6.2 Bank reconciliations

Importance of Bank Reconciliations

Bank reconciliations compare a company's cash balance per its general ledger (the "book balance") to the ending balance on the bank statement. Because these two figures almost never match on any given date, the reconciliation identifies why they differ and determines the correct cash figure for financial reporting.

• Reconciliations are a core internal control over cash. They catch errors, timing differences, and unauthorized transactions before they compound.
• Performing them regularly (at least monthly) gives management, auditors, and stakeholders confidence that the balance sheet reflects the company's true cash position.

Bank Reconciliation Process

Comparing Book vs. Bank Balances

Start by placing the book balance (from the general ledger) and the bank balance (from the bank statement) side by side. These two numbers will almost always differ because of timing differences, outstanding items, and errors on either side.

The goal is to adjust both balances until they meet at the same adjusted (correct) cash balance.

Adjusting the Bank Balance

Add or subtract items the bank doesn't know about yet:

• Add deposits in transit (company recorded them, bank hasn't credited them yet)
• Subtract outstanding checks (company recorded them, bank hasn't cleared them yet)
• Correct any bank errors (e.g., the bank debited the wrong account)

Adjusting the Book Balance

Add or subtract items the company doesn't know about until it sees the bank statement:

• Add interest earned, direct deposits, or EFT collections the bank credited
• Subtract bank service charges, NSF (not sufficient funds) checks, and other bank debit memos
• Correct any book errors (e.g., a check recorded at the wrong amount)

After both sides are adjusted, the adjusted book balance and the adjusted bank balance should be equal. If they aren't, something is still missing.

Types of Reconciling Items

Deposits in Transit

A deposit in transit is cash the company has received and recorded but the bank has not yet credited. This typically happens with deposits made late on the last day of the period or mailed deposits that haven't arrived.

• Where it goes: Added to the bank balance
• Journal entry needed? No. The company already recorded it.

Outstanding Checks

Outstanding checks have been written and recorded by the company but haven't cleared the bank yet. The payee may not have deposited the check, or it may still be in processing.

• Where it goes: Subtracted from the bank balance
• Journal entry needed? No. The company already recorded it.

Bank Service Charges and Interest

Banks charge fees (monthly maintenance, wire transfers, overdraft charges) and may credit interest to the account. The company typically doesn't learn about these until the statement arrives.

• Service charges: Subtracted from the book balance
• Interest income: Added to the book balance
• Journal entries needed? Yes, for both. See the journal entries section below.

NSF (Not Sufficient Funds) Checks

When a customer's check that the company deposited is returned because the customer's account lacks funds, the bank reverses the deposit. The company must also reverse the cash receipt on its books.

• Where it goes: Subtracted from the book balance
• Journal entry needed? Yes. Debit Accounts Receivable, credit Cash.

Book Errors vs. Bank Errors

• Book errors are mistakes the company made: recording a check for $\$450$ when it was actually $\$540$, posting to the wrong account, or omitting a transaction entirely. These are corrected on the book side with adjusting entries.
• Bank errors are mistakes the bank made: charging the wrong account, transposing digits, or omitting a deposit. These are corrected on the bank side of the reconciliation, and the company notifies the bank.

Preparing Journal Entries

Only items that adjust the book balance require journal entries. Here's a quick reference:

No journal entries are made for deposits in transit, outstanding checks, or bank errors. Those items only appear on the bank side of the reconciliation.

Bank Reconciliation Examples

Scenario 1: Deposit in Transit

ABC Company shows a book balance of $\$10{,}000$ and a bank balance of $\$8{,}000$ on March 31. A $\$2{,}000$ deposit made on March 31 was not credited by the bank until April 1.

The book balance is already $\$10{,}000$, so both sides agree. No journal entry is needed.

Scenario 2: Outstanding Checks

XYZ Company shows a book balance of $\$5{,}000$ and a bank balance of $\$7{,}000$ on April 30. Three checks totaling $\$2{,}000$ were written in April but didn't clear the bank until May.

Both sides agree at $\$5{,}000$. No journal entry is needed.

Scenario 3: Bank and Book Errors

LMN Company shows a book balance of $\$15{,}000$ and a bank balance of $\$14{,}500$ on May 31. Two problems are found:

1. The bank incorrectly debited LMN's account for $\$100$ (a charge that belonged to another customer).
2. LMN failed to record a $\$400$ check it wrote in May.

LMN needs a journal entry to record the $\$400$ check (debit the appropriate expense or payable, credit Cash). The bank error is reported to the bank for correction.

Internal Controls over Bank Reconciliations

Segregation of Duties

The person who prepares the bank reconciliation should not be the same person who records cash transactions or signs checks. Separating these duties makes it much harder for one individual to commit and conceal fraud.

Timely Preparation and Review

Reconciliations should be completed monthly (or more often for high-volume accounts). A supervisor or manager who was not involved in preparing the reconciliation should review and sign off on it. Delays give errors and fraud more time to go undetected.

Proper Documentation and Approval

Every reconciliation should include:

• A list of all outstanding items and adjustments
• Explanations for any investigated discrepancies
• Signatures and dates from both the preparer and the reviewer

This documentation creates an audit trail that supports the accuracy of the reported cash balance.

Common Bank Reconciliation Issues

Unrecorded Transactions

These are cash receipts or disbursements that appear on the bank statement but were never entered in the company's books. Examples include automatic loan payments, EFT collections, and bank fees. They show up during reconciliation and require adjusting journal entries on the book side.

Transposition and Calculation Errors

A transposition error swaps digits (recording $\$1{,}234$ as $\$1{,}243$). A useful trick: if the difference between the book and bank balances is evenly divisible by 9, a transposition error is a likely culprit. Calculation errors involve incorrect addition or subtraction. Both types require correcting entries on whichever side made the mistake.

Improper Cut-Off Procedures

Cut-off means making sure transactions land in the right accounting period. If a company records a receipt on March 31 but the bank doesn't process it until April 1, that's a normal timing difference. Problems arise when transactions are deliberately or accidentally shifted between periods, distorting the cash balance. Recording transactions based on the transaction date rather than the bank posting date helps keep cut-off clean.

Bank Reconciliation in Financial Reporting

Proper Cash Balance for the Balance Sheet

The adjusted book balance from the reconciliation is the cash figure that belongs on the balance sheet. If the reconciliation doesn't balance, there may be errors or misstatements in the financial statements that need to be resolved before reporting.

Detecting and Preventing Fraud

Regular reconciliations surface unauthorized transactions, check tampering, and embezzlement. The sooner unusual activity is spotted, the smaller the potential financial loss. This is one reason timely preparation matters so much.

Importance for Audit Purposes

Auditors treat bank reconciliations as key evidence for the existence, completeness, and accuracy of cash. They'll review the reconciliation, trace items to supporting documents, and evaluate whether internal controls over cash are effective. Well-prepared reconciliations with proper documentation make the audit process smoother and reduce the risk of audit adjustments.