Bank reconciliation with unrecorded items and internal control weakness
Rimu Trading's cash book shows a debit balance of $18,420 at 31 May. The bank statement shows a credit balance of $21,960. The following are discovered: (1) deposits not yet credited, $4,300; (2) unpresented cheques, $6,150; (3) a customer's direct deposit of $1,800 not recorded in the cash book; (4) bank charges of $95 not recorded; (5) a dishonoured cheque from a customer for $740, originally received and banked, not recorded as dishonoured; (6) the bank incorrectly debited Rimu's account with another entity's cheque, $520; (7) a standing order for insurance, $1,200, not recorded. The owner also reports that the same staff member receives cash, records receipts and performs the bank reconciliation, and that no sequential receipting is used.
1. Prepare the bank reconciliation to determine the corrected cash book balance and the adjusted bank statement balance.
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Cash book adjustments
Starting balance (debit) $18,420.
- Add direct deposit: +1,800
- Less bank charges: -95
- Less dishonoured cheque: -740
- Less standing order: -1,200
Adjusted cash book = 18,420 + 1,800 - 95 - 740 - 1,200 = $18,185.
Bank statement adjustments
Starting balance (credit) $21,960.
- Add deposits not credited: +4,300
- Less unpresented cheques: -6,150
- Add bank error (incorrect debit): +520
Adjusted bank statement = 21,960 + 4,300 - 6,150 + 520 = $20,630.
Check: The two adjusted balances do not agree ($18,185 vs $20,630), indicating a further unrecorded item or error of $2,445. This discrepancy should be investigated before finalising; it may be an unrecorded receipt or a transposition. Presenting a reconciliation that does not balance would be misleading.
2. Identify the internal control weaknesses and recommend specific controls to address them.
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Weaknesses
- Segregation of duties - one person receives cash, records receipts and reconciles the bank. This allows concealment of theft (e.g. teeming and lading).
- No sequential receipting - cash receipts cannot be traced, increasing risk of unrecorded receipts.
- Reconciliation not independent - the reconciler is the same person handling cash.
Recommendations
- Separate the functions: one person receives and receipts cash, another records in the cash book, and a third (e.g. owner or external accountant) prepares and reviews the reconciliation.
- Introduce pre-numbered receipts issued for every cash receipt and reconcile the sequence periodically.
- Require the owner to review and sign the monthly reconciliation, with supporting documents for adjustments.
- Rotate duties and require annual leave so anomalies surface.
- Restrict access to banking and accounting systems by role.
These controls target the specific risks rather than being generic; the reconciliation itself is a detective control and must be performed independently of custody.
3. Explain why the bank error of $520 is treated differently from the dishonoured cheque of $740.
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Bank error ($520): The error is the bank's, not Rimu's. Rimu's cash book is correct; the bank statement is wrong. It is therefore adjusted in the bank reconciliation (added back to the bank statement balance) and not recorded in Rimu's ledger. Rimu should notify the bank to correct it.
Dishonoured cheque ($740): This is a real economic event affecting Rimu - the customer's payment failed. Rimu's cash book must be adjusted (reduce cash) and the amount reinstated as a receivable from the customer. It is not a bank error.
Principle: Adjust the cash book for items the entity has not yet recorded that genuinely affect its cash position; adjust the bank statement side for timing differences and bank errors. Misclassifying the bank error as a cash book adjustment would overstate/understate Rimu's own records and distort the corrected balance.