Welcome to the World of Cash!
Hello there! Today, we are diving into one of the most important chapters in your Financial Accounting (FA) journey: Cash. You might think, "It’s just money, how hard can it be?" But in accounting, cash is the lifeblood of a business, and keeping track of it requires a bit of "detective work."
By the end of these notes, you will understand how businesses record money coming in and going out, how to manage small "petty" expenses, and how to make sure the business's records match what the bank says. Don't worry if this seems a bit technical at first—we will break it down step-by-step!
1. The Basics: Cash and the Cash Book
In accounting, when we talk about Cash, we usually mean two things: the physical coins and notes in the office, and the money held in the business's bank accounts.
The Cash Book is a book of prime entry. This means it is the very first place we record any transaction involving money. It has two sides:
• The Debit Side (Left): This is for Receipts (money coming in).
• The Credit Side (Right): This is for Payments (money going out).
Memory Aid: DEAD CLIC
Remember the rule: Cash is an Asset. According to DEAD CLIC, to increase an Asset, you Debit it. So, when money comes in, we Debit the Cash Book!
The "Mirror Image" Confusion
Have you ever noticed that when you put money into your bank account, the bank says they are "crediting" your account? But in our Cash Book, we "debit" it!
Why? Because the bank statement is written from the bank's perspective. To the bank, your money is a liability (they owe it back to you). To you, that same money is an asset. So, your Debit is their Credit!
Quick Review:
• Money In = Debit the Cash Book
• Money Out = Credit the Cash Book
• Bank Statement = The opposite of your Cash Book
2. Petty Cash and the Imprest System
Imagine a big company needing to buy a pint of milk or a few postage stamps. It would be a waste of time to write a formal check for $2.00. Instead, businesses keep a small amount of physical cash on hand called Petty Cash.
\n\nThe Imprest System
\nMost businesses use the Imprest System to manage petty cash. Here is how it works in 3 simple steps:
\n1. The Float: The business decides on a fixed amount of money to keep in the tin (e.g., $100). This is called the float.
2. The Spending: During the month, staff spend money and leave vouchers (receipts) in the tin to show what they bought.
3. The Top-up: At the end of the month, the cashier counts the vouchers. If there are $80 worth of vouchers, they "top up" the tin with exactly $80 to bring the balance back to the original $100 float.
Step-by-Step Example:
\n• Starting Float: $100
• Staff spends $10 on tea and $20 on taxi fares. (Total spent = $30)
\n• Remaining cash in tin: $70
• Topping up: The business writes a check for $30 to bring the tin back to $100.
Key Takeaway: Under the Imprest System, Cash in hand + Total of vouchers = The Float.
3. Bank Reconciliations: The Detective Work
This is a favorite topic in exams! A Bank Reconciliation is simply a report that explains why the balance in your Cash Book doesn't match the balance on your Bank Statement.
Why don't they match?
There are usually three reasons for a difference:
1. Timing Differences: Things we know about, but the bank doesn't yet.
2. Errors: Mistakes made by us or the bank.
3. Items we didn't know about: Things the bank has done that we haven't recorded yet.
Two Main Timing Differences:
• Unpresented Cheques: You wrote a check to a supplier and recorded it as a payment (Credit) in your Cash Book. However, the supplier hasn't taken it to the bank yet. The bank doesn't know about it!
• Outstanding Lodgements: You put money into the bank late on a Friday. You recorded it in your Cash Book (Debit), but the bank won't show it on your statement until Monday.
The Two-Step Process to Fix It
When you get a question on this, follow these two steps exactly:
Step 1: Update the Cash Book
Record the things the bank knows about, but you don't. These include:
• Bank Charges/Interest: Money the bank took out.
• Direct Debits/Standing Orders: Automatic payments.
• Dishonoured Cheques: A check you deposited that "bounced" (the customer had no money).
• Credit Transfers: Customers paying you directly into the bank.
\( \text{New Cash Book Balance} = \text{Old Balance} + \text{Receipts discovered} - \text{Payments discovered} \)
Step 2: The Bank Reconciliation Statement
Now, start with the Bank Statement balance and adjust it for the timing differences:
\( \text{Balance per Bank Statement} \)
\( + \text{Outstanding Lodgements} \)
\( - \text{Unpresented Cheques} \)
\( = \text{Adjusted Bank Balance} \)
Important! After these two steps, your New Cash Book Balance from Step 1 must equal the Adjusted Bank Balance from Step 2!
Common Mistake to Avoid:
Watch out for Bank Overdrafts! If the bank statement says "Debit $500" or "Credit Balance (Overdrawn)," it means the business owes money to the bank. Treat this as a negative number in your calculations.
4. Summary of Key Terms
• Books of Prime Entry: The first place transactions are recorded (Cash Book).
• Dishonoured Cheque: A check that the bank refuses to pay (usually because there isn't enough money).
• Standing Order: A fixed amount paid regularly by the bank.
• Direct Debit: A variable amount the bank allows a third party to take from your account.
Did you know?
In the modern world, many bank reconciliations are done automatically by software, but as an accountant, you must understand the logic behind it to spot when the software makes a mistake!
Final Encouragement:
Bank reconciliations can feel like a puzzle. If your numbers don't balance the first time, don't panic! Go back and check if you added an "Unpresented Cheque" when you should have subtracted it. You've got this!