3.1 Bank Reconciliation
The bank is a very important partner to all businesses. Not only does the bank provide basic checking services, but they process credit card transactions, keep cash safe, and may finance loans when needed.
Bank accounts for businesses can involve thousands of transactions per month. Due to the number of ongoing transactions, an organization’s book balance for its checking account rarely is the same as the balance that the bank records reflect for the entity at any given point. These timing differences are typically caused by the fact that there will be some transactions that the organization is aware of before the bank, or transactions the bank is aware of before the company.
For example, if a company writes a check that has not cleared yet, the company would be aware of the transaction before the bank is. Similarly, the bank might have received funds on the company’s behalf and recorded them in the bank’s records for the company before the organization is aware of the deposit.
With the large volume of transactions that impact a bank account, it becomes necessary to have an internal control system in place to assure that all cash transactions are properly recorded within the bank account, as well as on the ledger of the business. The bank reconciliation is the internal financial report that explains and documents any differences that may exist between the balance of a checking account as reflected by the bank’s records (bank balance) for a company and the company’s accounting records (company balance).
The bank reconciliation is an internal document prepared by the company that owns the checking account. The transactions with timing differences are used to adjust and reconcile both the bank and company balances; after the bank reconciliation is prepared accurately, both the bank balance and the company balance will be the same amount.
Note that the transactions the company is aware of have already been recorded (journalized) in its records. However, the transactions that the bank is aware of but the company is not must be journalized in the entity’s records.
Fundamentals of the Bank Reconciliation Procedure
The balance on a bank statement can differ from company’s financial records due to one or more of the following circumstances:
- An outstanding check: a check that was written and deducted from the financial records of the company but has not been cashed by the recipient, so the amount has not been removed from the bank account.
- A deposit in transit: a deposit that was made by the business and recorded on its books but has not yet been recorded by the bank.
- Deductions for a bank service fee: fees often charged by banks each month for management of the bank account. These may be fixed maintenance fees, per-check fees, or a fee for a check that was written for an amount greater than the balance in the checking account, called an nonsufficient funds (NSF) check. These fees are deducted by the bank from the account but would not appear on the financial records.
- Errors initiated by either the client or the bank: for example, the client might record a check incorrectly in its records, for either a greater or lesser amount than was written. Also, the bank might report a check either with an incorrect balance or in the wrong client’s checking account.
- Additions such as interest or funds collected by the bank for the client: interest is added to the bank account as earned but is not reported on the financial records. These additions might also include funds collected by the bank for the client.
Demonstration of a Bank Reconciliation
A bank reconciliation is structured to include the information shown in Figure 3.1.
Assume the following circumstances for Feeter Plumbing Company, a small business located in Northern Ohio.
- After all posting is up to date, at the end of July 31, the book balance shows $32,760, and the bank statement balance shows $77,040.
- Check 5523 for $9,620 and 6547 for $10,000 are outstanding.
- Check 5386 for $2,000 is removed from the bank account correctly but is recorded on the accounting records for $1,760. This was in payment of dues. The effects of this transaction resulted in an error of $240 that must be deducted from the company’s book balance.
- The July 31 night deposit of $34,300 was delivered to the bank after hours. As a result, the deposit is not on the bank statement, but it is on the financial records.
- Upon review of the bank statement, an error is uncovered. A check is removed from the account from Feeter for $320 that should have been removed from the account of another customer of the bank.
- In the bank statement is a note stating that the bank collected $60,000 in charges (payments) from the credit card company as well as $1,800 in interest. This transaction is on the bank statement but not in the company’s financial records.
- The bank notified Feeter that a $2,200 check was returned unpaid from customer Berson due to insufficient funds in Berson’s account. This check return is reflected on the bank statement but not in the records of Feeter.
- Bank service charges for the month are $80. They have not been recorded on Feeter’s records.
Each item would be recorded on the bank reconciliation as follows:
One important trait of the bank reconciliation is that it identifies transactions that have not been recorded by the company that are supposed to be recorded. Journal entries are required to adjust the book balance to the correct balance.
In the case of Feeter, the first entry will record the collection of the note, as well as the interest collected.
The second entry required is to adjust the books for the check that was returned from Berson.
The third entry is to adjust the recording error for check 5386.
The final entry is to record the bank service charges that are deducted by the bank but have not been recorded on the records.
The previous entries are standard to ensure that the bank records are matching to the financial records. These entries are necessary to update Feeter‛s general ledger cash account to reflect the adjustments made by the bank.
Company Name, Bank Reconciliation, December 31, 2018; Bank Statement Balance at 12/31/18 $X X X; plus Deposits in transit X X X; minus Outstanding checks (X X X); Adjusted Bank Balance $X X X. Book Balance at 12/31/18 $X X X; plus Income not recorded on books X X X; plus Bank interest income X X X; minus Expenses not recorded on books (X X X); minus Bank account charges (X X X); Adjusted Book Balance $X X X. Return
Feeter Plumbing, Bank Reconciliation, July 21, 2018; Bank Statement Balance $77,040; Add: Deposit $34,300 and Bank error 320 minus 34,620, subtotal 111,660; Deduct: Outstanding checks numbered 5523 (9,620) and 6547 (10,000) minus (19,620); Adjusted Bank Balance $92,040; Book Balance $32,760; Add: Collection of account $60,000 and Interest earned 1,800 minus 61,800, subtotal $94,560; Deduct: N S F check (2,200), Recording error (240), and Service charge (80) minus (2,520). Adjusted Book Balance $92,040. Return