Internal Control and Bank Reconciliation - TCE Accounting (Tasmania)
“Apply internal controls over cash and prepare a bank reconciliation statement.”
Internal controls are the procedures that protect cash from theft and error, such as dividing duties, banking daily and using receipts. A bank reconciliation then proves the cash records are correct by explaining the difference between the cash ledger balance and the bank statement, mostly through timing items.
What this dot point is asking
Cash is the asset most at risk of theft and error, so Unit 2 covers both controlling it and verifying it. Internal control is about prevention; bank reconciliation is about detection and proof.
Internal control over cash
Good control reduces the chance of fraud and mistakes going unnoticed. Common controls include:
- Separation of duties: the person who handles cash should not also keep the records, so no single person can both steal and hide it.
- Daily banking of all receipts, so cash does not accumulate on the premises.
- Issuing pre-numbered receipts and paying by cheque or electronic transfer for an audit trail.
- Regular bank reconciliation by someone independent of cash handling.
- Authorisation limits, so large payments need approval.
A control that splits the recording, custody and authorisation of cash among different people, so that committing and concealing an error or fraud would require collusion rather than one person acting alone.
Why the two cash figures differ
The business records cash in its Cash at Bank ledger, while the bank produces a bank statement. At any date the two rarely match, almost always because of timing.
- Outstanding (unpresented) cheques: recorded by the business but not yet cleared by the bank.
- Outstanding deposits: banked too late to appear on the statement.
- Bank entries the business has not recorded yet: bank fees, interest, direct debits and credits, and dishonoured cheques.
First update the cash records for items the bank knew about but the business had not recorded (fees, interest, direct transfers). Then prepare the reconciliation statement, adjusting the bank statement balance for outstanding cheques and deposits to agree with the corrected cash balance.
Worked example
Starting figures
Cash at Bank ledger balance (before adjustments): debit.
Bank statement balance: credit (in the bank's favour).
Step 1: Update the cash records
The statement shows bank fees not yet recorded and interest received not yet recorded.
Corrected cash balance .
Step 2: Reconciliation statement
- Balance as per bank statement:
- Less outstanding (unpresented) cheques:
- Add outstanding deposit:
- Reconciled balance
Result
The reconciled bank figure () equals the corrected cash ledger balance (), so the records are proven correct.
Which items correct the cash account, which go in the statement
The hardest part of a reconciliation is deciding where each difference belongs. The rule follows from who already knew about the item. If the bank processed something the business had not recorded (fees, account-keeping charges, interest received, direct debits and credits, and dishonoured cheques), the business is behind, so the cash account is corrected. If the business recorded something the bank has not yet processed (unpresented cheques, outstanding deposits), it is a timing difference, so it appears only in the reconciliation statement, never in the ledger.
A cheque the business banked and recorded as a receipt, but which the customer's bank later refused to pay (for example, insufficient funds). The bank reverses it on the statement, so the business must reduce its cash records and reinstate the debtor.
A dishonoured cheque
A dishonoured cheque is a common trap. The business originally recorded a receipt when it banked the cheque, increasing cash and reducing the debtor. When the cheque bounces, that receipt was never really money, so the cash account is reduced again and the debtor is reinstated (debit Debtors Control, credit Cash at Bank). Because it is something the business had not yet recorded at reconciliation, it corrects the cash account in step one, not the statement in step two.
Preventive versus detective controls
It helps to see internal controls in two groups. Preventive controls stop problems before they happen, such as separation of duties, authorisation limits, pre-numbered receipts and physical security over cash. Detective controls find problems after the fact, such as the bank reconciliation, regular stocktakes and supervisory review. A strong system uses both: prevention reduces the chance of fraud, while detection catches what slips through and deters wrongdoing because staff know checks are made.
Why this matters
A reconciliation that balances gives confidence that cash is recorded accurately and that nothing has been stolen or omitted. If it will not balance, it points to an error or possible fraud to investigate. Exam tasks usually require both steps: adjusting the cash account for bank-only items, then preparing the statement with timing items so the two figures agree.
Outstanding cheques and outstanding deposits are timing differences the bank has not processed yet, so they belong in the reconciliation statement, not in the cash ledger. Only items the business genuinely had not recorded (fees, interest, direct entries) are used to correct the cash account.
Exam-style questions
Questions in the style of TASC exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
Practice8 marksAt 30 June the Cash at Bank ledger shows a debit balance of 6\,890. Investigation reveals: bank fees $40 and interest received $25 not yet recorded; a dishonoured cheque from a debtor $180 not yet recorded; unpresented cheques $1\,765; and a deposit of $850 not yet on the statement. Update the cash records and prepare a bank reconciliation statement.Show worked answer →
Step 1, correct the cash ledger for items the bank knew about but the business had not recorded.
Corrected cash .
Step 2, reconcile the bank statement balance using timing items.
Balance per bank statement ; less unpresented cheques ; add outstanding deposit ; reconciled balance .
The two figures do not agree ( versus ), so a difference of remains, signalling an error or omitted item to investigate before finalising. (If the question's figures are intended to reconcile, the marker checks the method: correct cash adjustments for fees, interest and the dishonoured cheque, and the statement adjusted only for the unpresented cheques and outstanding deposit.) Markers reward putting fees, interest and the dishonour in the cash account and putting the timing items in the statement, not the reverse.
Practice4 marksExplain why separation of duties is an effective internal control over cash, and give one example of how duties might be separated in a small business.Show worked answer →
A full 4 mark answer explains the principle and gives a concrete example.
Separation of duties splits the handling of cash, the recording of cash, and the authorisation of payments among different people. It is effective because a single person can no longer both commit and conceal a theft or error; fraud would require two or more people to collude, which is far less likely and easier to detect. It also means one person's work is implicitly checked by another's.
Example: in a small shop the employee who takes customer payments and banks the cash should not also be the person who writes up the cash receipts journal or reconciles the bank account. Having a different person reconcile the bank statement means takings cannot be skimmed without the records failing to reconcile. Markers reward the collusion or check point and a realistic example of splitting custody from recording or authorisation.