Accounting: The Language of Business (Part 40)

Month end is approaching – Keep calm and carry on accounting. 

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Cash (Part D) 

by

Charles Lamson

Bank Reconciliation

For effective control, the reasons for the difference between the cash balance on the bank statement and the cash balance in the accounting records should be determined by preparing a bank reconciliation. A bank reconciliation is a listing of the items and amounts that cause the cash balance reported in the bank statement to differ from the balance of the cash account in the ledger.

A bank reconciliation is usually divided into two sections. The first section begins with the cash balance according to the bank statement and ends with the adjusted balance. The second section begins with the cash balance according to the depositor's records and ends with the adjusted balance. The two amounts designated as the adjusted balance must be equal. The content of the bank reconciliation is shown below.

The following steps are useful in finding the reconciling items and determining the adjusted balance of cash:

1. Compare each deposit listed on the bank statement with unrecorded deposits appearing in the preceding period's reconciliation and with deposit receipts or other records of deposits. Add deposits not recorded by the bank to the balance according to the bank statement.

2.  Compare paychecks with outstanding checks appearing on the preceding period's reconciliation and with recorded checks. Deduct checks outstanding that have not been paid by the bank from the balance according to the bank statement.

3.  Compare bank credit memorandums to entries in the journal. For example, a bank would issue a credit memorandum for a note receivable and interest that it collected for a depositor. Add credit memorandums that have not been recorded to the balance according to the depositors records.

4.  Compare bank debit memorandums to entries recording cash payments. For example, a bank normally issues debit memorandums for service charges and check printing charges. A bank also issues debit memorandums for not-sufficient funds checks. A not-sufficient funds (NSF) check is a customer's check that was recorded and deposited but was not paid when it was presented to the customer's bank for payment. NSF checks are normally charged back to the customer as an account receivable. Deduct debit memorandums that have not been recorded from the balance according to the depositor's records.

5.  List any errors discovered during the preceding steps. For example, if an amount has been recorded incorrectly by the depositor, the amount of the error should be added to or deducted from the cash balance according to the depositors records. Similarly, errors by the bank should be added to or deducted from the cash balance according to the bank statement. 

EXHIBIT 4 Bank Statement

To illustrate a bank reconciliation, we will use the bank statement for Power Networking in Exhibit 4 (from part 39 and reintroduced above). This bank statement shows a balance of $3,359.78 as of July 31. The cash balance in Power Networking's ledger as of the same date is $2,549.99. The following reconciling items are revealed by using the steps outlined above:

The bank reconciliation based on the bank statement and the reconciling items is shown in Exhibit 6.

EXHIBIT 6 Bank Reconciliation for Power Networking

No entries are necessary on the depositor's records as a result of the information included in the first section of the bank reconciliation. This section begins with the cash balance according to the bank statement. However, the bank should be notified of any errors that need to be corrected on its records.

Any items in the second section of the bank reconciliation must be recorded in the depositor's accounts. This section begins with the cash balance according to the depositor's records. For example, journal entries should be made for any unrecorded bank memorandums and any depositor's errors.

The journal entries for Power Networking, based on the preceding bank reconciliation, are as follows:

After these entries have been posted, the cash account will have a debit balance of $2,630.99. This balance agrees with the adjusted cash balance shown on the bank reconciliation. This is the amount of cash available as of July 31 and the amount that would be reported on Power Networking's July 31 balance sheet.

Although businesses may reconcile their bank accounts in a slightly different format from what we described above, the objective is the same: to control cash by reconciling the company's records to the records of an independent outside source, the bank. In doing so, any errors or misuse of cash may be detected.

For effective control, the bank reconciliation should be prepared by an employee who does not take part in or record cash transactions. When these duties are not properly separated, mistakes are likely to occur, and it is more likely that cash will be stolen or otherwise misapplied. For example, an employee who takes part in all of these duties could prepare and cash an unauthorized check, omit it from the accounts, and omit it from the reconciliation. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 293-295*

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