What is a bank reconciliation?

A bank reconciliation is an internal control procedure that explains the difference between the cash balances of two sets of independent accounting records. Each set of accounting records detail exactly the same cash transactions but on any given day they may not necessarily agree. These two sets of records are kept by (1) the business that record these cash transactions in the "Cash at Bank" account in the general ledger and (2) the bank that details these same cash transactions on a bank statement.

The Bank reconciliation definition and background Difference between the debit balance Cash at Bank account of the business and the credit balance in the bank statement?
One of the first differences we notice when we compare the 'Cash at Bank ' account in the business records with the bank statement provided by the bank, is the different credit/debit balances. When the 'Cash at Bank' account in the accounting records of the business shows a debit balance the bank statement will show a credit balance for the same set of transactions. The reason for this difference is a matter of accounting perspective. You see, while both entities record transactions according to the double-entry bookkeeping system, a business keeps their accounting records from the business perspective just as the bank keeps their accounting records from the bank's perspective. So while 'Cash at Bank' represents an asset in the accounting records of the business (i.e. it is an item of future economic value), the same cash deposited into the bank becomes a liability of the bank from the bank's perspective. (i.e. it becomes money owed by the bank to the business). So while both independent entities use the double-entry bookkeeping system they each observe the cash at bank transactions from opposite sides. We know from the debit/credit tables that asset accounts have a debit nature and liability accounts have a credit nature. We also know from the debit/credit tables that increases in assets are recorded as debits while increases in liabilities are treated as credits. So the $1,000 debit balance recorded in the "Cash at Bank' account of the business will appear as a $1,000 credit balance in the bank statement of the bank. In other words, our accounting records that claim that we have cash at bank assets worth $1,000 (debit balance), is confirmed by the bank who issue a statement explaining that they have a liability, which is claimable by the business, of $1,000 (credit balance).

Background to the bank reconciliation

A business uses the services of banks to securely hold the cash the business needs to operate. A business typically conducts many transactions that involve the movement of cash. Management of this cash movement is another service that the banks offer. Most cash movements involve the receipt of revenue and the payment of bills. Each of these cash transactions are recorded in the accounting records of the business as well as the accounting records of the bank. The business records the cash transaction details in the 'Cash at Bank' account and produces a general ledger print-out of this account to display the transactions. The bank produces a bank statements to report on the cash transactions that it has processed on behalf of the business. Now if all the cash transactions had been recorded accurately in both sets of accounting records, then you would think that they should agree ... but they rarely do! Why?

Well first of all, because there are timing differences between when the business records the cash transactions in their accounting records and when the transaction actually occurs at the bank. (i.e. a cheque written, posted and recorded on the 1st day of the month in the accounting records of the business may not be deposited at the bank until the 4th day of the month. This means that for the period from the 1st - 3rd day of the month, the accounting records of the business would not agree with the accounting records (bank statement) of the bank in regards to "Cash at Bank". This timing difference is just one reason why the two sets of accounting records may not agree on any given day. Other reasons might include: 1. Outstanding deposits (cash recorded in the business accounts but not yet banked) 2. Bank charges (payments for bank fees from the bank account that the business knows nothing about) 3. Dishonored and returned cheques (deposits recorded in the business accounts that have been reversed by the bank due to insufficient funds in the cheque issuer's bank account) 4. Electronic funds transfers (direct payments/deposits from and to the bank account) Of course there may also be recording inaccuracies on the part of the bank or business or worst some form of fraudulent activity that is causing the difference. The bank reconciliation sets out to bring activities relating to the movement of cash in and out of the bank account into the open. The bank reconciliation process ensures that the "Cash at Bank" reported by the business in their accounting records is consistent with the bank's accounting records as detailed in the bank statement. This is what bank reconciliation is all about. Now if youre familiar with balancing your personal checkbook, then you will already be familiar with the bank reconciliation process. You will be essentially doing the same thing and for the same reason. Bank reconciliation allows businesses or individuals to compare their own records relating to cash movement with the bank's records. The reconciliation is done so that any discrepancies can be identified and acted upon.

This process of confirming and explaining the difference in amounts between the two independent accounting records, is referred to as "reconciling the bank statement", "bank statement reconciliation", "bank reconciliation", or in slang terms, doing a "bank rec."

Bank reconciliation image

Bank Reconciliation

Why is a bank reconciliation necessary?

The reason for a bank reconciliation - Practicing level A bank reconciliation is a necessary part of the internal controls of a business particularly in terms of identifying recording errors and fraud. The bank reconciliation process provides an independent verification of the accuracy of the accounting records of the business and must be completed before preparing the financial statements.

The need for a bank reconciliation Why do we need to do a bank reconciliation?

The bank reconciliation needs to be completed regularly to independently verify the accounting records of the business. The bank reconciliation explains the differences between the business 'Cash at Bank' account balance and the balance displayed on the bank statement. Both the business and the bank keep accounting records in relation to the exact same cash at bank transactions. These cash transactions include deposits, cheques paid, electronic funds transfers and bank/government charges. Most differences between the two sets of independent accounting records can be explained by timing differences. i.e. the time difference between writing, posting and recording the cheque and the actual cashing of the cheque with the bank. Other differences occur because sometimes on set of records is unaware of cash transactions that the other has recorded. i.e. cash receipts that the business may have recorded but not yet banked or bank charges that the bank has paid from the bank account of the business but not yet notified the business. Also, the differences could be explained by recording errors or even fraudulent activity i.e. a person records cash receipts in the business records but does not bank the cash in the business bank account. Another reason for doing a bank reconciliation is to confirm the amount of money that the business actually has available. The cash amount recorded on the bank statement may not necessarily be the amount that is available for the business to spend. This is due to the fact that the bank does not know about the cheques that have been paid but not yet presented to the bank. Before preparing the financial statements, your accountant will verify the cash accounting records of the business by completing a bank reconciliation. If the differences between the 'Cash at Bank' account in the business accounting records and the bank's accounting records as shown on the bank statement can be explained by the bank reconciliation process, then the accountant has increased confidence in the accuracy of the business accounting records. The bank reconciliation is also required by auditors who check the accuracy of the financial statements of a business. These audits may be conducting for tax, funding or reporting purposes. In summary, the importance and need for a bank reconciliation may be given as follows: 1. The bank reconciliation process helps identify any errors committed by the business or the bank (rare) 2. The bank reconciliation helps the business identify the actual cash funds available to spend 3. The bank reconciliation will help identify any fraudulent activity in relation to the cash assets of the business 4. The bank reconciliation may also show any undue delay in the clearance of cheques. 5. A balanced bank reconciliation provides confidence in the accuracy of the business accounting records 6. The bank reconciliation is required by the auditors of the financial statements.

The reasons for differences between the "cash at bank" records of the business and the bank's records.

Bank reconciliation differences

While both the bank and the business keep the same records about the cash movements in and out of the business bank account, each entity is not always fully informed of cash transactions that the other has recorded. The bank reconciliation process makes this unknown information visible. The most common reasons for differences between the cash at bank accounting records of the business and the accounting records of the bank as displayed on the bank statement are:

outstanding cheques - e.g. a cheque that is issued by the business has not yet been presented to the bank for cashing. It can take a few days for an issued cheque to be cashed with the bank causing the two sets of accounting records to be out of balance during that time. bank charges - e.g. a bank charge/fees paid by the bank from the business bank account, has not yet been recorded in the business recording errors - e.g. either the bank or the business has made a recording error (most likely the business recording a different amount in the accounting records to the actual amount on the deposit or cheque) outstanding deposits - e.g. there are deposits in transit (outstanding deposits). i.e. cash received and recorded in the books of the business but not yet banked. automatic withdrawals and deposits - e.g. businesses may authorize a bank to automatically transfer funds into or out of their bank account. Automatic withdrawals from the account are often used to pay for loans (notes or mortgages payable), monthly utility bills, or other liabilities. Automatic deposits typically occur when the business' bank account receives automatic fund transfers from customers in payment of their accounts. interest earned - e.g. banks often pay interest on bank account balances. The bank uses the bank statement to inform the business of the interest income. The business will then record this information in the books of the business so that they reconcile with the bank's records. dishonored cheques - or NSF (not sufficient funds) cheques. e.g. a cheques previously recorded as part of a deposit may bounce (be returned by the issuer's bank) because there are not sufficient funds in the issuer's cheque account. When this happens, the bank will deducts the cheque amount from the bank account of the business reducing the amount of available cash in the bank account.

What are the steps in a bank reconciliation process?

Steps in a bank reconciliation process - Practicing level Bank reconciliations play an important part in the internal cash controls of a business. For this reason they should be done at regular intervals. Broadly speaking, there are four key steps in the bank reconciliation process: (1) gather the information (2) identify the discrepancies (3) update the business accounting records (4) prepare a bank reconciliation statement. The bank reconciliation process and statement

Steps in the bank reconciliation process

First some background - The bank reconciliation process sets out to explain the differences between two independently maintained accounting records that capture the same information i.e. the movement of cash into and out from the bank account. The business keeps one set of these accounting records in the form of the "Cash at Bank" account in their general ledger. The bank keeps the other set of accounting records which it details these cash movements in a bank statement. The bank provides a bank statement on demand to a business to allow them to do regular reconciliations.

Steps in the bank reconciliation process

Both the business and the bank keep these accounting records for their own purposes but both records are founded on the same double-entry bookkeeping system. The business needs to keep a record of the cash assets they control and the bank needs to keep a record of the cash liabilities they have to the businesses that deposit the cash with them. Both accounting records reflect the cash positions from their own (opposite) perspectives. This is why a business will record a cash deposit (increasing an assets) as a 'debit' in the "Cash at Bank" account of their accounting records while the bank will record the deposit as a 'credit' (increasing a liability). OK, now for the steps in the bank reconciliation process.

Step 1 - Gather information

To perform a bank reconciliation you will need to gather the following information and documentation:

1. The bank reconciliation statement prepared during the last bank reconciliation process. This bank reconciliation statement will have details of the outstanding deposits and unrepresented cheques as at the date of the reconciliation. 2. The bank statements detailing the cash movements through the bank account of the business from the date of the last bank reconciliation to the present date. You should ensure that the closing date and cash balance on the most recent bank statement covers your planned date of reconciliation. 3. "The Business Records" - These include the detailed general ledger print-out of the "Cash at Bank" account (or "Cheque Account) that matches the account shown on the bank statement. Set the printout to cover the period from the date of the last bank reconciliation to the closing date identified on the most recent bank statement. Alternatively gather the cash receipt journal and the cash payments journal covering the same period.

Step 2 - Identify the discrepancies

Compare the deposits listed in the credit column of the bank statement with "The Business Records" which include "Cash at Bank" debit column of the general ledger print-out or the bank column of the cash receipts journal as well as the outstanding deposits detailed in the previous bank reconciliation statement. o amounts that are identical between the bank statement and "The Business Records" are ticked in both sets of accounting records. These records are now ignored in the bank reconciliation process. o amounts that appear in one set of accounting records but not in the other are circled. o amounts that are similar (amounts/dates) but appear to be recording error, should be investigated and resolved in regard to the erring party (bank or business) Compare the payments listed in the debit column of the bank statement with "The Business Records" which include "Cash at Bank" credit column of the general ledger print-out or the bank column of the cash payments journal as well as the unrepresented cheques detailed in the previous bank reconciliation statement. o amounts that are identical between the bank statement and "The Business Records" are ticked in both sets of accounting records. These records are now ignored in the bank reconciliation process. o amounts that appear in one set of accounting records but not in the other are circled. o amounts that are similar (amounts/dates) but appear to be recording error, should be investigated and resolved in regard to the erring party (bank or business)

Step 3 - Update the business accounting records

The circled items on the bank statement (other than rare errors made by the bank) will be items that now must be entered into the accounting records of the business. o These adjustments could all be recorded in the general journal of the business or equally separated into the cash receipts journal adjustments or the cash payments journal adjustments. o recording errors identified in the comparison step should be corrected to match the actual bank statement amounts. o Bank fees and charges will be expensed, direct deposits will be typically recorded as accounts receivable payments, direct deposits could be loan repayments or expenses to the appropriate expense account, dishonored cheques will be reversed and interest earned credited to the appropriate revenue account. o After the updated transactions have been processed, you will need to obtain the new "Cash at Bank" account balance from the general ledger so that the bank reconciliation statement can be prepared.

Step 4 - Prepare the bank reconciliation statement

Finally, the circled items on the previous bank reconciliation and the "Cash at Bank" print-out or the cash receipts/payment journals will provide the necessary information required to prepare the bank reconciliation statement. 1. enter the bank account details including your planned bank reconciliation date 2. enter the cash balance as per the "Cash at Bank" account of the general ledger 3. enter the cash balance from the bank statement as at your planned reconciliation date 4. enter and add the total the outstanding deposits 5. enter the details and subtract total the unpresented cheques 6. add or (subtract) bank errors. Enter subtract as a negative number. 7. calculate the new amount for the bank statement and ensure it reconciles with the "Cash at Bank" balance

Below is a typical bank reconciliation statements example that reconciles the bank statement with the "Cash at Bank" account in the general ledger of the business.

The bank reconciliation statement

The bank reconciliation statement