Handle dishonored cheques

A dishonored cheque (or check or bank draft, according to local usage) has been presented for payment or deposited into a bank account but rejected or returned by the bank. Typical reasons include:

  • Insufficient funds
  • Closed account
  • Improper, incomplete, or illegible drafting
  • Cheque drawn on bank outside the receiving bank’s processing network
  • Forgery

In most cases, a dishonored cheque has already been recorded in Manager. Frequently, the cheque was a receipt against an outstanding sales invoice. Three courses of action are available. Which is most suitable depends on several factors, including:

  • Reason the cheque was not honored
  • Prospects for eventual, satisfactory payment
  • Processing practices of your bank
  • Local banking regulations
  • Accounting standards and practices followed by your business
  • Use of accrual or cash basis accounting
  • Involvement of inventory items in the transaction

The three options, in order of increasing complexity, are:

  • Leave the cheque in Pending status
  • Delete the transaction
  • Reverse the transaction

Leave in Pending status

When a cheque is dishonored because of an honest mistake and can be resubmitted, the easiest course of action is to leave its status on the receipt entry form within Manager as Pending:

After whatever problem preventing clearance of the cheque is resolved and the cheque is accepted by your bank, edit the transaction and enter the optional date of clearance:

This situation is equivalent to entering a received cheque into Manager but waiting several days before actually depositing it into your bank.

This option cannot be used if the cheque was presented for cash and received into a cash account. Cash accounts do not include transaction status options in the Receipts & Payments tab.

This option can be used only if:

  • Local banking practices allow dishonored cheques to be resubmitted, AND
  • Your bank does not record the dishonored cheque before returning it or notifying you of the problem.

Brilliant Industries receives and records a cheque from Lumen Lighting for a sales invoice. Brilliant immediately records and deposits the cheque into its bank account. However, because of a bank holiday, earlier deposits by Lumen into its own bank account were not processed as expected. By coincidence, Brilliant and Lumen use the same bank. The cheque is dishonored due to insufficient funds. But the bank is able to determine the cheque is not good before processing it. So it returns the dishonored cheque to Brilliant without recording it.

Brilliant and Lumen have a long business relationship, and Lumen assures Brilliant’s accounting staff that funds are now available. Brilliant leaves status for the receipt as Pending and resubmits the cheque to the bank. When the cheque clears successfully, Brilliant updates the status.

Delete transaction

Receiving an invalid cheque is like receiving no payment at all. You might decide to delete the receipt recording such a dishonored cheque entirely. This will leave any balance in Accounts receivable as it was before the receipt was recorded.

This option can safely be used for cheques presented for cash.

This option can be used for a cheque deposited to your bank only if the cheque has not been recorded by your bank.

This option is most attractive when using cash basis accounting, because you will not want to recognize income you have not collected.

Brilliant Industries receives and records a cheque from a new customer. But when the cheque is presented to the bank for deposit, the bank detects it as a forgery. The cheque is not processed. Bank regulations require the bank to destroy it.

Brilliant deletes the receipt from its records. Further investigation reveals the customer is bankrupt and no longer in business. Brilliant writes off the associated sales invoice as a bad debt.

This option cannot be used when the cheque was received in a non-credit sale (in other words, when no sales invoice was issued). The original receipt in such cases is the mechanism for recording not only sales income, in general, but inventory movement, in particular. If the receipt is deleted, income figures will be incorrect and inventory counts will be off. Unlike a credit sale via sales invoice, a non-credit sale leaves no other record besides the receipt.

Reverse transaction

The most complex and, unfortunately, the most common option is reversing the transaction.

Reversal is required whenever your bank records a cheque before dishonoring and reversing it. Unless you reverse the original transaction, your records will not match your bank statement, leading to potential reconciliation and audit problems.

Reversal for credit sale

To reverse receipt of a dishonored cheque received against a sales invoice, go to the Receipts tab. Select New Receipt :

Complete the receipt form exactly as you would for an incoming receipt in the amount of the cheque, but enter the Unit price as a negative number. Post the reversal to the same customer subaccount and sales invoice under Accounts receivable as the original receipt.

A convenient short cut is to View and Clone the original receipt, but edit the unit price to be negative before clicking Create.

Brilliant Industries deposits a cheque from Bob’s Hardware for sales invoice #4, recording the receipt as below:

After the deposit is recorded to Brilliant’s account by the bank, the cheque is dishonored for insufficient funds. Brilliant’s bank subtracts the deposited amount from Brilliant’s account. The bank does not return the dishonored cheque, following its standard practices.

Brilliant clones the original bank receipt and edits the clone by making the unit price negative and adjusting dates. It also edits the description to explain the transaction:

The customer’s Accounts receivable balance is restored to what it was prior to entry of the dishonored cheque:

Reversal for non-credit sale

Recall the Caution note above about why receipts for non-credit sales cannot be deleted. The information on sales and inventory movement they contain must be preserved. They must be reversed in a manner that maintains a record of what the customer owes.

Therefore, reversing a non-credit sale for which there is no sales invoice requires a customer to first be created in the Customers tab. Then, a new receipt with negative Unit price equal to the amount of the cheque can be entered and posted to that customer’s subaccount of Accounts receivable. No invoice number needs to be entered. This action creates a receivable for the customer, just as would have been the case if a sales invoice had originally been issued.

In this way, inventory and income figures are correctly preserved. If satisfactory payment is subsequently received, it should be recorded against Accounts receivable for the customer. If satisfactory payment is never received, that receivable must be written off as a bad debt.

Handling bank fees for dishonored cheques

Most banks assess fees when cheques are dishonored. Such fees represent completely separate transactions between your business and your bank. They must be entered as separate bank payments, naming the bank as payee and posting the fees to an appropriate expense account, such as Bank fees.

If you are able to charge the issuer of the dishonored cheque for the fees, issue a separate sales invoice. Do not attempt to combine the new transaction with the original sales transaction or a reversal.

Get Involved
Subscribe to Updates

Subscribe to our newsletter and get exclusive product updates you won't find anywhere else straight to your inbox.

© 2023 — Based in Sydney, Australia but providing goodness globally