Reconciling the entity’s accounting records with those of their bank provides an important control over banking transactions and confirms the bank balance disclosed in the statement of financial position. The bank statement is, in effect, a copy of the bank’s ledger account reflecting transactions from the bank’s standpoint. This statement, while not infallible, is a useful independent source of information against which to check the completeness and accuracy of the entity’s information on its banking activities.
Bank statements record all deposits by the customer as credit entries and all withdrawals as debits, reflecting the bank’s view of these transactions. Deposits by customers are liabilities (credits) of the bank, and withdrawals are either reductions of these deposits (and hence debits) or are advances by the bank, which constitute assets of the bank (debits). Hence all transactions will be recorded as ‘mirror images’ (with opposite signs) by the entity and the bank.
Furthermore, the timing of entries will differ, making it unlikely that, at any given time, the balance in the general ledger account will be the same as that on the bank statement. Each entity records transactions as it becomes aware of them, for example, on receipt of a customer’s payment or on drawing a check on settlement of a supplier’s account. The bank entry will be triggered by presentation of the item at the bank – as part of a (combined) deposit of customer payments, or when the supplier presents the check or payment (via their bank).
In addition, some entries will be made by the bank before the client entity receives advice of the transaction. Examples are bank charges and interest, automatic payments (APs), direct debits (DDs) and direct credits (DCs), where customers pay by bank transfer rather than by mail or in person. Automatic payments require the payer to authorize varying amounts, whereas DDs (and DCs) allow variations in amount, subject to the right of cancellation.
The reconciliation procedure is as follows:
1. Compare and tick off each matching pair of:
(a) Deposits and direct credits in the bank column of the cash receipts journal with amounts in the credit column of the bank statement ensure dates are compatible
(b) Checks drawn or auto payments recorded in the cash payments journal with checks presented in the debit column on the bank statement (ensure checks numbers or details of auto payments agree).
2. Adjust the entity’s records for omissions or errors:
(a) Enter omitted (unticked) items on the bank statement into the appropriate cash journal: (i) Credit items on the bank statement are entered in the cash receipts journal. These are deposits (a liability of the bank to its customer), for example, direct credits or interest on savings. (ii) Debit items on the bank statement are entered in the cash payments journal. These are withdrawals that reduce in-fund balances (or increase overdrafts). Examples include payments under auto payment or direct debit authorities, or interest and fees charged by the bank.
(b) Correcting journal entries may also be needed where amounts have been initially entered incorrectly in the journals. In practice it is necessary to check from original sources which entry is correct – the bank’s or the entity’s record.
3. Adjust the balance on the bank statement for any items not yet recorded by the bank – for example, deposits in transit and unpresented checks at the date of the statement; or any errors in the bank’s recording process.
4. Prepare the reconciliation. This takes the form of a statement prepared as at a certain date, starting with the bank statement balance – the independent amount – and adjusting it for any deposits not yet credited (outstanding deposits) and any checks not yet debited (unpresented checks).
This procedure confirms the accuracy of the recording process and the existence of the funds, as confirmed by the bank. Note the use of in funds (I/F), or O/D if overdrawn, to avoid the confusion of using Dr or Cr, which have differing meanings on the bank account and on the bank statement.
To gain maximum benefit from this control, organizations should obtain bank statements regularly, and ensure that the bank account (in the general ledger) is compared with the bank statement and any differences adequately explained and followed up. The frequency depends on the volume of transactions and the reliability of other controls, but it should be carried out at least monthly.
Bank reconciliations must be carried out on a regular basis, especially with the large number of electronic transactions that are now first recorded on bank statements. In addition, reconciliations provide a strong control over cash handling (for example, by high lighting any delays in making deposits), as well as providing assurance that the entity’s accounting records are reliable.