Bank Reconciliation and Cash Book Errors at Dovecott Ltd
Dovecott Ltd's cash book showed a debit balance of £8,450 at 31 May 20X6. The bank statement at the same date showed a credit balance of £7,890. The following were discovered: unpresented cheques £2,340; outstanding lodgements £3,150; bank charges £180 and a direct debit £560, both not in the cash book; a customer's cheque for £740 returned unpaid, not recorded; a cash sale receipt of £1,250 entered in the cash book as £1,520; and a £2,000 loan received from the bank, not recorded in the cash book. The bookkeeper wants to simply adjust the bank statement balance to the cash book balance and treat the difference as a suspense item. The managing director is concerned because the draft profit currently includes the full £1,520 receipt and no bank charges.
1. Prepare the adjusted cash book and the bank reconciliation at 31 May 20X6.
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Adjusted cash book: start with debit £8,450. Deduct bank charges £180, direct debit £560, dishonoured cheque £740 and the £270 overstatement of the receipt (£1,520 − £1,250). Add the unrecorded loan £2,000. Adjusted balance = £8,450 − £180 − £560 − £740 − £270 + £2,000 = £8,700.
Bank reconciliation: balance per bank statement £7,890 credit. Add outstanding lodgements £3,150; deduct unpresented cheques £2,340. Reconciled balance = £7,890 + £3,150 − £2,340 = £8,700, agreeing with the adjusted cash book.
2. Explain why unpresented cheques and outstanding lodgements are not adjusted in the cash book.
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Unpresented cheques are cheques already entered in the cash book but not yet cleared through the bank. Outstanding lodgements are receipts already entered in the cash book but not yet credited by the bank. Both are timing differences: the business has recorded the transaction when it happened, while the bank records it later.
The cash book is the business's record and is already correct for these items, so no adjustment is made to it. They appear only in the reconciliation to explain why the bank statement balance differs. Adjusting the cash book for them would double-count the transactions once the bank processes them.
3. Advise on the treatment of the dishonoured cheque, the £270 error and the unrecorded loan, and explain the effect on profit if the bookkeeper's approach is followed.
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The dishonoured cheque means the original receipt has failed. The cash book must be reduced by £740 and the customer's receivable reinstated, because the debt is owed again. The £270 error means cash and sales were overstated; the correction is Dr Sales £270 / Cr Cash £270. The £2,000 loan is a genuine receipt and must be added to the cash book.
The bookkeeper's plan to adjust the bank statement and put the difference to suspense is wrong: it leaves the cash book incorrect, and suspense is not a dumping ground for reconciling items. Profit is also affected: bank charges £180 and the direct debit £560 are expenses not yet recorded, the dishonoured cheque may require a bad debt write-off or allowance, and sales are overstated by £270. If the cash book is not corrected, profit is overstated.