Practical bookkeeping

Bank reconciliations

The cash book and the bank statement rarely agree on the same day. A bank reconciliation explains the difference, in two stages.

1. Update the cash book for items on the bank statement that haven’t been recorded yet. The business usually only finds out about these when it sees the statement:
   • Bank charges and interest: fees the bank takes, or interest it pays or charges.
   • Direct debit: a payment the business has allowed someone else to collect from its account. The amount can change, like an electricity bill.
   • Standing order: a fixed regular payment the business has told its bank to make, like monthly rent.
   • BACS receipt: money paid straight into the account electronically, for example by a customer. BACS is the UK system for bank-to-bank payments.
   • Dishonoured cheque: a customer’s cheque that bounced because they didn’t have enough money. The money is taken back out, so the customer owes it again.
2. Reconcile the updated cash book to the bank statement. The remaining differences are timing: cheques sent out that haven’t cleared (unpresented cheques) and money paid in that the bank hasn’t processed yet (outstanding lodgements).

VAT (UK standard rate 20%)

VAT (value added tax) is a tax on sales that businesses collect for the government. A VAT-registered business charges output VAT on its sales and pays input VAT on its purchases. It pays HMRC (HM Revenue & Customs, the UK tax authority) the difference.

Net means before VAT. Gross means including VAT. From a net amount, VAT = net × 20%. From a gross amount, VAT = gross × 1/6, because the gross figure is 120% of the net and 20/120 = 1/6. Example: a gross invoice of £1,200 contains £1,200 × 1/6 = £200 VAT, and the net amount is £1,000.

A credit sale with VAT is recorded as Dr Trade receivables (gross), Cr Sales (net), Cr VAT control (the VAT).

Control accounts

A sales ledger control account summarises every customer account in one total, so it can be checked against the list of individual balances.

The less obvious items:

• Discounts allowed: money knocked off because a customer paid early. The customer now owes less.
• Sales returns: goods sent back by customers.
• Irrecoverable debts: amounts a customer will never pay, for example because they have gone bust. They are written off as an expense.
• Dishonoured cheques: a customer’s bounced cheque. They owe the money again, so it goes back on the debit side.
• Contra: when a business both sells to and buys from the same company, it can cancel what they owe each other. Example: a customer owes you £800 and you owe them £300. A £300 contra leaves them owing you £500, and you owe them nothing.

Cash sales never go in a sales ledger control account, because no customer owes anything.

Suspense accounts

If a trial balance doesn’t agree, the difference is put into a temporary suspense account so the draft accounts can be prepared. Each error is then found and corrected with a journal, and the suspense account is cleared to nil.

A month-end close checklist

• Post all sales and purchase invoices for the month.
• Reconcile every bank account.
• Reconcile the sales and purchases ledger control accounts.
• Post accruals, prepayments and depreciation.
• Clear the suspense account.
• Review the management accounts (the monthly figures prepared for the directors, not for the public) for anything unusual before sending them on.

The cash book shows £4,200. The bank statement shows £5,030. It also shows bank charges of £45, a £300 insurance direct debit and a £650 BACS receipt from a customer, none of which are in the cash book yet. Cheques of £1,625 haven’t cleared, and £1,100 paid in on the last day isn’t on the statement.