Direct Debit is an instruction to the bank to transfer funds to another account on a recurring basis. The payment is initiated by the payee himself although the account in which the funds will be transferred needs to be first authorized by the payer. Direct Debits are useful where regular payments are to be made to certain parties such as in payment of credit card bills, lease rentals, interest on bank loan, etc. This saves the company the hassle of issuing cheques every month. Whereas standing orders can only be made of specific amounts and dates, direct debits can be created for varying dates and amounts.
Bank records the amount paid as soon as the transfer through direct debit is made but the business entity records the amount when it receives intimation by the bank through bank statement or otherwise. Therefore, the balance as per bank statement may be lower than the balance as per cash book due to payments made through direct debits not yet accounted for by the entity. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co. pays office rent amounting to $1000 via direct debit on 30 December 2010. The Company has not recorded the rent paid in its books. The balance on the cash book shows a balance of $19,000. Bank statement shows the following:
| Bank Statement of ABC & Co. for the month of December 2010 | |||||
|---|---|---|---|---|---|
|
Date |
Particulars |
Opening Balance |
Debit |
Credit |
Balance |
|
01-12-2010 |
|
21,000 |
- |
- |
21,000 |
|
30-12-2010 |
Fund Transfer |
21,000 |
1,000 |
- |
20,000 |
Since the bank debited the account of ABC & Co. as soon as the direct debit was made, the balance as per bank statement is lower than the cash book balance by $1000. ABC & Co. must record the rent paid through direct debit in its cash book before preparing the bank reconciliation to remove the difference. Following accounting entry must be recorded to arrive at the corrected cash book balance:
|
Debit |
Rent Expense |
$1,000 |
|
Credit |
Bank |
$1,000 |