (payment) – This is covered in Chapter 4.
Cash sales
A cash sale arises when customers pay cash to the business in exchange for goods or services.
The cash receipt affects at least two ledger accounts.
- Cash or Bank account
- Sales account
Dr Cash/Bank, Asset, cash (assets) increased
Cr Sales tax (if any), Liability, Taxes due to authorities (liability) increased
Cr, Sales, Income, Sales (income) increased
The amount entered into the Sales account is the net amount (price after discounts but bef0re sales tax)
Cash Purchases (inventory)
Cash purchases for inventory are cash payments made to a supplier in exchange for goods a business intends to sell (either raw material or finished goods)
The cash paid for the inventory purchase affects at least two ledger accounts.
- Inventory Purchases account
- Cash or Bank account
Dr, Purchases, Expense, Inventory purchases (expense) increased
Dr Sales tax (if any), asset, taxes due from authorities (assets) increased
Cr, Cash/Bank, Asset, Cash (assets) decreased
The amount entered into the Purchases account is the net amount (price after discounts but before sales tax).
There are no settlement discounts in cash purchase transactions, as payments are made immediately.
Expense Payments
Expenses such as electricity bills, rent, or advertising fees are incurred by businesses to conduct its operation.
The payment of these expenses affects at least two ledger accounts.
- Individual Expense account
- Cash or Bank account
Dr Individual expense, Expense, Expenses have increased
Dr Sales tax (if any), asset, taxes due from authorities (assets) increased
Cr Cash/bank, asset, cash (assets) decreased
Income Payments
A business may also have secondary income sources apart from its trading operations, such as receiving rental income from leasing part of its office buildings and bank interest income from investing its deposits.
The receipt from income payments affects at least two ledger accounts.
Dr, Cash/Bank, Asset, Cash (assets) increased
Cr, Sales Tax (if any), Asset, Taxes due to authorities (liabilities) increased
Cr, Individual Income, Income, Income has increased
Each cash receipt and cash payment transaction is transferred to the ledger accounts in the general ledger. Each ledger account is represented in a “T-Account”.
Closing off Ledger Accounts
When all the transactions have been posted to the general ledger accounts at the end of the period, the accountant can then ‘close off’ the accounts. Closing off a ledger account identifies the account balance to be transferred to the trial balance.
To close off a ledger account,
Sum up the debit and credit sides in the ledger account.
The difference between the totals is the closing balance (balance c/d).
Reporting of cash and bank balances
Each ledger account balance is categorised into one of the following elements in the trial balance:
[see diagram]
SFP - a) current asset or non current asset
b) current liability or non current liability
C) capital or drawings
Statement of profit or loss - x) income
y) expense
Bank and Cash ledger accounts are reported as one of the categories in the Financial Statements.
Bank Current Account
The Bank account is recorded as an asset because it is a resource controlled by the business. As cash in the bank is liquid (converts to cash easily), it is a current asset.
Bank Overdraft Account
An overdraft bank account is recorded as a Liability because it is owed and is repayable on demand by the bank. As the overdraft account deals with cash, it is a CURRENT Liability.
In practice, some banks take a business’s overdraft and current account balance as a whole by subtracting one balance from the other to arrive at a net balance. This is called ‘offsetting’.
If a bank has an offsetting policy, the business should sum the two balances and report a single current asset or current liability in the financial statements.
Cash Account (Cash-in-Hand or Petty Cash)
The Cash account is recorded as a CURRENT ASSET as it is a resource controlled by the business and is liquid.
*the BANK LEDGER and the SALES TAX LEDGER are examples of accounts that may be assets or liabilities depending on their financial balance
A Bank ledger is reported as an Asset if there are balances in the Bank account. If the account is in an overdraft position, the Bank ledger balance is reported as a Liability.
A Sales Tax ledger is reported as an asset if the business is in a net input sales tax position (refundable from tax authorities).
The Sales Tax ledger account is reported as a liability if the business is in a net output sales tax position (payable to tax authorities).
Purpose of Bank Reconciliations
*A bank reconciliation is a reconciliation between the BANK STATEMENT balance and the balance on the BANK LEDGER account.
The bank balance reported in the business’s financial records should accurately reflect the amount of cash in the bank account.
The bank keeps records of transactions in and out of the business’s bank account. Information on these transactions is sent to the business through a bank statement.
In the modern era of digital banking, bank statements and other banking records are easily extracted from the bank’s internet website.
The balance on the bank statement or internet banking records may differ from the balance in the Bank ledger account. In such cases, a BANK RECONCILIATION is prepared to highlight the differences and calculate the correct Bank account balance.
Reasons for differences (4)
The bank statement balance may not agree with the Bank ledger account balance. Differences may arise from errors, omissions, or timing differences.
Errors
Omission
Dishonoured cheques (bounced cheques)
Timing differences
Errors
can be found in both the Bank ledger accounts and the bank statement. Errors may occur due to transactions posted twice or an incorrect amount reflected in either of these balance statements.
Omission
of transactions could cause a difference between the two sources’ balances. Transactions such as standing orders, bank charges, or interest received could be reflected in the bank statement but not in the Bank ledger account or vice versa.
