6.2 Bank reconciliations
7 min read•august 20, 2024
Bank reconciliations are crucial for ensuring accurate financial reporting and detecting discrepancies. This process compares a company's to its bank statement, identifying and resolving differences caused by timing issues, errors, or fraud.
The reconciliation process involves adjusting both book and bank balances for outstanding items and errors. Key include , , and . Proper internal controls and timely reconciliations are essential for maintaining financial accuracy and preventing fraud.
Importance of bank reconciliations
- Bank reconciliations are a critical internal control procedure that helps ensure the accuracy and completeness of a company's cash balances and transactions
- Reconciling the book balance to the on a regular basis helps identify any discrepancies, errors, or fraudulent activity in a timely manner
- Bank reconciliations provide assurance to management, auditors, and stakeholders that the company's financial statements accurately reflect its cash position and transactions
Bank reconciliation process
Comparing book vs bank balances
Top images from around the web for Comparing book vs bank balances
Passbook - Wikipedia View original
Is this image relevant?
Bank Account Reconciliation Report Template View original
Is this image relevant?
Making Changes and Correcting Errors | Boundless Accounting View original
Is this image relevant?
Passbook - Wikipedia View original
Is this image relevant?
Bank Account Reconciliation Report Template View original
Is this image relevant?
1 of 3
Top images from around the web for Comparing book vs bank balances
Passbook - Wikipedia View original
Is this image relevant?
Bank Account Reconciliation Report Template View original
Is this image relevant?
Making Changes and Correcting Errors | Boundless Accounting View original
Is this image relevant?
Passbook - Wikipedia View original
Is this image relevant?
Bank Account Reconciliation Report Template View original
Is this image relevant?
1 of 3
- The process begins by comparing the company's book balance (cash balance per the general ledger) to the bank balance (ending balance per the bank statement)
- Any differences between the two balances need to be investigated and reconciled
- The book balance and bank balance will often differ due to timing differences, outstanding items, and errors
Adjusting book balance for outstanding items
- The book balance needs to be adjusted for any transactions that have been recorded in the company's books but have not yet cleared the bank (outstanding items)
- Common outstanding items include deposits in transit (recorded in books but not yet credited by bank) and outstanding checks (recorded in books but not yet cleared by bank)
- These outstanding items are added to or subtracted from the book balance to arrive at the adjusted book balance
Adjusting bank balance for bank errors
- The bank balance may need to be adjusted for any errors made by the bank, such as incorrect debits or credits, omitted transactions, or transposition errors
- are identified by carefully reviewing the bank statement and comparing it to the company's records
- Any bank errors are added to or subtracted from the bank balance to arrive at the adjusted bank balance
Types of reconciling items
Deposits in transit
- Deposits in transit are amounts that have been received and recorded by the company but have not yet been credited to the company's account by the bank as of the statement date
- These deposits are typically made at the end of the period and will appear on the following month's bank statement
- Deposits in transit are added to the bank balance when reconciling
Outstanding checks
- Outstanding checks are checks that have been written and recorded by the company but have not yet cleared the bank as of the statement date
- These checks will be presented to the bank for payment in the following period
- Outstanding checks are subtracted from the book balance when reconciling
Bank service charges & interest
- Bank service charges are fees charged by the bank for maintaining the company's account, such as monthly maintenance fees, overdraft fees, or wire transfer fees
- is earned on the company's bank balance and is credited to the account by the bank
- Bank service charges are subtracted from the book balance, while interest income is added to the book balance when reconciling
Book errors vs bank errors
- are mistakes made by the company in recording transactions, such as omitting a transaction, recording an incorrect amount, or posting a transaction to the wrong account
- Bank errors are mistakes made by the bank, such as incorrectly debiting or crediting the company's account or omitting a transaction
- Book errors are corrected by making to the company's books, while bank errors are corrected by the bank and adjusted on the bank reconciliation
Preparing journal entries
For deposits in transit
- Deposits in transit require no journal entry because they have already been recorded in the company's books
- However, they are added to the bank balance on the bank reconciliation to arrive at the adjusted bank balance
For outstanding checks
- Outstanding checks require no journal entry because they have already been recorded in the company's books
- However, they are subtracted from the book balance on the bank reconciliation to arrive at the adjusted book balance
For bank service charges & interest
- Bank service charges are recorded as an expense in the company's books with a debit to Bank Service Charges Expense and a credit to Cash
- Interest income is recorded as revenue in the company's books with a debit to Cash and a credit to Interest Income
- These journal entries adjust the book balance to match the adjusted bank balance
For book errors
- Book errors are corrected by making adjusting entries to the company's books
- The specific adjusting entry depends on the nature of the error (omission, incorrect amount, wrong account)
- These adjusting entries correct the book balance to match the adjusted bank balance
Bank reconciliation examples
Scenario with deposits in transit
- ABC Company has a book balance of 8,000 as of March 31
- Upon review, it is discovered that a $2,000 deposit made on March 31 was not credited by the bank until April 1
- The 10,000
Scenario with outstanding checks
- XYZ Company has a book balance of 7,000 as of April 30
- Upon review, it is discovered that three checks totaling $2,000 were written and recorded in April but did not clear the bank until May
- The 5,000
Scenario with bank & book errors
- LMN Company has a book balance of 14,500 as of May 31
- Upon review, it is discovered that the bank incorrectly debited the company's account for 400 check written in May
- The 400 book error is subtracted from the book balance, reconciling both balances to $14,900
Internal controls over bank reconciliations
Segregation of duties
- The person responsible for preparing the bank reconciliation should be independent of the person responsible for recording cash transactions and signing checks
- This helps prevent and detect errors or fraud by ensuring that no single individual has control over the entire cash process
Timely preparation & review
- Bank reconciliations should be prepared and reviewed on a timely basis, typically monthly or more frequently for high-volume accounts
- allows for prompt identification and correction of errors or discrepancies
- Timely review by a supervisor or manager ensures that the reconciliation is accurate and complete
Proper documentation & approval
- Bank reconciliations should be properly documented, including a list of outstanding items, made, and any discrepancies investigated
- The reconciliation should be signed and dated by the preparer and reviewer to evidence their approval
- and approval provide an audit trail and support the accuracy and completeness of the reconciliation
Common bank reconciliation issues
Unrecorded transactions
- Unrecorded transactions are cash receipts or disbursements that have not been recorded in the company's books
- These may include bank charges, interest income, or transactions that were overlooked or misplaced
- Unrecorded transactions are identified during the bank reconciliation process and require adjusting entries to correct the book balance
Transposition & calculation errors
- Transposition errors occur when digits are reversed or transposed when recording a transaction (e.g., recording 1,243)
- Calculation errors occur when amounts are incorrectly added, subtracted, or otherwise miscalculated
- These errors are identified during the bank reconciliation process and require adjusting entries to correct the book balance
Improper cut-off procedures
- Cut-off refers to the process of ensuring that transactions are recorded in the proper accounting period
- Improper cut-off can result in deposits in transit, outstanding checks, or other reconciling items that cross over accounting periods
- Proper cut-off procedures, such as recording transactions based on the transaction date rather than the posting date, help minimize reconciling items and ensure accurate financial reporting
Bank reconciliation in financial reporting
Proper cash balance for balance sheet
- The bank reconciliation process ensures that the cash balance reported on the balance sheet is accurate and properly stated
- The adjusted book balance from the bank reconciliation should match the cash balance reported on the balance sheet
- Any unreconciled differences may indicate errors or misstatements in the financial statements
Detecting & preventing fraud
- Bank reconciliations can help detect and prevent fraudulent activities, such as unauthorized transactions, embezzlement, or check tampering
- Regular reconciliations can identify unusual or suspicious transactions that warrant further investigation
- Timely detection of fraud can minimize financial losses and reputational damage to the company
Importance for audit purposes
- Bank reconciliations are a key audit procedure that provides evidence of the existence, completeness, and accuracy of a company's cash balances and transactions
- Auditors typically review bank reconciliations and supporting documentation to assess the effectiveness of internal controls over cash and to identify any material misstatements
- Properly prepared and reviewed bank reconciliations can help streamline the audit process and reduce the risk of audit adjustments or modifications to the auditor's opinion
Key Terms to Review (21)
Accounting software: Accounting software is a digital tool designed to manage financial transactions and automate various accounting tasks, such as tracking income, expenses, and generating financial statements. This software streamlines the accounting process, making it easier for businesses to maintain accurate financial records and perform bank reconciliations efficiently.
Accrual Accounting: Accrual accounting is a method of accounting that recognizes revenue when it is earned and expenses when they are incurred, regardless of when cash is actually received or paid. This approach provides a more accurate picture of a company's financial position by matching income and expenses to the period in which they occur, thus ensuring that financial statements reflect the true performance and obligations of the business.
Adjusting entries: Adjusting entries are accounting journal entries made at the end of an accounting period to allocate income and expenses to the correct period. These entries ensure that the financial statements reflect the true financial position of a company, adhering to the accrual basis of accounting. They typically involve accrued revenues, accrued expenses, deferred revenues, and deferred expenses, all of which are essential for accurate financial reporting.
Adjustments: Adjustments refer to the necessary changes made to account balances to ensure that the financial statements reflect the true financial position of a business. These changes are essential in reconciling discrepancies between the company’s records and external sources, such as bank statements, and they help in maintaining accurate financial reporting and compliance with accounting standards.
Bank balance: Bank balance refers to the amount of money that an account holder has available in their bank account at any given time. It plays a crucial role in financial management, influencing both personal budgeting and business cash flow, as it reflects current funds that can be used for transactions, savings, or investments.
Bank charges: Bank charges are fees that financial institutions impose on customers for various services, transactions, or account maintenance. These charges can include monthly maintenance fees, transaction fees, overdraft fees, and other service-related costs that can affect a company's financial statements. Understanding these charges is crucial for accurate financial reporting and reconciliation of bank accounts.
Bank errors: Bank errors refer to mistakes made by financial institutions in processing transactions, which can affect account balances or the accuracy of bank statements. These errors can lead to discrepancies during bank reconciliations, causing confusion for account holders and necessitating careful review to ensure correct financial reporting.
Bank reconciliation: Bank reconciliation is the process of comparing a company's cash balance on its books to the cash balance reported by its bank to identify any discrepancies between the two. This process is crucial for ensuring accurate financial reporting and helps in detecting errors or fraud. Regular bank reconciliations help maintain the integrity of financial records and provide a clearer picture of a company's cash flow.
Book balance: Book balance refers to the amount of money recorded in a company's accounting books or ledgers, reflecting its cash position before any adjustments from bank transactions. This balance plays a critical role in understanding the company's financial health, as it directly impacts cash flow management and reconciliation processes with bank statements.
Book errors: Book errors refer to mistakes made in the recording of financial transactions in the accounting records. These errors can arise from various reasons, such as data entry mistakes, miscalculations, or misclassifications of accounts. Identifying and correcting book errors is essential for maintaining accurate financial statements and ensuring proper bank reconciliations.
Cash basis accounting: Cash basis accounting is an accounting method where revenues and expenses are recorded only when cash is received or paid out. This approach contrasts with the accrual basis of accounting, where transactions are recorded when they are earned or incurred, regardless of cash movement. Cash basis accounting simplifies financial reporting and is often used by small businesses and individuals due to its straightforward nature.
Checking account: A checking account is a type of deposit account held at a financial institution that allows for withdrawals and deposits. It provides easy access to funds for daily transactions, often through checks, debit cards, or electronic transfers, making it a key financial tool for managing personal finances and conducting regular banking activities.
Deposits in transit: Deposits in transit are amounts of money that have been received and recorded by a company but have not yet been reflected on the bank statement. This occurs because the deposit was made after the bank's cutoff time or on a weekend or holiday, resulting in a timing difference between the company's accounting records and the bank's records. Understanding deposits in transit is crucial for accurate bank reconciliations, as they help ensure that both the company’s and the bank's records are aligned.
Interest income: Interest income is the revenue earned by an entity from interest-bearing assets, such as cash equivalents, loans, or investments. This income is crucial for understanding the financial health of an organization, as it contributes to overall profitability and cash flow. It plays a significant role in financial reporting and impacts various accounting practices.
Outstanding Checks: Outstanding checks are checks that have been written and issued by a company or individual but have not yet been cleared or processed by the bank. They represent a liability on the balance sheet until they are presented for payment, impacting the reconciliation between the bank's records and the entity's records. The presence of outstanding checks is crucial in ensuring accurate cash flow management and proper financial reporting.
Proper Documentation: Proper documentation refers to the systematic process of recording, organizing, and maintaining accurate financial records that support the transactions and balances reported in financial statements. This practice is crucial in ensuring transparency, reliability, and compliance with applicable regulations, particularly in the context of bank reconciliations where accurate records help identify discrepancies between bank statements and company records.
Reconciling items: Reconciling items refer to discrepancies or differences between the balances shown in a bank statement and the amounts recorded in a company's accounting records. These items are essential for ensuring that financial records accurately reflect actual cash transactions and help identify any errors or fraudulent activity. The reconciliation process involves adjusting the company's books and understanding various transactions that might not have been accounted for, such as outstanding checks or deposits in transit.
Savings account: A savings account is a deposit account held at a financial institution that provides a modest interest rate and allows for easy access to funds. Typically used for saving money, this type of account helps individuals accumulate interest on their deposits while ensuring the safety of their funds. The convenience of withdrawals and transfers makes it an essential tool for personal finance management.
Segregation of duties: Segregation of duties is an internal control principle that ensures no single individual has control over all aspects of a financial transaction. This practice helps prevent fraud and errors by dividing responsibilities among different individuals, making it harder for one person to manipulate financial information undetected. By separating roles related to authorizing, processing, and reviewing transactions, organizations can enhance the integrity of their financial reporting processes.
Spreadsheets: Spreadsheets are software tools that allow users to organize, analyze, and store data in a tabular format. They are essential for financial tasks, enabling users to perform calculations, create charts, and manage large sets of information efficiently. The versatility of spreadsheets makes them invaluable in various applications, including budgeting, forecasting, and reporting.
Timely preparation: Timely preparation refers to the process of completing necessary tasks and activities at appropriate intervals to ensure accuracy and efficiency in financial reporting and management. In the context of bank reconciliations, it involves preparing reconciliations promptly to identify discrepancies between the bank statement and the company's records, allowing for swift resolution and accurate financial information.