Bank Reconciliation

How do you know that the cash balance on your Statement of Financial Position is correct? Remember that cash includes all money on company premises and cash in the bank. We can count the petty cash and compare to the account balance. Reconciling petty cash is easy! But what about cash in the bank?

Hmmm… Is there a document we can use to verify that our accounting records for cash in bank are correct? Yes, the bank statement! We can compare accounting records to the bank statement! This comparison is called a bank reconciliation. Bank reconciliations are completed every time a company receives their bank statement, which traditionally is monthly. Access to bank records online, however, allows companies to access their bank balance and transactions anytime, allowing for more flexibility. So how do companies decide how often to reconcile their bank accounts? It depends on the number of transactions going through the bank, and the risk of theft or misuse of money in the bank.

What does a bank reconciliation look like, you may ask. Great question! A bank reconciliation compares (1) the transactions that the company has recorded in the cash account to (2) the transactions the bank recorded on the bank statement. We want to identify all the differences between the company’s calculation of their bank balance and the ending balance on the bank statement. There will almost always be differences.

For example, a company will record cheques written to suppliers, a decrease to the bank account, as soon as the cheque is mailed. But the bank doesn’t know they mailed a cheque. When does the bank find out? The bank records the cheque when the supplier deposits it. It might take a day, week, or even a month until the supplier takes the cheque to the bank. For that day, week, or month before the cheque is deposited, there will be a difference between the company’s accounting record and the bank’s record. Which will be higher? Of course, the bank because the outstanding cheque will decrease the bank account balance and this decrease has only been recorded in the company’s accounts.

Similarly, there are transactions happening in our bank account that we aren’t aware of until we get the statement. Bank charges and electronic fund transfers (EFT) are good examples of transactions a company may not be aware of until they get their bank statement.

Let’s prepare a bank reconciliation. Start by writing a title so we know the type of report and the cutoff date for transactions. Consider the fictitious company ZayZay Inc. and reconcile their RBC bank account at 31 October 20X2. After writing the title, divide your paper in two. On the left-hand side, record the balance in your booksBalance per Books:
The unadjusted or adjusted financial account balance taken from the trial balance at the reconciliation date. Required to reconcile bank accounts, investment accounts, and credit card balances. See also: Bank reconciliation, Balance per bank. for the RBC account at 31 October You can find this balance from a T-account, trial balance, or Statement of Financial Position. On the right-hand side, record the balance 31 October balance from the bank statementBalance per Bank:
The unadjusted or adjusted bank account balance at the reconciliation date. The source document for balance per bank is the bank statement, investment statement, or credit card statement. See also: Bank reconciliation, Balance per books..

ZayZay has received their bank statement which shows an ending balance of $10,672. When you look into ZayZay’s trial balance, the RBC bank account has a balance of $14,972. Let’s record this.

ZayZay Inc.
Bank Reconciliation
(RBC account #250-15851-223)
31 October 20X2

Notice that these two amounts are not the same. Don’t worry. There are several differences that need to be reconciled. We will start by adjusting the balance per bank side for outstanding cheques and deposits in transit. In their books, ZayZay has recorded all the cheques they have written and mailed to suppliers. Most of these cheques will have been cashed, and the money taken from our account, but some of these cheques haven’t been cashed yet. So ZayZay has correctly recorded that cash has left their bank account, but the bank has no idea that this money has been spent. This discrepancy, namely ZayZay writing cheques but the bank being unaware, is referred to as outstanding cheques. All cheques that ZayZay has written but have not been recorded by the bank will be subtracted from the balance per bank.

Calculating Outstanding Cheques

Let’s calculate outstanding cheques for ZayZay given the following information:

• On last month’s bank reconciliation there were two outstanding cheques:

  ZayZay Inc.
  Bank Reconciliation (Excerpt)
  (RBC account #250-15851-223)
  30 September 20X2

  (-) Outstanding Cheques:
  #234	(234)
  #327	(590)	(824)

  Cheque #234 was withdrawn from ZayZay’s bank account during October, but cheque #246 has not been withdrawn yet.

• ZayZay wrote several cheques during October. Three of these cheques have not cleared ZayZay’s bank:

  Cheque #299: written for $120 to Freight Ltd

  Cheque #320: written for $1,030 to Ink Supplies Co.

  Cheque #327: written for $52 to Window Cleaners Ltd.

Which cheques are still outstanding? In other words, which cheques does the bank not know about yet, even though the cheque payment has been recorded by ZayZay? Cheque 234 was brought to the bank by ZayZay’s supplier, so the bank has recorded that cheque. But the bank doesn’t know about cheques #246, #299, #320, and #327. These cheques are still outstanding in the amount of $1,792 (calculated as 590 + 120 + 1,030 + 52).

ZayZay Inc.
Bank Reconciliation
(RBC account #250-15851-223)
31 October 20X2

We will keep working until the adjusted balance per bank equals the adjusted balance per books. Clearly we aren’t done yet. Let’s keep going.

Calculating Deposits in Transit

Deposits in transit are amounts that are deposited into the bank, but the bank has not recorded yet. Typically cash deposited at the end of day is recorded by the bank first thing in the morning. So a deposit made late on the last day of the month, say 31 October will show up on the November bank statement. Again, the company has correctly recorded the deposit in their accounts on 31 October because that’s when the physical transfer took place, but the bank records the deposit the next morning when they receive it. Which side of the bank reconciliation needs to be updated for deposits in transit? The bank side, of course. The deposit has happened, but the bank is late to record it. So let’s adjust the balance per bank.

Consider ZayZay’s deposit in transit. ZayZay Inc. deposited $7,600 in the bank on 31 October but the deposit didn’t show up on the October bank statement. This amount will be added to the balance per bank side.

ZayZay Inc.
Bank Reconciliation
(RBC account #250-15851-223)
31 October 20X2

Still not balanced. No problem, let’s look at some adjustments on the balance per books side. We are looking for items on the bank statement that have not been recorded in ZayZay’s books. The bank statement is a source document for bank service charges, interest received, and electronic fund transfers. Source document just means the first place we become aware of a transaction. For example, the bank doesn’t send us an invoice for bank service charges, they just take it from our bank account. So we won’t know that the bank has taken these funds from our account until we see the bank statement.

Using the Bank Statement as a Source Document

Back to our example. The bank statement contains the following transactions that are not in ZayZay’s accounting books:

EFTs:

Two customers paid their accounts by electronic fund transfer (EFT): LoveYourStuff Ltd. transferred $830 on 15 October; and ILikeToBuy Inc. transferred $390 on 21 October.

Service Fees:

Bank service fees were $32 and charged on 31 October.

NSF Fees:

On 29 October a deposited cheque came back NSF (nonsufficient funds). The cheque was from MoreGidgets Ltd as a payment of $300 on their account. The bank also charged $10 as an NSF fee.

The EFTs were received from ZayZay’s customers and increased ZayZay’s bank balance. Let’s add these EFTs to the balance per books side.

Bank service fees reduce the bank balance. We’ll subtract the $32 from the balance per books side.

The NSF cheque was from a customer. Basically, the customer didn’t have enough cash in their bank account to cover the cheque. ZayZay had previously recorded this cheque as an increase in cash, but now they have to reverse the transaction. To record the NSF cheque we will subtract the cheque amount of $300 from the balance per books side. In addition, the bank charged a service fee of $10 on the NSF cheque which has to be deducted on the balance per books side.

Here’s our updated bank reconciliation for ZayZay Inc:

ZayZay Inc.
Bank Reconciliation
(RBC account #250-15851-223)
31 October 20X2

Lastly, we’ll have to adjust for errors made by the company and by the bank. Then we’ll add up each column. If the adjusted balance per bank equals the adjusted balance per books, it’s reconciled and we’re done! If not, we go back to find our mistakes.

Catching and Correcting Errors

Let’s continue with our example. When you compare the bank statement to the cash account, you notice that there’s an error in ZayZay’s cash account! On 5 October ZayZay wrote cheque #310 to a supplier for $290. This cheque correctly cleared the bank for $290, but the bookkeeper entered it as $920 instead of $290. This is called a transposition error: when two numbers are switched around.

This error must be corrected in the accounting records in the amount of $630 (calculated as 920 – 290). But will the error increase or decrease the account balance? Let’s think about this one.

The original entry was a cheque written to a supplier for $920 – that original entry reduced the cash balance. If we reverse this $920, the result would be an increase in balance per books.

But we still have to record the $290 that actually went through the bank. This $290 has not been properly recorded, but would reduce the cash account balance.

Overall, the effect is an increase of $630, calculated as the increase due to reversal of $920 less the actual reduction in ZayZay’s bank account of $290. Let’s include this error adjustment in ZayZay’s bank reconciliation. Fingers crossed that it balances!

ZayZay Inc.
Bank Reconciliation
(RBC account #250-15851-223)
31 October 20X2

Amazing! Two lines under the adjusted balance indicates that the statement is reconciled. Well done!

Journalizing Transactions After Reconciliation

Now here’s the very last step. Everything we adjust on the balance per books side must be recorded in our books. After all, these are corrections that need to be made in our accounting records. Luckily, you are already practiced in journal entries: the debit and credit change-makers to our accounts! After we finish our bank reconciliation, we’ll create journal entries for each adjustment on the balance per books side.

Now that the bank reconciliation is complete, ZayZay asks you to record any necessary journal entries. Refer to the bank reconciliation above. For reference, I have summarized each balance per books reconciling item for you below.

Journalizing Reconciling Items

EFTs:

Hurray; ZayZay has received cash in their bank account! ZayZay’s books are incomplete because they haven’t recorded these receipts from customers. EFTs will increase the balance per books: the company has more money than they thought! And remember, for each item adjusting the balance per books we’ll have to record a journal entry. Our journal entry will reflect that ZayZay has more money, and LoveYourStuff and ILikeToBuy owe ZayZay less money (decrease to A/R):

15 October 20X2:

(to record EFT received)

DR		Cash in RBC bank	830
	CR	A/R (LoveYourStuff)		830

21 October 20X2:

(to record EFT received)

DR		Cash in RBC bank	390
	CR	A/R (ILikeToBuy)		390

Bank Fees:

ZayZay made a payment to the bank of $42 that isn’t recorded in their books yet. RBC withdrew $32 in monthly bank service fees, and $10 in NSF fees. You could adjust for each fee separately (i.e. on a separate line) or simply add them up on one line (showing all your work!). Total bank fees paid during October were $42. We have to record a journal entry to reflect these bank fees in our books:

31 October 20X2:

(to record bank service charges for October)

DR		Bank service charge expense	32
	CR	Cash in RBC Bank		32

NSF Cheque:

Looks like a customer wrote us a cheque (which we deposited), but the customer didn’t have enough cash in their account. So when the bank went to withdraw the money from the customer’s account, and the cash wasn’t there, they cancelled the transaction (i.e. reversed the earlier cheque deposit) thereby decreasing your bank balance for the cheque amount of $300. The bank also charges you a fee of $10 for the inconvenience. The company will call the customer to let them know their cheque was rejected by the bank and request another form of payment. Because the customer hasn’t made a viable payment, the $300 is still owing on account. So ZayZay will reinstate the A/R with a debit of $300. And we’ll have to record the NSF bank service charge.

29 October 20X2:

(to reinstate customer’s A/R for NSF cheque)

DR		Accounts Receivable (A/R)	300
	CR	Cash in RBC Bank		300

(to record NSF service charges)

DR		Bank service charges expense	10
	CR	Cash in RBC Bank		10

Error in Books:

Oops; ZayZay’s bookkeeper inverted two digits when entering the cheque into the accounting system. The journal entry recorded was DR A/P $920; CR Cash $920 but the journal entry should have been DR A/P $290; CR Cash $290. Because the calculation of errors is more complex than other adjustments, let’s adjust the books first and then enter the adjustment into the bank reconciliation. Here we go: (a) undo the incorrect journal entry then (b) enter the correct journal entry.

5 October 20X2:

(to reverse error in cheque 310 and record actual)

DR		Cash in RBC Bank	920
	CR	A/P		920
DR		A/P	290
	CR	Cash in RBC Bank		290

Now it’s your turn. Take a big breath and do your best – you’ve got this!

Alright; well done! Now make all necessary journal entries from the bank reconciliation. Hint: you only need to make journal entries for the balance per books side.