Accounting (9706) | Reconciliation and verification

Welcome to Reconciliation and Verification (AS Level Accounting 9706: Topic 1.4)

Hello future accountant! This chapter is incredibly important because it moves beyond just recording transactions and teaches you how to find and fix mistakes. Think of it as being the detective in your accounting system! Without reliable checking procedures, the financial statements prepared later (Topic 1.5) will be meaningless.
We will learn three core methods of ensuring accuracy: managing the Trial Balance, checking the bank balance, and verifying the subsidiary ledgers.

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1. The Need for Reconciliation and Verification (1.4.1)

What are Reconciliation and Verification?

In simple terms, good accounting is accurate accounting. If two records of the same event disagree, something is wrong. Reconciliation and verification are the tools we use to achieve this accuracy.

• Verification: This is the process of confirming that an amount is correct, usually by checking it against a source document (like an invoice, receipt, or bank statement).
• Reconciliation: This means comparing two independent sets of figures or balances that should theoretically agree, and investigating any differences.

Benefits and Limitations (1.4.1)

Benefits of Reconciliation and Verification

1. Accuracy: They ensure the fundamental principle of double entry is maintained, leading to reliable financial statements.

2. Fraud Detection: Comparing records (e.g., Control Accounts or Bank Statements) helps identify irregularities or theft promptly.

3. Better Decision Making: Users rely on accurate financial data (like the true Cash balance) for making informed choices.

4. Timeliness: Procedures like Bank Reconciliation ensure that the internal records (Cash Book) are updated with external information quickly.

Limitations of Reconciliation and Verification

No system is perfect. These measures have limits:

• They often rely on the diligence of staff; if the person making the checks is careless, errors will be missed.
• Collusion (two or more people working together to commit fraud) can bypass internal verification systems.
• The process takes time and resources, which might be costly for very small businesses.

Key Takeaway: Reconciliation is comparing two existing figures; verification is proving a figure is real using evidence. Both are crucial for trustworthy accounts.

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2. The Trial Balance and Error Correction (1.4.2)

What is a Trial Balance (TB)?

A Trial Balance is a list of all the balances in the ledger accounts (Assets, Liabilities, Income, Expenses, Capital) drawn up at a specific date. If the total debits equal the total credits, it suggests (but does not guarantee) that the double-entry system has been applied correctly.

Errors that Affect the Trial Balance

If the totals of the Debit and Credit columns of the Trial Balance are not equal, you know an error has occurred. This difference is temporarily placed in a Suspense Account.

Common errors that affect the TB include:

• A transaction posted only once (single entry).
• Posting the wrong amount to an account (transposition error).
• Incorrectly adding up ledger accounts (arithmetical error).

Errors that DO NOT Affect the Trial Balance

Don't worry if this seems tricky at first! These are the most common and difficult errors because the double-entry rule (Debit = Credit) was technically followed, even if the wrong accounts were used.

We often use the mnemonic CO-PRC to remember the five main types (or six if you include compensating):

1. C - Commission

When the correct amount is posted, but to the correct side of the wrong account of the same class.

Example: Cash sale to customer X debited to customer Y's account (both are Trade Receivables).

2. O - Omission

A transaction is completely forgotten and never entered into the books at all.

Example: A purchase invoice is filed away without being recorded.

3. P - Principle

A transaction is posted to the wrong class of account (violating an accounting concept).

Example: Recording the purchase of a new non-current asset (Capital Expenditure) as a repair expense (Revenue Expenditure).

4. R - Reversal of Entries

The correct accounts and amount are used, but the accounts are posted to the wrong sides (e.g., Debit becomes Credit, and vice versa).

Example: Cash payment received from a customer is Debited to Cash Book and Credited to the customer (correct), but the customer account is accidentally Debited and Cash is Credited (reversed).

5. O - Original Entry

The original amount recorded in the book of prime entry is wrong, but the double-entry postings (Dr and Cr) reflect this incorrect original figure.

Example: An invoice for $520 is recorded in the Sales Journal as $250, and both the Sales and Customer account are posted with $250.

6. C - Compensating

Two or more errors occur that cancel each other out in the Trial Balance. These are the hardest to find!

Example: Sales account is overstated by $100 AND Rent expense is also overstated by $100. The TB still balances, but both figures are wrong.

Correcting Errors using the Suspense Account (1.4.2)

If the TB does not balance, the difference is temporarily stored in a Suspense Account. This account helps balance the books immediately while you search for the mistake.

Step-by-Step Correction Process:

1. Determine the imbalance: Calculate the difference between the TB Debit total and Credit total. If Debits are higher, the Suspense Account will have a Credit balance (and vice versa).

2. Identify the Error: Determine which accounts are wrong and how they need to be fixed (i.e., should they be Debited or Credited to correct them?).

3. Prepare the Journal Entry: Use the General Journal to record the correction. This is the crucial step.

Analogy: If an account was wrongly Debited $100, you need to Credit $100 to fix it. If the error was one that affected the TB (like posting only half the double entry), the other side of your journal entry will be the Suspense Account.

4. Post to Ledgers: Post the journal entry to the relevant ledger accounts, including the Suspense Account, which should now clear to zero once all errors are found.

Example of Correction:

Scenario: A purchase of machinery for $5,000 was wrongly debited to the Purchases account (an error of principle). The TB balanced using a Suspense Account due to other errors.

• Current status: Purchases (Expense, too high) is Debited $5,000. Machinery (Asset, too low) is $0.
• Correction needed: Need to reduce Purchases (Credit $5,000) and increase Machinery (Debit $5,000).
• Journal Entry:
  

  Debit Machinery Account \(5,000\)
  Credit Purchases Account \(5,000\)

Notice: Since this specific error (Principle) was one that did not affect the TB when it occurred, the correction itself does not involve the Suspense Account!

The Effect on Financial Statements (1.4.2)

The correction of errors must be recorded in the General Journal before being posted to the ledgers and adjusted in the final accounts.

• If an expense (like Purchases) was overstated, the correction will increase Profit for the year.
• If an asset (like Non-Current Assets) was understated, the correction will increase the value of the assets in the Statement of Financial Position.

Key Takeaway: The Suspense Account is only used when the original error caused the Trial Balance to imbalance. When correcting an error that didn't affect the TB, the journal entry must correct the two wrong accounts used.

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3. Bank Reconciliation Statements (BRS) (1.4.3)

A Bank Reconciliation Statement (BRS) is prepared to explain the difference between the balance shown in the company’s internal Cash Book and the balance shown on the external Bank Statement.

Analogy: When you check your wallet (Cash Book) against your bank app (Bank Statement), the figures often don't match exactly because of transactions still 'in transit'.

Step 1: Updating the Cash Book

The Cash Book is the company's record. It must be updated for items the bank has processed but the business has not yet recorded internally.

• Debit entries in the Bank Statement (Credit in the Cash Book):
  These are payments and reductions you didn't know about yet. Examples: Bank charges, Direct Debits, Standing Orders, Dishonoured Cheques.
• Credit entries in the Bank Statement (Debit in the Cash Book):
  These are receipts and increases you didn't know about yet. Examples: Interest received, Direct credits (deposits made directly by a customer).

After these entries, calculate the Updated Cash Book Balance. This is the correct balance of cash the company truly owns.

Step 2: Preparing the Bank Reconciliation Statement (BRS)

The BRS explains why the updated Cash Book balance does not equal the Bank Statement balance. It starts with the Bank Statement balance and adjusts for items the company knows about, but the bank has not yet processed.

• Unpresented Cheques: Cheques issued by the company (recorded as payments in the Cash Book) but which have not yet been cashed by the payee. (This reduces the bank balance.)
• Uncredited Deposits (or Outstanding Lodgements): Cash or cheques paid into the bank by the company (recorded as receipts in the Cash Book) but which the bank has not yet processed. (This increases the bank balance.)

The BRS finishes with the Updated Cash Book Balance (which should match the figure from Step 1).

Structure of the BRS:

Balance as per Bank Statement (Date X)

Add: Outstanding Lodgements (Uncredited Deposits)

Less: Unpresented Cheques

Balance as per Updated Cash Book

Benefits and Limitations of BRS (1.4.3)

• Benefit: Identifies errors made by the bank or the business.
• Benefit: Provides the true, accurate cash figure for the Statement of Financial Position.
• Limitation: Relies entirely on the bank providing accurate and timely statements.
• Limitation: Does not prevent fraud if the Cash Book preparer is intentionally forging figures.

Key Takeaway: Always update the Cash Book first! The BRS only deals with items in transit.

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4. Control Accounts (1.4.4)

What are Control Accounts?

A large business maintains hundreds or thousands of individual accounts for its credit customers and suppliers in subsidiary ledgers (known as the Sales Ledger and Purchases Ledger).

A Control Account (Sales Ledger Control Account or Purchases Ledger Control Account) is a total account kept in the main General Ledger. It acts as a summary of all transactions affecting the specific subsidiary ledger.

Entries in Control Accounts

Control Accounts are fed by the totals from the Books of Prime Entry:

Sales Ledger Control Account (SLCA)

This checks the total owed by customers (Trade Receivables). It usually has a Debit balance.

• Debited with: Total Credit Sales (from Sales Journal), Dishonoured Cheques (because the customer now owes the money again), Interest charged to customers.
• Credited with: Total Cash/Cheques received from customers (from Cash Book), Total Sales Returns (from Sales Returns Journal), Total Discounts Allowed, Irrecoverable Debts written off.

Purchases Ledger Control Account (PLCA)

This checks the total owed to suppliers (Trade Payables). It usually has a Credit balance.

• Credited with: Total Credit Purchases (from Purchases Journal).
• Debited with: Total Payments to Suppliers (from Cash Book), Total Purchases Returns (from Purchases Returns Journal), Total Discounts Received.

Reconciliation Statements (1.4.4)

The primary verification check is the reconciliation between the Control Account balance and the list of individual balances (Schedule of Debtors or Creditors) drawn from the Sales or Purchases Ledger.

• Control Account Balance (e.g., SLCA): This balance is used in the Statement of Financial Position (as the total Trade Receivables).
• Schedule of Balances: The total of all individual balances in the subsidiary ledger.

These two totals must match. If they don't, errors must be found.

Common Errors Found During Control Account Reconciliation

Often, the error only exists in the *subsidiary ledger* and not the Control Account, because the Control Account uses summary totals, which might be correct.

• Example: If a credit customer's balance is added up incorrectly in the Sales Ledger, the SLCA total (from the Sales Journal) will still be right, but the Schedule of Balances total will be wrong.
• Fixing Errors: If the discrepancy is found, a reconciliation statement is prepared to explain the difference, and the error is corrected in the specific ledger account affected.

Benefits and Limitations of Control Accounts (1.4.4)

Benefits:

• Internal Check: They provide an instant check on the arithmetical accuracy of the Sales and Purchases Ledgers.
• Fraud Detection: They help localize errors quickly, as staff often do not have access to both the individual ledgers AND the control accounts.
• Efficiency: They simplify the preparation of the Trial Balance, as only two summary accounts (SLCA and PLCA) are needed, not hundreds of individual debtor/creditor balances.

Limitations:

• If the total taken from the book of prime entry is wrong (e.g., the Sales Journal was totalled incorrectly), the error will be in the Control Account and will not be highlighted by the reconciliation procedure.
• It only verifies mathematical accuracy; it won't detect if an invoice was completely omitted (error of omission).

Key Takeaway: Control Accounts verify the integrity of the subsidiary ledgers. The Control Account balance goes in the SoFP; the Schedule of Balances is the total of the list of individual accounts. They must agree.