Bank reconciliation with a suspected fraud
On 30 June the Cash at Bank ledger of Harlow Studio shows a debit balance of $14,260. The bank statement shows a credit balance of $16,905. The assistant, Dane, prepared this reconciliation: balance per bank $16,905, add outstanding deposits $2,400, less unpresented cheques $1,150, less bank charges $95, equals $18,060 - which he says matches the ledger after 'adjustments'. The ledger does not match. Investigation finds: a customer's direct deposit of $3,200 not recorded in the ledger; a dishonoured cheque from a customer for $780; an unpresented cheque of $4,100 Dane omitted; and a $1,600 payment to a supplier recorded twice in the ledger. Dane alone opens the mail, records receipts, and prepares the reconciliation.
1. Prepare a correct reconciliation. Identify each error and whether it is a ledger or bank statement timing item.
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Classify each item:
- Outstanding deposits $2,400 - timing item; add to bank statement balance.
- Unpresented cheques $1,150 + omitted $4,100 = $5,250 - timing item; deduct from bank balance.
- Bank charges $95 - ledger omission; deduct from ledger.
- Direct deposit $3,200 - ledger omission; add to ledger.
- Dishonoured cheque $780 - ledger omission; deduct from ledger.
- Duplicate payment $1,600 - ledger error; the payment was recorded twice, so add back $1,600 to the ledger.
Bank statement side: $16,905 + $2,400 − $5,250 = $14,055.
Ledger side: $14,260 + $3,200 − $780 − $95 + $1,600 = $18,185.
These do not agree, so a further unreconciled difference of $18,185 − $14,055 = $4,130 remains. This must be investigated, not plugged. Dane's figure of $18,060 was manufactured by omitting the $4,100 cheque and adding items to the wrong side; the arithmetic was made to 'fit'.
2. Assess the internal control weaknesses and recommend three specific controls.
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Weaknesses:
- No segregation of duties. Dane opens the mail (custody), records receipts (recording) and reconciles the bank (independent check). One person controls the entire cash cycle, so errors or theft can be concealed.
- The reconciliation was forced to balance. A reconciliation that is adjusted until it 'matches' defeats its purpose as a detective control.
- No independent review. The owner appears not to review the reconciliation or approve adjustments.
- Unresolved $4,130 difference left unexplained - a red flag for unrecorded receipts or payments.
Recommendations:
- Segregate duties: the owner or a second person should open mail and list receipts before passing them to Dane; a different person should prepare the bank reconciliation.
- Independent review and sign-off: the owner should review and sign the reconciliation monthly, with each reconciling item supported by documentation (bank statement, cheque butt, remittance).
- Investigate the $4,130 immediately and reconcile daily cash receipts to bank deposits; require two signatories on payments above a threshold.
Also consider rotating duties, requiring Dane to take leave (fraud often surfaces during absence), and using bank feeds so transactions are recorded automatically rather than keyed by the same person who handles cash.