Accounting: The Language of Business - Vol. 2 (Intermediate: Part 153)

The plans of the diligent lead to profit (Proverbs 21:5) ...

 Short-Term Operating Assets: Cash and Receivables (Part R)

by

Charles Lamson

Controlling Cash by Use of a Bank Account

Bank accounts provide a company with several important controls over cash because banks have standing procedures to safeguard cash. For example, key documents used by banks to protect depositors' cash include checks, deposit tickets, signature cards, and bank statements.

Bank Reconciliation

Referring to the bank statements, companies prepare a bank reconciliation each month. A bank reconciliation compares the bank statement to the amount recorded in the company general ledger cash account. Any differences between the company's books and the bank statement amounts must be reconciled. The bank reconciliation is a significant part of internal controls over cash: If differences cannot be explained, the company will investigate and determine whether any misappropriation has occurred. 

There are four common reconciling items:

1. Deposits in transit

2. Outstanding checks

3.  Bank charges and credits

4.  Errors

Deposits in Transit. Deposits in transit reflect a timing difference that occurs when a company makes a bank deposit at the end of the current month and the amount of that deposit is recorded in the company's books. However, that deposit may not be recorded by the bank until the following months.

Outstanding Checks. Outstanding checks also results from timing differences. The company will deduct checks written on the books, but the checks may not have cleared the bank in time to be reported on the bank statement. 

Bank Charges and Credits. Bank charges are fees that depositors pay for services such as check printing, safe deposit box rentals, and other services. There are also charges for nonsufficient funds (NSF checks). The company is usually not aware of the amount of these charges until receiving the bank statement. Bank credits are deposits of cash such as interest accrued. The company is not notified regarding any interest earned until it receives the bank statement.

Errors. The company may make one or more errors, such as incorrectly recording or omitting a check or deposit. The bank may also make an error, but that is far less common.

When a company learns about bank charges and bank credits or company errors in the preparation of its bank reconciliation, it makes any journal entries required to record these in its accounting system.

Format for the Bank Reconciliation

There are two formats used to construct a bank reconciliation:

• Reconcile bank to book or book to bank.

• Reconcile both bank and book balances to the correct cash balance.

The most common approach used in practice is to reconcile both the bank and book balances to the correct cash balance:

1. Start with the bank balance and add any deposits in transit and subtract any outstanding check to arrive at the correct balance.

2.  Begin with the book balance and subtract any bank charges and add any bank credits.

3. And just did what balance for any company error to arrive at the correct cash balance. The corrected bank and book balances should be identical.

After completing the bank reconciliation, the company makes journal entries to reflect accrued interest revenue, other bank credits, and bank charges because these events are not previously recorded on the company's books. Entries are also required to correct any book errors. Example 9A.1 illustrates a reconciliation of both the bank and book balances to the correct amounts.

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 501-504*

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