Bank Reconciliation - Online Tutor, Practice Problems & Exam Prep

Bank reconciliation is a crucial internal control over cash, ensuring that a company's records align with its bank statement. Key components include deposits in transit, outstanding checks, and bank errors. Adjustments are made to both the bank and book sides to achieve an adjusted balance. Common adjustments involve bank collections, electronic funds transfers (EFT), service charges, interest revenue, and non-sufficient funds (NSF) checks. Understanding these elements is essential for accurate financial reporting and maintaining liquidity in the accounting cycle.

Bank Reconciliation:Bank Column

Alright, so a great internal control over cash is the use of bank reconciliation. This is where the company takes the monthly bank statement that they receive from the bank and checks it against the company's records to ensure that everything is okay between the two.

Cash is the most liquid asset, right? When we talk about liquidity, liquidity is how quickly it can be converted to cash. Well, cash is already cash, so it's extremely liquid and easy to steal, right? Anyone who gets their hands on the cash might have an incentive to actually steal it. So, we're going to need specific internal controls over cash, and one is the bank reconciliation. Like I said, this is where we compare the bank statement that we get every month to the company records.

What we're going to notice is that the bank statement is generally not going to be the same as what we see in our company records, and this difference is due to a time lag. Think about it: for a company that's constantly receiving money from customers, buying stuff, having all sorts of expenses, there's all sorts of activity in the account. If we were to stop at a certain point in time, there would still be things that hadn't been processed on either end.

For instance, back in the day, you might receive a check on payday and it wouldn't clear immediately. You'd have to go to the bank, deposit it, and then wait for it to clear. There's this time lag. You might have recorded something in your books that the bank hasn't recorded yet, or the bank might have recorded something that you didn't know about until you got the monthly bank statement. Let's see how this bank reconciliation works.

The goal of the bank reconciliation is to get to an adjusted balance. We're going to have a number from the bank that represents the amount of cash in our bank account as of that date, and we'll have our accounting records that show us some amount as well, and we're going to adjust those numbers for different items to end up at the same number in both accounts.

Let's start with the bank column of the reconciliation. This is when there are events recorded by the company but not yet by the bank. For example, first, we have deposits in transit. This is where the company has received a check. Think about it: the customer had mailed a check to the company, the company received the check and they're like "Sweet, we got this money" and they made an entry. They received cash, credit accounts receivable. They got money from a customer and then they go deposit it in the bank, but the bank hasn't cleared the check yet. So, we need to add the deposits in transit to the bank side of the reconciliation because we recorded it in our books, but the bank has not recorded it yet.

The opposite situation is an outstanding check. This is where we receive an invoice from a supplier, and we write a check. So, we write a check to say, "Okay, we're going to pay the supplier," so we wrote that check and made a journal entry to decrease our cash because we were going to pay cash to our supplier. But at this point in time, that check hasn't cleared yet; maybe the supplier hasn't deposited it in their account yet, or maybe the bank is still waiting to clear it. For whatever reason, the bank balance does not show that we paid this check yet. So we need to subtract this amount from the bank balance to ensure that we get to the correct adjusted balance.

And the last one for banks, well, those are the two big ones: deposits in transit and outstanding checks. You're pretty much always going to see these when you do a bank reconciliation. They're always on the bank side of the reconciliation. There's nothing that's going to be done on the book side for those. The last category here is bank errors; banks sometimes just love to make errors especially in accounting problems. So, when an error occurs, we need to remove its effects. Unfortunately, this could be anything, often something like confusing the numbers, for example, they were supposed to make a $150 payment, but they made a $510 payment instead.

That's the bank side of the reconciliation. Let's pause, and then we'll go over the book side of the reconciliation.

Bank Reconciliation:Book Column

Alright, let's continue here with the book column of the reconciliation. Notice there are a few more things here, and it could be all sorts of things that the bank recorded, but we didn't know about it until we received the bank statement. So this is literally us getting the bank statement at the end of the month and saying, "Oh, I didn't notice that the bank charged us a fee," and then we would make a journal entry for the fee, right? Things like that. So let's go ahead and see what those are. The first one is bank collections. This is where the bank collects money on our behalf. Sometimes we have a situation, especially with customers that we have ongoing, that they just deposit the money directly into your bank account. Maybe you're a landlord and you just have the customer deposit the rent; I know that's what I do, I just deposit my rent in the bank account. Oh, speaking of which, it's the 3rd of the month, uh-oh. Well, anyway, I deposit it straight into my landlord's bank account and I don't give them any record. Eventually, they're going to check and be like, "Oh, there's the money. Okay. Cool." So what do we have to do? We're going to have to add the bank collections to the book because we're going to look and say, "Oh, that customer paid us," and then we'll make an entry to increase our cash.

Okay, the next one is electronic funds transfer. So these are EFT payments or EFT receipts. This is basically automatic payments. This is the same logic as the bank collections where we didn't really know about it until we looked at the record, and these are like automatic payments. EFT is just an automatic payment. So when we had an EFT receipt, that means we received some sort of automatic payment that we didn't notice until we looked at the bank record, so we would add an EFT receipt, right? Because we received money, and we would subtract EFT payments from the book, right? Because we paid money. So that's pretty straightforward, right? On this side, remember we're thinking about the company's records here.

Okay, next is the service charge. We look on the bank statement, "Oh, they charged us a fee of $10 for, know, whatever the bank wants to charge us fees for." Well, the bank charges a fee, but we never recorded it, so it's time to record it. We need to subtract the fees from the book balance, right? We're going to have to decrease our cash because of these fees.

Interest revenue, oh man, maybe there were days where the banks actually paid us interest on our checking accounts, but I don't remember those days. Well, interest revenue, this could be if you had some money in the account and you earned interest and you check, and look at that, we earned some interest on this account. Well, we need to add the interest to the book, right? We didn't know we had earned this money; this is more cash for the company. We would add that to the books.

The next one is the NSF checks, not sufficient funds, okay? So this one's pretty tricky because a lot of times students tend to think that nonsufficient funds checks, this is a check that bounced, a check that did not go through. So a lot of times students think that this is the company that wrote the check, but that's not true. This is the company that received the check from a customer. So the customer paid the company, and the company's like, "Oh sweet, we received some money, let's go ahead and increase our cash balance," but then when they go to deposit it, the bank actually tells them, "Hey, that customer doesn't have money in that account. We can't cash that check." So what we have to do, we recorded this so this is where it's tricky. In our books, we had recorded that we received money. Right? We got the cheque, and we recorded this receipt, but we didn't receive it, right? The cheque bounced, that money never actually was deposited into the bank account, so we have to subtract NSF checks, okay? This is decreasing because we previously thought we got this money, but actually, we did not get this money. Okay, so not sufficient funds checks, these are receipts from customers that are bad, right? So they didn't actually pay us, okay?

So the last one here, book errors. Just like the bank can make errors, the book makes errors especially in accounting problems. They love to make errors. So again, we have to remove the effects of the errors. It's hard to tell you what to expect, but it's generally you have to think, okay, if they had done this correctly, what would have been the correct entry and then get it to that state, right? We have to change the incorrect entry to the correct entry. So usually, these bank errors and book errors, that's usually the trickiest spot because you have to kind of think logically what happened. Alright? So if I had to pick the things that are going to show up the most when you talk about bank reconciliations, I would say that the most common things that they talk about are your deposits in transit, your outstanding checks, errors (and I'm going to say errors do they do like to do that because it makes you think a little critically), then they love to do the interest revenue, service charges, interest revenue and not sufficient fund checks. I would say those are the most common things that come up when you talk about bank reconciliations, but not to say that all of these won't show up. Okay? So it's nice to know about all of them, but those are the main ones that show up. Alright? So let's go ahead and, let's go ahead and try a bank reconciliation and see how this works in practice. Alright? Let's do that now.

A company has a current balance in its Cash account of $3,400. The bank statement arrived showing a bank balance of $5,900. Prepare the cash reconciliation noting the following events:

• Deposits in transit total $600

• EFT receipt of dividend revenue of $900

• Bank error:the bank deducted $100 for a check written by another company.

• Service charge $20

• NSF check from a customer $50

• Book error:Company Check no. 333 was recorded for $510. The actual amount paid on account was $150.

• Outstanding checks total $2,010

Alright. Let's try this one here. A company has a current balance in its cash account of $34,100. The bank statement arrived showing a bank balance of $59,100. So notice there's a difference in the account, right? The book is showing $34,100 in our T account when we show cash, it says, right now we have $34,100, but the bank says there's $59,100. What's the difference? Well, it has to do with all of these items here. So let's prepare our bank reconciliation and let's go ahead and show you how I do that. We're going to have 2 columns. We're going to have 1 column for the book and 1 column for the bank. We're going to start with our beginning balance in each. We're going to add and subtract items, and get to an ending balance. The ending balance should be the same for both of them, and that's how you know you did it correctly. Alright, let's check it out. So I'm going to make a column here for the book, a column here for the bank. Okay? So let's go ahead and start with our beginning balance in each and let's see what those were. The book balance was current balance in its cash account $34,100. This one started at $59,100, right? Those are our beginning balances right there. So let's go ahead and one by one, we're going to add and subtract. In question that if one of these items would affect both. They're always only going to affect one column here, okay? Deposits in transit, so a deposit in transit totaling $600. This means that the company had received $600, right? They had received a check let's say for $600 and they're like oh sweet, let's deposit this. So they put it into the bank account but the bank has not cleared those checks yet. So we're going to put the deposits in transit to increase our bank balance by $600, right? EFT receipt of dividend revenue. So an EFT receipt, this is where we had an automatic receipt of money. When we have automatic receipts of money, we probably didn't get a signal that we received this money, only when we checked the bank statement. We're like, hey, we received $900, so we're going to increase the cash in the books by $900, so that dividends are going to increase our book balance by $900, right? Next is a bank error. The bank deducted $100 for a check written by another company. So maybe there's another company with a name similar to ours and the bank took $100 out of our account. We're going to call them and get that $100 back, so the bank error had previously decreased our balance. We need to increase our balance by $100 back, okay? Next, service charge of $20. This means that the bank charged us money, but we didn't know about it yet. We looked at our statement and we saw hey, there's a $20 service charge, we need to decrease our cash in the books by $20, right? The bank already took the $20 out of our account, now the book needs to take the $20 out of the account. NSF check from a customer for $50. This is not sufficient funds check. A customer wrote us a check, and we thought this check was good, so our cash balance is already increased by $50, but now we're learning we never received that $50 because the check bounced. So we have to decrease our book balance by $50. Outstanding checks totaled $2,010. This means that the company has written checks to their suppliers and we had written the record on our books, we had decreased our cash balance because of these checks, but the bank has not cleared these checks yet. So the outstanding checks are going to decrease our bank balance by $2,010. Lastly, book error. Company check number 333 was recorded for $5.10, the actual amount paid was $1.50. We had reduced our cash by $5.10, but the correct amount was $1.50. We took out too much cash from our account. To correct this, $3.60 needs to be added back to increase the cash balance by $3.60. Alright, so we've dealt with all of these issues. We've got something for all of them and the last is to make sure that our adjusted balance is the same. Let's go ahead and do this math and see if our adjusted balance is the same. The balance calculations are: $34,100 + $900 - $20 - $50 + $360 for the book, and $59,100 + $600 + $100 - $2,010 for the bank. Both sides need to equal the correct adjusted balance. If they match, we've done it correctly. This is how we set up our bank reconciliation and get to this adjusted balance. The final step would be to make journal entries to adjust the books to reflect the correct balance.

Here’s what students ask on this topic:

What is a bank reconciliation and why is it important?

A bank reconciliation is a process where a company compares its internal financial records to the monthly bank statement provided by its bank. This ensures that the company's cash records are accurate and align with the bank's records. The importance of bank reconciliation lies in its role as an internal control mechanism. It helps identify discrepancies due to time lags, errors, or unauthorized transactions, thereby preventing fraud and ensuring the accuracy of financial statements. Regular bank reconciliations also help maintain liquidity and provide a clear picture of the company's cash position.

What are deposits in transit and how are they handled in a bank reconciliation?

Deposits in transit are amounts that have been received and recorded by the company but have not yet been recorded by the bank. These typically occur when a company deposits checks or cash at the end of the month, and the bank has not yet processed these deposits. In a bank reconciliation, deposits in transit are added to the bank statement balance to adjust it to the correct amount. This ensures that the bank's records reflect the actual cash available in the company's account.

What are outstanding checks and how do they affect the bank reconciliation process?

Outstanding checks are checks that the company has issued and recorded in its books but have not yet been cleared by the bank. These checks reduce the company's cash balance in its records but are not yet reflected in the bank statement. During the bank reconciliation process, outstanding checks are subtracted from the bank statement balance to adjust it to the correct amount. This ensures that the bank's records align with the company's actual cash outflows.

How are bank errors handled in a bank reconciliation?

Bank errors occur when the bank makes a mistake in recording transactions. These errors can include incorrect amounts, duplicate entries, or missed transactions. In a bank reconciliation, bank errors are identified and corrected by adjusting the bank statement balance. For example, if the bank mistakenly recorded a $150 payment as $510, the error would be corrected by adding $360 to the bank statement balance. This ensures that both the bank's and the company's records are accurate and consistent.

What are non-sufficient funds (NSF) checks and how are they treated in a bank reconciliation?

Non-sufficient funds (NSF) checks are checks that a company receives from customers but cannot be processed by the bank due to insufficient funds in the customer's account. When an NSF check is identified, the company must reverse the initial cash receipt recorded in its books. In a bank reconciliation, NSF checks are subtracted from the book balance to reflect the actual cash available. This adjustment ensures that the company's records accurately represent the cash that has been successfully deposited and is available for use.