Cash: Bank Reconciliations

For many students, bank reconciliations are a difficult topic because most people don’t
do them anymore. Twenty years ago, before debit cards and online banking, there was
only one way to keep track of how much money you had in the bank: keep a checkbook
and reconcile it.
Clearly, online banking has not made us better at managing our bank accounts. In
2012, U.S. consumers paid $32 billion in overdraft fees. That’s approximately $135 per
adult in the United States! Maybe we should consider going back to writing down all our
transactions and balancing our checkbooks!

What is a bank reconciliation?

A bank reconciliation is a monthly process by which we match up the activity on the
bank statement to ensure that everything has been recorded in the company’s or
individual’s books. As we all engage in more automatic and electronic transactions, this
is a critically important step to ensure that the cash balance is correct.
There are two parts to a bank reconciliation, the book (company) side and the bank
side. When the reconciliation is completed, both balances should match.

What are we looking for?

There are a number of items that can cause differences between your book and bank
balances. Here is a list of the most common items you’ll encounter when doing a bank
reconciliation:
1. Deposits in Transit – A deposit in transit is a deposit that has been submitted to
the bank but has not get been recorded by the bank. The account holder has
recorded the deposit in his records but the bank has not. This occurs because a
deposit was submitted after the bank closed for the day or because of lag in
electronic deposits. We see this a lot with credit card deposits because there is
typically a 1-3 day lag in the time the card is processed and when the funds are
deposited to the merchant’s account. Deposits in Transit must be added to the bank
side of the reconciliation because they have been added to the book side when the
deposits were recorded by the company.
2. Outstanding Checks – These are checks that have been written by the
company but have not yet cleared the bank. When a check is written it takes a few
days to clear. Most businesses have a number of outstanding checks at the end of
the month. Outstanding Checks should be subtracted from the bank side of the
reconciliation because they were subtracted from the book balance when the
checks were written.
3. Bank Service Charges – These are amounts that the bank withdraws from the
account as a charge for having the account. Bank service charges include regular
monthly fees, overdraft fees, returned check fees and credit card processing fees.
Typically, the company does not record these fees until the bank statement is
received. Bank service charges are subtracted from the book balance since they are
a decrease in the account balance and have not yet been recorded.
4. Interest Earned – Some banks pay interest on account. The account holder
does not know how much the interest will be until the bank statement is received.
Interest earned is deposited into the account by the bank causing the balance to
increase. Interest earned is added to the book balance to reflect the increase in the
balance from the deposit of interest.
5. Returned Checks – A returned check is an item that was originally deposited
into the company’s account (usually a customer check) and later bounced. When
this happens the bank withdraws the funds from the company’s account and sends
a notice to the company. Returned checks should be subtracted from the book
balance since the bank removed the amount from the balance when the check
bounced.
6. Recording Errors – A recording error occurs when the company incorrectly
records a transaction or when the bank clears an item for the incorrect amount. This
sometimes occurs when checks are written and an incorrect amount is entered into
the system. Sometimes the bank clears the transaction for the wrong amount. Say
the company wrote a check for $452.00 but the bank cleared the check for $450.00.
There is now a $2 error in the books. Since the bank has cleaned the transaction,
you must adjust the books to match. Recording errors should be added or
subtracted from the book balance. If the item cleared the bank for less than the
amount in the books, add the amount of the error. If the item cleared the bank for
more than the amount in the books, subtract the amount of the error.
7. Other Unrecorded Items – With the number of transactions that occur digitally
or automatically, it’s easy to forget to record transactions, especially if they occur
infrequently. Look for remaining items that cleared the bank that have not been
recorded on the books. Other unrecorded items can be either deposits or
withdrawals. All other unrecorded items should be recorded on the book side of the
reconciliation. To determine if you should add or subtract the item, mimic what the
bank did. If the bank added it to the account balance, do the same to the book
balance. 

How to start
To do a bank reconciliation, you’ll need a copy of the bank statement and a copy of all
of the outstanding items in the checking account through the ending date of the bank
statement. For some businesses, including my own, the bank statement does not close
at the end of the month. Sometimes the statement end date is based on the date the
account was opened.
Once you have those two items, use a pencil or highlighter to mark off all the items that
appear on both the bank statement and the check register. If an item appears on both,
that means that the item was properly recorded and has cleared. After going through all
the items, anything that remains unmarked is a an item that will need to be dealt with in
the reconciliation.
Create two columns on a piece of paper or use a spreadsheet to do the calculations for
you. My bank reconciliations look like a large T-account.
Start by writing the ending balance for the book and the bank under the appropriate
column.

I like to do the bank side first because it is generally easier than the book side. You are
only dealing with outstanding checks and deposits in transit on the bank side. List the
deposits in transit and the outstanding checks. Add the deposits in transit to the
beginning balance and subtract the outstanding checks.
The bank side is relatively easy to do. That is why I like to do that side first. It is more
likely to be correct if you have an error in your reconciliation. Most students who have
errors have them on the book side. Being confident in the bank side helps resolve errors
on the book side.
On the book side, most items are fairly simple. Subtract bank service charges and add
interest income. Subtract returned checks. Add unrecorded deposits and subtract
unrecorded withdrawals. The last item, recording errors, requires a bit more thinking.
Let’s imagine that you recorded a check for $715, but the bank cleared that check for
$751. The check was used to pay for utilities and was recorded to utilities expense for
$715. If the check cleared for $751, what happened to your utilities expense? Did it
increase or decrease? It increased because more was paid for utilities. If the expense
increased, cash must have decreased. Therefore, cash must be adjusted down or
decreased by $36. This would be subtracted from book side of the reconciliation.
Thinking about what is happening to your expenses can help you work your way
through the problem.
Once you have worked through all the remaining items on the book side, compute the
reconciled balance for the books.

When you are finished, the reconciled balances should agree.

If they do not, take the difference between the two balances. Does that amount stick out
in your mind. Check to see if there is a missing item for that amount that you might have
forgotten to record. You may have forgotten multiple items. Place them in the
reconciliation and see if you now balance.
If you do not have an item for that amount, take the difference and divide it by 2. Look
for that amount. If that amount appears in your reconciliation, you added (or subtracted)
the amount when you should have subtracted (or added) the amount. Reverse the sign
and check your balance again.
Once you finish the bank reconciliation, there is one more step in the process. All the
items that you recorded on the book side of the reconciliation must be recorded in the
company’s accounting system. Prepare a journal entry (or several) to record those
items. I usually record one large journal entry but you can also record a separate entry
for each item in the reconciliation. Only record items on the book side!
Bank reconciliations become easier as you do more of them. Get all the practice you
can. Here is the bank reconciliation problem I created for the video on this subject. You
are provided with the check register and the bank statement. See if you can complete
the reconciliation before watching the video.