Simulation Quarter 2: The Bank
This level shows the central role of the bank, how to process different types of bank transactions, and how to reconcile a bank account.
These bank transactions will either debit (income) or credit (expenditure) the Bank Account, with the double-entry either going to an income or expense account respectively, except for the cash being paid into the bank (which will debit the bank account and credit the cash account).
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Cash Receipts
Narrative
During the previous quarter Alex found himself being asked if he could take a cheque instead of being paid in cash, and a couple of times one of his customers asked why he had to keep getting cash from the bank which was too far away and inconvenient for him.
He decides to open a bank account so that he can be paid by cheque instead. The bank are very generous and give him a paying-in book, a cheque book, a debit card, and a £500 overdraft facility for good measure. During this quarter he also decides to use some of his earnings to invest in more workwear and some low-value equipment. He finds that some of the tools provided by his customers are worn out and he can do a better job with his own. He likes the idea of giving his business a name, and he tells the bank this when opening his account. The bank tell him that they have to show the account as being in his own name, but he can add 'trading as..' and whatever name he wants to use. They explain that this is because he is a sole trader and it is Alex Baker who is the 'legal entity' they are doing business with. He settles on 'Alex Baker t/a Jewel Gardening'.
He also continues to promote his business by rewarding customers with a gnome for introducing new customers, and starts to look at ways of building the business.
He starts to worry about how much cash he is carrying around and pays some of it into the bank account from time to time.
He can also see that he is beginning to accumulate a lot of paperwork and starts to write notes on receipts so his book-keeper knows what they are for.
Processing
The bank account needs to be set up in the book-keeping system. A new account is always created for each bank account, no matter how many there are. This account should be an asset account on the balance sheet.
Income
Enter the Sales Receipts first. The two basic categories of income are still the same as before (Gardening services and Machinery services), but some of the sales are now paid by cheque instead of cash.
Alex has marked each receipt accordingly, and when he has received a cheque he has paid it into the bank straight away. It is important to get the distinction right between sales paid in cash and sales paid into the bank.
Notice that for the sales paid by cheque, as a book-keeper you don't see the actual cheque; Alex has paid that into the bank. What you see the sales receipt that Alex completes (as shown above); and a copy of the bank 'giro' used for paying the cheque into the bank
When you enter the Sales Receipts paid by cheque, make sure you use the Bank account, instead of the cash account. The Bank Giro shows the cheque being paid into the bank account, but remember you have already entered this transaction as a Sales Receipt. Be careful not to enter the transaction twice.
For example, transaction tx-49 is the same as tx-50 . Some book-keeping systems allow a two-part process to record cheques received for sales and then bank them as a separate transaction. This means that the cheques can be grouped together and banked in one go.
The bank giros also show the cash being paid into the bank. These transactions are not sales, because the accounting for the cash sales has already taken place in receiving the cash from the customer. The cash paid into the bank is a transfer from one asset account (the Cash Account) to another asset account (the Bank Account). Make sure that these transactions simultaneously increase the bank balance and reduce the cash balance.
Expenditure
The cash expenses are shown marked up with incrementing numbers as they were in the previous simulation. Process these in the same way as before. You will need a new expense account called Entertainment for the cost of the lunch.
Enter the bank expenditure, classifying the transactions in the same way as when you processed the cash expenses, but this time making sure the payments come from the bank account. Three cheque counterfoils are shown along with the supporting documents which are marked-up as paid by cheque. There are also five transactions paid by debit card.
Create a new expense account called 'Subsistence' for the Rockwater Café (tx-57) expense and a new expense account for Postage.
There are two more transactions to enter because the bank has sent advice notes. One is a receipt of £2.00 for interest (tx-80) , the other is a bank expense of £23.90 (tx-81) for bank charges. These can be entered now, but in reality the book-keeping for bank-generated transactions is often done at the same time as the bank reconciliation.
Reconciliation & Assessment
Cash
Once again a statement has been provided showing the cash at the end of the period, and this can be agreed to the records. It should now be£303.71. If it is different then the difference must be found.
Bank reconciliation
Because bank activity is so central to the financial operation of a business or organisation, the bank reconciliation is fundamental to good book-keeping. Most accounting software includes a function for reconciling bank accounts.
Having entered all the bank transactions, the balance should be £1,289.05. The bank statement provided shows a different balance of£1,365.25 . Use the statement to reconcile the transactions in your own records. Start at the opening balance, in this case obviously zero, and work down the lists matching-up and marking-up each transaction.
You should find that all but one transaction has matched up - 'cleared' - and that this transaction explains the difference of£76.20 between your records and the bank statement. There is a reconciliation statement on analysis paper provided which shows the key information. The cheque 100001 for £76.20 (tx-48) is shown in brackets as a way of showing it is negative.
If anything has gone wrong and your balances don't agree then find out what went wrong and correct any mistakes. The balances on the Cash and Bank accounts must be correct to the penny before you can move on.
For some reason the outstanding cheque hasn't been cleared. It may have got lost in the post or something. When transactions are entered and then don't clear they need to be kept under review and possibly reversed. For now it will be left as it is.
Assessment
If you have already completed the reconciliations then you should have the same results as shown in the reports provided.
Run the Trial Balance, Profit & Loss, Balance Sheet and Customer reports as before. Make sure the date ranges cover the periods being processed.
Observations
- Unlike most transactions where the double-entry tends to affect both the balance sheet and profit and loss account, when the cash is paid into the bank only the balance sheet is affected - essentially swapping one asset for another.
- Notice how on the bank statement, the Account Name is 'Alex Baker t/a Jewel Gardening', the 't/a' being 'trading as' abbreviated.
- There is a difference between the pub meal Alex Baker has with a customer in The Kings Head, which is Entertainment, and the sandwich he has in the Rockwater Café, which is subsistence. Whenever he is working away from his base he can claim for subsistence expenses. Because the tax rules are different for Entertainment it is best to keep this kind of expense separate.
- The trade exhibition that he has paid to go and see is more of a one-off and could be classified under Reference and Subscriptions.
VAT
Although Alex Baker is still not registered for VAT, he has become aware that he is paying VAT on some of his costs, and he could reclaim this if he registered. However, he also realises that he would also have to charge VAT on his sales and this would increase his costs to his customers.
Next Steps: Debtors