Bank transactions and timing - Standing orders and direct de...

Learning Outcomes

After studying this article, you will be able to explain the use and accounting treatment of standing orders and direct debits. You will recognize their effect on bank records and reconcile timing differences between the bank statement and the cash at bank ledger account. You will also learn how these recurring payments affect financial reporting and be able to process related transactions accurately for the ACCA FA2 exam.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand the recording and reconciliation of bank transactions, including the impact of automated payments. This article addresses the following syllabus areas:

• The process for recording bank transactions in general ledger accounts
• Identification and accounting for standing orders and direct debits
• Preparation of bank reconciliations and recognition of timing differences
• Correction of omissions and errors related to automated bank payments
• Accurate reporting of cash and bank balances in financial statements

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following best describes a standing order?
   1. A payment made once via cheque
   2. A one-off direct transfer
   3. A regular payment of a fixed amount, set up by the account holder
   4. A variable payment requested by the payee

2. A business's bank statement shows a direct debit payment for $30 not yet recorded in the cash at bank ledger. What is the correct journal entry to update the books?

3. True or false? A direct debit is generally used for payments where the amount can vary between periods.

4. Briefly explain why standing orders and direct debits may cause timing differences requiring adjustments during bank reconciliation.

Introduction

Bank accounts are used for both one-off and recurring payments. Businesses often make regular payments, such as rent or utility bills, using automated methods rather than manual cheques. The two most common automated payment types are standing orders and direct debits. Both ensure bills are paid promptly but differ in their setup and treatment.

To prepare accurate accounting records and bank reconciliations for the ACCA FA2 exam, it is necessary to understand how standing orders and direct debits operate, how they are recorded, and how any timing differences between the bank and ledger balances are resolved.

Key Term: standing order
An instruction from a bank account holder to the bank to pay a fixed amount at regular intervals to a specified payee.

Key Term: direct debit
An authorization given by the account holder to a payee, allowing the payee to collect varying amounts from the account holder's bank account, typically on specific due dates.

Bank Transactions: Standing Orders and Direct Debits

Banks offer automated methods for making recurring payments. Understanding both systems is important for accurate bookkeeping and reconciliation.

Standing Orders

A standing order is used when the same amount needs to be sent to the same payee regularly. The account holder instructs the bank to pay an exact sum on specified dates. Examples include rent, loan repayments, or subscription fees. Only the account holder (payer) can set up, amend, or cancel a standing order.

In accounting, when a bank statement shows a standing order payment not yet recorded in the cash at bank account, the business should:

• Debit the expense account (e.g., Rent expense)
• Credit the cash at bank account

Direct Debits

A direct debit authorizes a payee (usually a company or service provider) to collect funds directly from the account holder's bank account. The amount and payment date can vary, for example, for utility bills where usage changes monthly. While the initial authorization is given by the payer, the payee controls the amount and timing after that.

Direct debits are suitable for variable payments, such as phone bills or insurance premiums. Accounting entries are similar to those for standing orders:

• Debit the relevant expense account (e.g., Utilities)
• Credit the cash at bank account

Timing Differences in Bank Reconciliation

Standing orders and direct debits can appear on the bank statement before a business records them in its own accounting system, causing timing differences. Without prompt ledger entries, the cash at bank ledger balance will not match the bank statement balance.

Bank reconciliations must adjust for such items. To do this:

• Identify all standing orders and direct debits on the bank statement not yet recorded in the cash at bank ledger.
• Make the necessary accounting entries to include these payments in the books.

These adjustments ensure all actual cash outflows are matched between the statement and the ledger.

Worked Example 1.1

A business receives its March bank statement, noting a $1,000 rent standing order and $120 phone bill direct debit, neither of which have been recorded in the cash at bank ledger. What are the correct journal entries?

Answer:

• Rent (standing order):
  Debit Rent expense $1,000
  Credit Cash at bank $1,000
• Phone bill (direct debit):
  Debit Telephone expense $120
  Credit Cash at bank $120

Worked Example 1.2

The bank statement for April shows a new direct debit payment of $65 for insurance. The cash at bank ledger account does not record this transaction. How will this affect the reconciliation?

Answer:
The cash at bank balance in the accounting records will be $65 higher than the balance per the bank statement. The missing direct debit payment must be recorded by debiting Insurance expense and crediting Cash at bank by $65.

Exam Warning

Failing to record standing orders or direct debits that appear on the bank statement but not in the ledger will cause discrepancies in the reconciliation. Always check for such items during reconciliation and post adjusting entries without delay.

Summary

Standing orders and direct debits are automated payment methods used to settle regular liabilities. Standing orders are for fixed sums, initiated by the payer. Direct debits are generally for variable sums, controlled by the payee following initial authorization. Both types of payments can cause timing differences between the bank statement and the cash at bank ledger. Accurately posting any missing payments in the accounts is essential to ensure matched balances for bank reconciliation.

Key Point Checklist

This article has covered the following key knowledge points:

• Distinguish between standing orders and direct debits in business banking
• Identify examples of each payment type and typical usage
• Record transactions for standing orders and direct debits in expense and bank accounts
• Recognize and correct timing differences caused by automated payments in bank reconciliation
• Understand the impact of unrecorded standing orders and direct debits on cash at bank balances

Key Terms and Concepts

• standing order
• direct debit