A bank reconciliation is a process performed by a company to ensure that its records (check register, general ledger account, balance sheet, etc.) are correct. This is done by comparing the company's recorded amounts with the amounts shown on the bank statement. Any differences must be justified. When there are no unexplained differences, accountants state that the bank statement has been reconciled.
The bank reconciliation is an important part of a company's internal controls over its assets. To be effective, it should be done by someone other than an authorized check signer and/or record keeper.
The bank statement shows a June 30 balance of Rs.5,975. Note that this balance is different from the company's general ledger's Cash account balance of Rs.7,000. Generally, neither balance is the correct amount of cash that should be reported on the company's balance sheet.
To reconcile the company's balance and the bank's balance requires comparing the details. To illustrate, let's assume that:
We prefer to perform the bank reconciliation by adjusting both the company's cash balance and the bank statement balance to be the correct amount of the company's checking account balance, as shown here:
Since both the company's books and the bank statement have an adjusted balance of Rs.6,975 the bank statement has been reconciled.
Since the amount of the bank's credit memo has already been added to the bank's balance, the bank reconciliation will not reconcile unless the amount is also included in the company's general ledger Cash account. To record the bank credit memo the company will debit Cash and credit another account. For example, if the bank statement shows a credit memo of Rs.20 for interest earned, the company will debit Cash for Rs.20, and credit Interest Income for Rs.20. (The company's Cash account needs to be debited because its asset has increased.)
Since the amount of a bank debit memo has already been subtracted from the bank account, the amount must also be subtracted from the company's general ledger Cash account. For example, if the bank statement shows a debit memo of Rs.25 for a service charge, it means that the company's general ledger Cash account will need an entry that credits Cash for Rs.25, and debits Bank Fee Expense or Miscellaneous Expense for Rs.25. (The company's Cash account needs to be credited because the company's asset account has decreased.)
Some of the reasons for a difference between the balance on the bank statement and the balance on the books include:
Any items that are already recorded in the company's general ledger accounts, but have not yet appeared on the bank statement (outstanding checks, deposits in transit), will be noted as an adjustment to the balance per bank statement. Outstanding checks are a deduction to the balance per bank; deposits in transit are an addition to the balance per bank.
If an item is on the bank statement but has not yet been entered on the books, the items are noted as an adjustment to the balance per books. Bank service charges, check printing charges, and other electronic deductions that are not yet recorded in the company's accounts will become deductions from the cash balance per the books. Electronic deposits not yet recorded by the company will become additions to the cash balance per books.
If an outstanding check from the previous month did not clear the bank account in the current month, the check will remain on the list of outstanding checks. As a result, the bank reconciliation for the current month will again show the outstanding check amount as a subtraction from the bank statement balance.
If an outstanding check of the previous month clears the bank, it means the bank paid the check and the check will appear as a deduction on the statement. Hence, the check is removed from the list of outstanding checks.
The balance on June 30 in the company's general ledger account entitled Checking Account is the book balance that pertains to the bank account being reconciled. (For an individual, the book balance is likely to be the balance appearing in the person's check register.) It is common for the book balance to not agree with the balance on the bank statement as of the same day. This is the case when there are bank fees or electronic transfers on the bank statement that have not yet been recorded in the company's general ledger accounts. For example, the bank statement may reveal that a bank service charge was withdrawn from the account on the last day of the month.
No entry is made to a company's general ledger for outstanding checks when preparing a bank reconciliation. The reason is outstanding checks are an adjustment to the bank balance. Outstanding checks are not an adjustment to the company's Cash account in its general ledger.
However, if a company voids one of its outstanding checks, the company will need to make an entry to its general ledger. The entry will debit Cash in order to increase the account balance. The credit portion of the entry will likely be to the account that was originally debited when the check was issued.
Some software will allow a person to go into a previous period's activity (as well as the current period's activity) and remove the voided check or to change the amount to zero. This too will increase the cash balance and will remove the debit from the account originally debited when the check was recorded.
The bank reconciliation might reveal that some revenues and/or receipts were electronically deposited into the bank account but were not yet recorded in the accounting records. Likewise, there might be some expenses and/or payments that were deducted electronically from the bank account, but were not yet entered into the company's accounts. Further, the bank reconciliation might reveal some errors in the transactions already recorded in the company's general ledger.
To save time and to improve internal control, have the bank reconciliation be performed by someone other than the person writing the checks and/or recording amounts in the general ledger.
The general ledger account has always been correct, because the amount of the check reduced the general ledger account balance at the time the check was written and recorded.
The problem was the previous bank statements. The bank statement balances were too high since the check had not yet cleared the bank checking account. That's why we subtract the amount of the outstanding checks from the bank statement balance. Now that the bank statement balance has been reduced by the check clearing the bank account, there is no longer a need to further subtract the amount of the check as outstanding.
Cash receipts should be recorded with the date the money was received. For example, a church collects money during each of its services on Sunday, June 4.
On Monday, June 5, the money is counted and is deposited into the church's bank account. The transaction to record the cash and the revenues (remember double entry) should be dated Sunday, June 4, since that is the day of the transaction—the day the church received the money.
The day the money is deposited into the bank account is not the proper date of the transaction. The accounting records should report that the money was received on Sunday, June 4.
Next, look at the general ledger account that is associated with the bank statement. Let's assume it is the Cash account. Be certain that the Cash account shows items that appear on the recent bank statements. For example, Have the bank service charges been entered in the Cash account? Have the electronic transfers been entered? If not, you will need to make those entries. You may have to go back to earlier bank statements and enter those amounts as well.
Eventually, you need to get the August 31 balance in the Cash account to be equal to the adjusted balance per bank. If the difference is not a significant amount, you can debit or credit the Cash account for the amount necessary for it to agree to the adjusted balance per bank. I would put the same amount into an income statement account such as Difference per Bank Reconciliation Keep a copy of your documentation and begin a file entitled Bank Reconciliations.
When the September 30 bank statement arrives, prepare another bank reconciliation. Using a copy of the August 31 listing of outstanding checks, cross off the checks that cleared on the September bank statement. Prepare a September 30 listing of outstanding checks beginning with the checks not crossed off on the August 31 copy, and then add the checks written in September that did not clear on the September bank statement. The total of the outstanding checks as of September 30 should be deducted from the bank statement balance of September 30 to arrive at the adjusted balance per bank as of September 30. Be sure to enter into the Cash account the September bank service charge and other items appearing on the bank statement that have not yet been entered in the Cash account. This adjusted balance in the Cash account as of September 30 should be the same as the adjusted balance per bank as of September 30. If there is a difference, you must identify it and make any necessary adjustments.