With an overdraft, every item still moves the balance in the same direction as before. A payment makes the business worse off, and a receipt makes it better off. Only the starting position is different.
This lesson is part of finding the cause of a reconciliation difference. It assumes you can already prepare the standard bank reconciliation.
Why do signs help?
Treat money held in the bank as positive and an overdraft as negative. Then each item is a simple gain or loss, and you do not need to decide whether to “add to a credit” or “deduct from a credit”.
A bank charge is a loss, so the number falls. A receipt is a gain, so the number rises. The words at the end, overdrawn or in credit, come from the final sign.
Worked example: cash book overdrawn by RM1 850
The cash book shows an overdraft of RM1 850. Three items are on the statement but not yet in the cash book: a dishonoured customer cheque of RM400, a direct credit from a customer of RM700, and RM60 of bank charges. Two items are in the cash book but not yet on the statement: unpresented cheques of RM900 and a deposit of RM500.
Step 1: update the cash book. Start at −1 850 and apply each item as a gain or a loss.
The charges are a loss of 60. The dishonoured cheque is a loss of 400, because the receipt is reversed. The direct credit is a gain of 700.
−1 850 − 60 − 400 + 700 = −1 610, which is an overdraft of RM1 610.
Step 2: reconcile to the statement. Call the bank statement balance S.
The bank has not yet deducted the unpresented cheques, so the true position is lower by 900. It has not yet added the deposit, so the true position is higher by 500.
S − 900 + 500 = −1 610, so S = −1 610 + 400 = −1 210. The statement shows an overdraft of RM1 210.
Check in words: the bank says RM1 210 overdrawn. It has yet to deduct RM900, which makes it RM2 110, and yet to credit RM500, which brings it to RM1 610. That equals the updated cash book.
The mistake that loses marks
The common slip is to reverse a bank charge because the account is overdrawn, which shows a smaller overdraft. A bank charge always reduces what the business holds.
Another slip is to confuse the label. A credit balance in the cash book is an overdraft, and a statement that shows a debit balance is the same overdraft viewed by the bank.
Check yourself
The cash book shows an overdraft of RM640. RM25 of bank charges are on the statement only. There are unpresented cheques of RM300. Find the updated cash book balance, then the statement balance.
Answer
Updated cash book: −640 − 25 = −665, an overdraft of RM665.
For the statement balance S: S − 300 = −665, so S = −365.
The statement shows an overdraft of RM365. Check: RM365 overdrawn plus the RM300 not yet presented gives RM665.
What to study next
Move on to tracing an omitted receipt through a control account, or test your signs in the accounting controls practice set.
To have a teacher rebuild the sign logic on your own questions, see online one-to-one Accounting tuition.