What is Bank Reconciliation

Bank reconciliation statement is a report which compares the bank balance as per company’s accounting records with the balance stated in the bank statement.
It is normal for a company’s bank balance as per accounting records to differ from the balance as per bank statement due to timing differences. Certain transactions are recorded by the entity that are updated in the bank’s system after a certain time lag. Likewise, some transactions are accounted for in the bank’s financial system before the company incorporates them into its own accounting system. Such timing differences appear as reconciling items in the Bank Reconciliation Statement.

steps-in-preparing-bank-reconciliation-statement-1
The purpose of preparing a Bank Reconciliation Statement is to detect any discrepancies between the accounting records of the entity and the bank besides those due to normal timing differences. Such discrepancies might exist due to an error on the part of the company or the bank.

Importance of Bank Reconciliation
Preparation of bank reconciliation helps in the identification of errors in the accounting records of the company or the bank.

Cash is the most vulnerable asset of an entity. Bank reconciliations provide the necessary control mechanism to help protect the valuable resource through uncovering irregularities such as unauthorized bank withdrawals. However, in order for the control process to work effectively, it is necessary to segregate the duties of persons responsible for accounting and authorizing of bank transactions and those responsible for preparing and monitoring bank reconciliation statements.
If the bank balance appearing in the accounting records can be confirmed to be correct by comparing it with the bank statement balance, it provides added comfort that the bank transactions have been recorded correctly in the company records.
Monthly preparation of bank reconciliation assists in the regular monitoring of cash flows of a business.

Preparing a Bank Reconciliation Statement
Following is a sample Bank Reconciliation Statement:
ABC LTD
Bank Reconciliation Statement as at 31 December 2011
Balance as per corrected Cash Book 1 xxx
Add:
Unpresented Cheques 2 xxx
Less:
Deposits in Transit 3 (xxx)
Errors in Bank Statement 4 (xxx)
Balance as per Bank Statement xxx
1. Balance as per corrected Cash Book:
This is the starting point of a bank reconciliation. Corrected bank balance is calculated by adjusting the cash book ledger balance for transactions that are recorded by the bank but not by the entity as shown below:

Balance as per Cash Book xxx
Add:
Direct Credits 5 xxx
Interest on Deposit 6 xxx
Less:
Bank Charges 7 (xxx)
Direct Debits 8 (xxx)
Standing Order 9 (xxx)
Errors in Cash Book 10 (xxx)
Balance as per corrected Cash Book xxx

Unpresented Cheques
These represent cheques that have been issued by an entity to a customer or another third party but which have not presented to the bank by the reconciliation date. Entity records the payment in its cash book as soon as the cheque is issued to the person but the bank records the transaction when it receives the cheque. This causes a timing difference in the recording of the payment.
As the bank would not have recorded the unpresented cheques, the balance appearing in bank statement would be higher than the cash book balance which is why the amount of outstanding cheques is added to the cash book balance in the bank reconciliation.

Example
ABC & Co. purchases goods worth $2000 and writes a cheque of the same amount in favor of the supplier on 28 December 2010. Following accounting entry was recorded by the entity on that date:
$ $
Debit Purchases 2,000
Credit Bank 2,000
The supplier however does not present the cheque until 3 Janaury 2011. Therefore, $2000 of unpresented cheques should appear in the bank reconciliation on 31 December 2010 because the bank had not accounted for the transaction by that date even though ABC & Co. had recorded the payment in its cash book on the date of payment.

Deposits in Transit
There may be a time lag between when a company deposits cash or cheque in its account and when the bank credits it. Since the company records the increase in bank balance in its accounting records as soon as the cash or cheque is deposited, the balance as per bank statement would be lower than the balance as per cash book until the deposit is processed by the bank. Therefore, any outstanding deposits must be subtracted from the balance as per cash book in the bank reconciliation statement.
Example
ABC & Co. deposits a cheque of $1000 it had received from a credit customer on 29 December 2010. The following accounting entry was recorded by the company on that date:
$ $
Debit Bank 1,000
Credit Receivable 1,000
While preparing a bank reconciliation statement, ABC & Co. finds out that the bank had not credited the cheque in its account until 2nd January 2011. Therefore, $1000 of deposits in transit should appear in the bank reconciliation on 31 December 2010 because the bank had not accounted for the transaction by that date even though ABC & Co. had recorded the receipt in its cash book on the date of deposit.

Errors in bank statement
Errors or omissions by the bank can lead to a difference between the balance as per bank statement and the balance as per cash book. For instance, bank may incorrectly record the deposits or withdrawals of another account into the company’s bank account. Likewise, a deposit or withdrawal be erroneously recorded twice by the bank. Such discrepancies would cause the balance shown in the bank statement to be higher or lower than cash book balance depending on the nature of the error or the omission. The differences must be intimated to the bank for timely correction.
Example
ABC & Co.’s bank statement for the month of December 2010 shows that bank charges of $500 have been incorrectly been recorded twice by the bank. As the balance as per bank statement would be lower than the balance as per ABC & Co.’s cash book due to the error, $500 must be subtracted from the balance as per cash book in the bank reconciliation statement.

Direct Credits
Direct Credits or Direct Deposits are amounts deposited directly by someone into an account of the company. The payer rather than the payee in this case initiate the deposit. Direct Credits are useful where regular receipts are expected from known parties (such as rent, interest on investment, royalties, etc) who can deposit the money without the involvement of the payee. The deposit may be made through cash, cheque or a fund transfer.
Bank records the amount received as soon as the transfer through direct credit is made but the business entity records the amount when it receives intimation by the bank through bank statement or otherwise. Therefore, the balance as per bank statement may be higher than the balance as per cash book due to direct credits not yet accounted for by the entity. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co. receives rent amounting to $1000 on its leased property via direct credit into its bank account on 30 December 2010. The Company has not recorded the rent received in its books. The balance on the cash book shows a balance of $20,000. Bank statement shows the following:
Bank Statement of ABC & Co. for the month of December 2010
Date Particulars Opening Balance Debit Credit Balance
01-12-2010 20,000 – – 20,000
30-12-2010 Fund Transfer 20,000 – 1000 21,000
As the bank credited the account of ABC & Co. as soon as the direct credit was made, the balance as per bank statement is higher than the cash book balance by $1000. ABC & Co. must record the rent received through direct credit in its cash book before preparing the bank reconciliation to remove the difference. Following accounting entry must be recorded to arrive at the corrected cash book balance:
$ $
Debit Bank 1,000
Credit Rent Income 1,000

Interest on Deposits
Interest earned on various saving accounts may be credited directly into the accounts by the bank at the end of a month. The account holding company records the interest receipt after it receives intimation from the bank through bank statement. Therefore, until the interest received is recorded in the cash book, the balance as per bank statement will be higher than the cash book balance. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co. earns interest on its saving account of $1000 for the month of December 2010 which has been directly credited to the company’s account on 31 December 2010 by the bank. The Company has not yet recorded the interest received in its books. The balance on the cash book shows a balance of $20,000. Bank statement shows the following:
Bank Statement of ABC & Co. for the month of December 2010
Date Particulars Opening Balance Debit Credit Balance
01-12-2010 20,000 – – 20,000
30-12-2010 Interest- Dec 20,000 – 1000 21,000
As the bank has already credited the account of ABC & Co. in respect of interest received, the balance as per bank statement is higher than the cash book balance by $1000. In order to remove the difference, ABC & Co. must record the interest received in its cash book before preparing the bank reconciliation. Following accounting entry must be recorded to arrive at the corrected cash book balance:
$ $
Debit Bank 1,000
Credit Interest Income

Bank Charges
Bank charges are the various fees accountholders are charged in respect of maintenance of the account along with any other charges incurred in respect of specific transactions (e.g. cheque clearance charges, fund transfer charges, collection charges, etc). Bank charges are charged directly to the customer account thereby reducing the bank balance shown in the bank statement. These charges are usually not recorded by the business until the bank provides the bank statement at the end of a month which is why balance as per bank statement may be lower than the cash book balance. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co. has been charged $500 in respect of bank charges for the month of December 2010. The Company has not yet recorded the bank charges in its books. The balance on the cash book shows a balance of $20,000. Bank statement shows the following:
Bank Statement of ABC & Co. for the month of December 2010
Date Particulars Opening Balance Debit Credit Balance
01-12-2010 20,000 – – 20,000
30-12-2010 Charges- Dec 20,000 500 – 19,500
As the bank has already debited the account of ABC & Co. in respect of bank charges, the balance as per bank statement is lower than the cash book balance by $500. In order to remove the difference, ABC & Co. must record the bank charges in its cash book before preparing the bank reconciliation. Following accounting entry must be recorded to arrive at the corrected cash book balance:
$ $
Debit Bank Charges 500
Credit Bank 500
Direct Debit
Direct Debit is an instruction to the bank to transfer funds to another account on a recurring basis. The payment is initiated by the payee himself although the account in which the funds will be transferred needs to be first authorized by the payer. Direct Debits are useful where regular payments are to be made to certain parties such as in payment of credit card bills, lease rentals, interest on bank loan, etc. This saves the company the hassle of issuing cheques every month. Whereas standing orders can only be made of specific amounts and dates, direct debits can be created for varying dates and amounts.

Bank records the amount paid as soon as the transfer through direct debit is made but the business entity records the amount when it receives intimation by the bank through bank statement or otherwise. Therefore, the balance as per bank statement may be lower than the balance as per cash book due to payments made through direct debits not yet accounted for by the entity. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.

Example
ABC & Co. pays office rent amounting to $1000 via direct debit on 30 December 2010. The Company has not recorded the rent paid in its books. The balance on the cash book shows a balance of $19,000. Bank statement shows the following:
Bank Statement of ABC & Co. for the month of December 2010
Date Particulars Opening Balance Debit Credit Balance
01-12-2010 21,000 – – 21,000
30-12-2010 Fund Transfer 20,000 1000 – 20,000
Since the bank debited the account of ABC & Co. as soon as the direct debit was made, the balance as per bank statement is lower than the cash book balance by $1000. ABC & Co. must record the rent paid through direct debit in its cash book before preparing the bank reconciliation to remove the difference. Following accounting entry must be recorded to arrive at the corrected cash book balance:
$ $
Debit Rent 1,000
Credit Bank 1,000

Standing Order
Standing Order is an instruction to the bank to transfer funds of a specific amount to another account on a specific date on a recurring basis. It is very similar to a direct debit except that the amount and date of payment cannot be varied. The payment is initiated by the payee himself although the account in which the funds will be transferred needs to be first authorized by the payer. Standing orders are useful where regular payments of fixed amounts are to be made to certain parties such as the payment of mortgage rent and loan installments.
Bank records the amount paid as soon as the transfer through standing order is made but the business entity records the amount when it receives intimation by the bank through bank statement or otherwise. Therefore, the balance as per bank statement may be lower than the balance as per cash book due to payments made through standing orders not yet accounted for by the entity. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co has made a standing order to its bank to transfer an amount of $5000 on the last day of the month as security charges to a security company. On 31 December 2010, the bank statement shows a balance of $20,000 whereas the cash book balance is $25,000. The difference represents the amount of payment through standing order not yet recorded by ABC Co. LTD.
Bank Statement of ABC & Co. for the month of December 2010
Date Particulars Opening Balance Debit Credit Balance
01-12-2010 25,000 – – 25,000
30-12-2010 Fund Transfer 25,000 5,000 – 20,000
In order to eliminate the difference between the two balances, ABC Co. LTD must record the following accounting entry:
$ $
Debit Security Charges Payable 5,000
Credit Bank 5,000
This will reduce the cash book balance to $20,000 which is equal to the balance as shown in the bank statement.

Errors in Cash Book
Errors or omissions in the cash book can lead to a difference between the balance as per bank statement and the balance as per cash book. For instance, an entity may incorrectly record the bank deposits or withdrawals in another accounting ledger or it may record the entry by a wrong amount. Likewise, a bank deposit or withdrawal may be completely omitted from the cash book. Such discrepancies would cause the balance shown in the bank statement to be higher or lower than cash book balance depending on the nature of the error or the omission. The difference needs to be eliminated by adjusting the cash book of the company before the preparation a bank reconciliation.
Example
ABC & Co.’s bank statement shows a bank balance of $20,000 on 31 December 2010 where as its balance in the cash book at that date is only $19,000. The difference is due to a bank payment of $1000 incorrectly recorded twice by ABC & Co. in its cash book. The difference can be eliminated by adjusting the cash book by a debit entry of $1000.

Source :- FB Finance Article

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