What is a Bank Reconciliation Statement? How to Prepare it?

The bank reconciliation statement helps to check the correctness of the entries recorded in the books of accounts and thereby, ensures the accuracy of bank balances.

What Is a Bank Reconciliation Statement?

A bank reconciliation statement is a summary of banking and business activity that reconciles an entity’s bank account with its financial records. The statement outlines the deposits, withdrawals, and other activities affecting a bank account for a specific period. A bank reconciliation statement is a useful financial internal control tool used to thwart fraud.

Bank Reconciliation Statement

Explanation

Bank accounts for businesses can involve thousands of transactions per month. Due to the number of ongoing transactions, an organization’s book balance for its checking account rarely is the same as the balance that the bank records reflect for the entity at any given point.

These timing differences are typically caused by the fact that there will be some transactions that the organization is aware of before the bank or transactions the bank is aware of before the company.

For example, if a company writes a check that has not cleared yet, the company would be aware of the transaction before the bank is. Similarly, the bank might have received funds on the company’s behalf and recorded them in the bank’s records for the company before the organization is aware of the deposit.

With the large volume of transactions that impact a bank account, it becomes necessary to have an internal control system in place to assure that all cash transactions are properly recorded within the bank account, as well as on the ledger of the business.

The bank reconciliation is the internal financial report that explains and documents any differences that may exist between the balance of a checking account as reflected by the bank’s records (bank balance) for a company and the company’s accounting records (company balance).

Things to Reconcile in (BRS)

The following items are reconciled in the bank reconciliation statement:

  • Unpresented cheques (also called outstanding cheques): This timing difference will come to an end when bank eventually records payment of the cheques. The amount to be reconciled in BRS must exclude post-dated, cancelled and time-barred cheques.
  • Uncredited items (also called outstanding deposits or lodgements): This timing difference will come to an end when the cheque is cleared/collected/ credited by the bank. The amount to be reconciled in BRS must exclude post-dated, cancelled, time-barred and dishonoured cheques.
  • Error or omission by bank: The identified error is communicated to the bank for correction. The correction process may take some time, meanwhile the error is mentioned in BRS as a reconciling item

Reasons for Difference Between Bank Statement and Company’s Accounting Record

When banks send companies a bank statement that contains the company’s beginning cash balance, transactions during the period, and ending cash balance, the bank’s ending cash balance and the company’s ending cash balance are almost always different. Some reasons for the difference are:

  • Deposits in transit: Cash and checks that have been received and recorded by the company but have not yet been recorded on the bank statement.
  • Outstanding checks: Checks that have been issued by the company to creditors but the payments have not yet been processed.
  • Bank service fees: Banks deduct charges for services they provide to customers but these amounts are usually relatively small.
  • Interest income: Banks pay interest on some bank accounts.
  • Not sufficient funds (NSF) checks: When a customer deposits a check into an account but the account of the issuer of the check has an insufficient amount to pay the check, the bank deducts from the customer’s account the check that was previously credited. The check is then returned to the depositor as an NSF check.

Nowadays, many companies use specialized accounting software in bank reconciliation to reduce the amount of work and adjustments required and to enable real-time updates.

What is a Bank Reconciliation Statement

Bank Reconciliation Procedure

  • On the bank statement, compare the company’s list of issued checks and deposits to the checks shown on the statement to identify uncleared checks and deposits in transit.
  • Using the cash balance shown on the bank statement, add back any deposits in transit.
  • Deduct any outstanding checks.
  • This will provide the adjusted bank cash balance.
  • Next, use the company’s ending cash balance, add any interest earned and notes receivable amount.
  • Deduct any bank service fees, penalties, and NSF checks. This will arrive at the adjusted company cash balance.
  • After reconciliation, the adjusted bank balance should match with the company’s ending adjusted cash balance.

RECONCILING THE BALANCE

RECORDING AND CORRECTIONS IN CASH BOOK

The logical way to deal with errors and omissions in the cash book is to record the unrecorded items and correct the errors in accounting records.

One or more of the following adjustments may be required:

  • Bank charges: This should be recorded on payment side of cash book.
  • Dividend/interest received: This should be recorded on receipt side of cash book.
  • Interest on overdraft balance charged by bank: This should be recorded on payment side of cash book.
  • Standing orders: This is an instruction by account-holder to its bank to pay/transfer a same amount at regular intervals to another party’s (the payee’s) account. This method is usually used for monthly rent payments and periodic subscriptions. This should be recorded on payment side of the cash book.
  • Direct debits: In this method, an account-holder allows another party to directly collect amounts on regular basis from its bank, amount may be different in different periods. This method is usually used for monthly utility bills or credit card bills. This should be recorded on payment side of the cash book.
  • Direct credits: These are amounts directly credited into accounts by another party. For example, a customer deposits/transfers the amount due directly into the bank account of the business. This should be recorded on receipt side of cash book.
  • Dishonoured cheques received from customers: These should be reversed in cash book. As when deposited, these are included on the receipt side, on reversal, these are recorded on payment side.
  • Errors in cash book: There may be casting errors, balancing errors, etc. in cash book. These need to be adjusted on receipt side or payment side accordingly. When an item is incorrectly included on the other side of cash book (debit instead of credit or vice versa), the correction is made by adjusting twice the amount on correct side.
  • Post-dated cheques: If these have been included in cash book, a reversal should be made.
  • Time-barred cheques: A cheque becomes time-barred after six month have passed from the date mentioned on it and the bank might not pay it anymore. Therefore, these are cancelled and reversal is to be recorded.
  • Cancelled cheques: A cheque may also be cancelled for other reasons, for example, incorrect name was mentioned, the payment was made using another method, a replacement cheque has been issued and parties intend to cancel the old one. In these cases, a reversal should be recorded in cash book.

Adjusted Balance

This is the balance as per the cash book after all the errors and omissions in the cash book have been corrected and adjusted. This is also called the true balance of cash and this is the amount to be presented in the statement of financial position.

This amount is also used for reconciling balance with bank statement’s balance in the bank reconciliation statement.

Bank Reconciliation Terminology

The key terms to be aware of when dealing with a bank reconciliation are:

  • Deposit in transit. Cash and/or checks that have been received and recorded by an entity, but which have not yet been recorded in the records of the bank where the entity deposits the funds. If this occurs at month-end, the deposit will not appear in the bank statement, and so becomes a reconciling item in the bank reconciliation. A deposit in transit occurs when a deposit arrives at the bank too late for it to be recorded that day, or if the entity mails the deposit to the bank (in which case a mail float of several days can cause a delay), or the entity has not yet sent the deposit to the bank at all.
  • Outstanding check. A check payment that has been recorded by the issuing entity, but which has not yet cleared its bank account as a deduction from cash. If it has not yet cleared the bank by the end of the month, it does not appear on the month-end bank statement, and so is a reconciling item in the month-end bank reconciliation.
  • NSF check. A check that was not honored by the bank of the entity issuing the check, on the grounds that the entity’s bank account does not contain sufficient funds. NSF is an acronym for “not sufficient funds.” The entity attempting to cash an NSF check may be charged a processing fee by its bank. The entity issuing an NSF check will certainly be charged a fee by its bank.

Benefits of a Bank Reconciliation Statement

Bank reconciliation statements are effective tools for detecting fraud. For example, if a check is altered, resulting in a payment larger than anticipated, measures can be taken to interrupt the unscrupulous activity.

Bank reconciliation statements also help identify errors that could adversely financial reporting. Financial statements show the health of a company for a specific period or point in time and are often used to calculate profitability. Accurate financial statements allow investors to make informed decisions and give companies clear pictures of their cash flows.

Reconciling bank statements helps to identify errors that affect tax reporting. Without reconciling, companies may pay too much or too little in taxes.

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