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8. Bank Reconciliation

One of the most common cash control procedures, and one which you may already be performing on your own checking account, is the bank reconciliation. In business, every bank statement should be promptly reconciled by a person not otherwise involved in the cash receipts and disbursements functions. The reconciliation is needed to identify errors, irregularities, and adjustments for the Cash account. Having an independent person prepare the reconciliation helps establish separation of duties and deters fraud by requiring collusion for unauthorized actions.

There are many different formats for the reconciliation process, but they all accomplish the same objective. The reconciliation compares the amount of cash shown on the monthly bank statement (the document received from a bank which summarizes deposits and other credits, and checks and other debits) with the amount of cash reported in the general ledger. These two balances will frequently differ. Differences are caused by items reflected on company records but not yet recorded by the bank; examples include deposits in transit (a receipt entered on company records but not processed by the bank) and outstanding checks (checks written which have not cleared the bank). Other differences relate to items noted on the bank statement but not recorded by the company; examples include nonsufficient funds (NSF) checks ("hot" checks previously deposited but which have been returned for nonpayment), bank service charges, notes receivable (like an account receivable, but more "formalized") collected by the bank on behalf of a company, and interest earnings.

The following format is typical of one used in the reconciliation process. Note that the balance per the bank statement is reconciled to the "correct" amount of cash; likewise, the balance per company records is reconciled to the "correct" amount. These amounts must agree. Once the correct adjusted cash balance is satisfactorily calculated, journal entries must be prepared for all items identified in the reconciliation of the ending balance per company records to the correct cash balance. These entries serve to record the transactions and events which impact cash but have not been previously journalized (e.g., NSF checks, bank service charges, interest income, and so on).

8.1. Comprehensive Illustration of Bank Reconciliation

The following illustration provides a detailed example of a bank statement, additional data, the reconciliation process, and the corresponding journal entries. Conducting a bank reconciliation requires careful attention to the slightest of details. Even the smallest error will lead to frustration in trying to bring closure to the reconciliation effort.

THIS STATEMENT COVERS:

STATEMENT FOR:

July 1, 20X3 through July 31, 20X3

The Tackle Shack 445 Main Street Lake City

CHECKING ACCOUNT #

MONTHLY SUMMARY

76-7888-0987

Previous statement balance on 6-30-X3

46,543.89

Total of 4 deposits for

31,209.11

+

Total of 16 withdrawals for

27,077.77

Interest earnings for

119.34

+

Service charges for

55.00

New balance

50,739.57

CHECKS AND

OTHER DEBITS

CHECK DATE PAID

AMOUNT

CHECK

DATE PAID

AMOUNT

5454 2-Jul

4,456.09

*5465*

16-Jul

85.58

*5457* 3-Jul

245.00

5466

19-Jul

1199.19

5458 3-Jul

12.34

5467

23-Jul

76.14

5459 10-Jul

66.14

5468

23-Jul

375.62

5460 5-Jul

11,998.20

5469

30-Jul

2779.59

5461 9-Jul

3,000.00

5470

27-Jul

9.31

*5463* 16-Jul

2,119.44

*5472*

31-Jul

109.00

Electronic funds transfer

11-Jul

109.07

NSF returned check

17-Jul

437.06

NSF fee

31-Jul

25.00

Monthly service fee

31-Jul

30.00

DEPOSITS AND OTHER CREDITS

DATE POSTED

AMOUNT

Customer deposit at main location

10-Jul

12994.36

Customer deposit at river branch location

17-Jul

8855.10

Collection item - note receivable

25-Jul

5,450.00

Credit card posting - transaction 07e79849657

25-Jul

3,909.65

Interest earnings

31-Jul

119.34

Additional Data

The preceding bank statement is for The Tackle Shop for July of 20X3. The following additional data is needed to reconcile the account:

o The first check listed on the previous page, #5454, was written in June but did not clear the bank until July 2.

o There were no other outstanding checks, and no deposits in transit at the end of June.

o The EFT (electronic funds transfer) on July 11 relates to the monthly utility bill; The Tackle Shop has authorized the utility to draft their account directly each month.

o The Tackle Shop is optimistic that they will recover the full amount, including the service charge, on the NSF check ("hot check") that was given to them by a customer during the month.

o The bank collected a $5,000 note for The Tackle Shop, plus 9% interest ($5,450).

o The Tackle Shop's credit card clearing company remitted funds on July 25; the Tackle Shop received an email notification of this posting and simultaneously journalized this cash receipt in the accounting records.

o The Tackle Shop made the 2 deposits listed on the previous page, and an additional deposit of $3,565.93 late in the afternoon on July 31, 20X3.

o The ending cash balance, per the company general ledger, was $47,535.30.

o The following check register is maintained by The Tackle Shop, and it corresponds to the amounts within the Cash account in the general ledger:

DATE

PARTY

REF #

CHECK

DEPOSIT

Balance

1-Jul

Balance

$42,087.80

1-Jul

Bailey

5457

$ 245.00

41,842.80

2-Jul

Boyatzis

5458

12.34

41,830.46

3-Jul

Smith

5459

66.14

41,764.32

5-Jul

Blaize

5460

11,998.20

29,766.12

8-Jul

Paronto

5461

3,000.00

26,766.12

8-Jul

Void

5462

26,766.12

9-Jul

Deposit

$12,994.36

39,760.48

15-Jul

Sanchez

5463

2,119.44

37,641.04

15-Jul

Bauer

5464

525.00

37,116.04

15-Jul

Cameron

5465

85.58

37,030.46

17-Jul

Deposit

8,855.10

45,885.56

19-Jul

Hartman

5466

1,199.19

44,686.37

21-Jul

Ashkanasy

5467

76.14

44,610.23

22-Jul

Forest

5468

375.62

44,234.61

24-Jul

Augier

5469

2,779.59

41,455.02

24-Jul

Arbaugh

5470

9.31

41,445.71

25-Jul

Credit Card

3,909.65

45,355.36

25-Jul

Bento

5471

30.30

45,325.06

30-Jul

Peterson

5472

109.00

45,216.06

30-Jul

Taggart

5473

1,196.69

44,019.37

30-Jul

Klimoski

5474

50.00

43,969.37

31-Jul

Deposit

3,565.93

47,535.30

$23,877.54

$29,325.04

Bank Reconciliation

The bank reconciliation for July is determined by reference to the preceding bank statement and other data. You must carefully study all of the data to identify deposits in transit, outstanding checks, and so forth. Be advised that tracking down all of the reconciling items can be a rather tedious, sometimes frustrating, task. Modern bank statements facilitate this process by providing sorted lists with asterisks beside the check numbers that appear to have gaps in their sequence numbering. Below is the reconciliation of the balance per bank statement to the correct cash balance. You should try to identify each item in this reconciliation within the previously presented data. If you need help, you might wish to refer to the companion website for a link to a line drawing that helps you find the necessary elements.

The reconciliation of the balance per company records to the correct cash balance is presented below. This reconciliation will trigger various adjustments to the Cash account in the company ledger. If you need a little help finding the noted items, check the link provided on the companion website. The identified items caused cash to increase by $4,968.21 ($52,503.51 correct balance, less the balance on the company records of $47,535.30). Most of these amounts are fairly intuitive, except for the $462.06 debit to Accounts Receivable - which indicates that The Tackle Shop is going to attempt to collect on the NSF check and related charge. The interest income of $569.34 reflects that posted by the bank ($119.34) plus the $450 on the collected note.

B

C

D

16

17

Ending balance par company records

$ 47,535.30

18

19

20

Add: Customer note collection

$

5.450.00

21

Interest earnings

119.34

5,569.34

22

23

Deduct:

24

EFT for utilities

$

109.07

25

NSF check returned

437.06

26

_NSF fee _

25.00

27

Service charges

30.00

(601.13)

28

29

Correct cash balance

$ 52,503.51

7-31-X3

Cash

4,968.21

Utilities Expense

109.07

Accounts Receivable

462.06

Miscellaneous Expense

30.00

Notes Receivable

5,000.00

Interest Income

569.34

To record adjustments necessitated by bank reconciliation

8.2. Proof of Cash

Many a business prepares a reconciliation just like that illustrated. But, you should note that it leaves one gaping hole in the control process. What if you learned that the bank statement included a $5,000 check to an employee near the beginning of the month, and a $5,000 deposit by that employee near the end of the month (and these amounts were not recorded on the company records)? In other words, the employee took out an unauthorized "loan" for a while. The reconciliation would not reveal this unauthorized activity because the ending balances are correct and in agreement. To overcome this deficiency, some companies will reconcile not only the beginning and ending balances, but also the total checks per the bank statement to the total disbursements per the company records, and the total deposits per the bank statement to the total receipts on the company accounts. If a problem exists, the totals on the bank statement will exceed the totals per the company records for both receipts and disbursements. This added reconciliation technique is termed a proof of cash. It is highly recommended where the volume of transactions and amount of money involved is very large. Such unauthorized "borrowing" not only steals company interest income, but it also presents a risk of loss if the company funds are not replaced. Make no mistake, such schemes are highly illegal!

Also illegal is "kiting." Kiting occurs when one opens numerous bank accounts at various locations and then proceeds to write checks on one account and deposit them to another. In turn, checks are written on that account, and deposited to yet another bank. And, over and over and over. In time, each of the bank accounts may appear to have money, but it is illusionary, because there are numerous checks "floating" about that will hit and reduce the accounts. Somewhere in the process of running this scam, the crook makes off with a cash withdrawal (or writes a check that appears to be good to an unsuspecting merchant) and skips town. That is why you will often see bank notices that deposited funds cannot be withdrawn for several days; they have been burned once too often, and want to be sure that a deposit clears the bank on which it is drawn before releasing those funds. Now, the point of this discussion is not to give you any ideas - but to alert you to be careful in your dealings with others. Kiting is complex and illegal, and many a person is "doing time" in jail for such dealings. Enhanced electronic clearing procedures adopted by banks in recent years have made kiting far more difficult to accomplish.

 
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