6.2 Bank reconciliations

Bank reconciliations are crucial for ensuring accurate financial reporting and detecting discrepancies. This process compares a company's book balance to its bank statement, identifying and resolving differences caused by timing issues, errors, or fraud.

The reconciliation process involves adjusting both book and bank balances for outstanding items and errors. Key reconciling items include deposits in transit, outstanding checks, and bank charges. Proper internal controls and timely reconciliations are essential for maintaining financial accuracy and preventing fraud.

Importance of bank reconciliations

• Bank reconciliations are a critical internal control procedure that helps ensure the accuracy and completeness of a company's cash balances and transactions
• Reconciling the book balance to the bank balance on a regular basis helps identify any discrepancies, errors, or fraudulent activity in a timely manner
• Bank reconciliations provide assurance to management, auditors, and stakeholders that the company's financial statements accurately reflect its cash position and transactions

Bank reconciliation process

Comparing book vs bank balances

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• The bank reconciliation process begins by comparing the company's book balance (cash balance per the general ledger) to the bank balance (ending balance per the bank statement)
• Any differences between the two balances need to be investigated and reconciled
• The book balance and bank balance will often differ due to timing differences, outstanding items, and errors

Adjusting book balance for outstanding items

• The book balance needs to be adjusted for any transactions that have been recorded in the company's books but have not yet cleared the bank (outstanding items)
• Common outstanding items include deposits in transit (recorded in books but not yet credited by bank) and outstanding checks (recorded in books but not yet cleared by bank)
• These outstanding items are added to or subtracted from the book balance to arrive at the adjusted book balance

Adjusting bank balance for bank errors

• The bank balance may need to be adjusted for any errors made by the bank, such as incorrect debits or credits, omitted transactions, or transposition errors
• Bank errors are identified by carefully reviewing the bank statement and comparing it to the company's records
• Any bank errors are added to or subtracted from the bank balance to arrive at the adjusted bank balance

Types of reconciling items

Deposits in transit

• Deposits in transit are amounts that have been received and recorded by the company but have not yet been credited to the company's account by the bank as of the statement date
• These deposits are typically made at the end of the period and will appear on the following month's bank statement
• Deposits in transit are added to the bank balance when reconciling

Outstanding checks

• Outstanding checks are checks that have been written and recorded by the company but have not yet cleared the bank as of the statement date
• These checks will be presented to the bank for payment in the following period
• Outstanding checks are subtracted from the book balance when reconciling

Bank service charges & interest

• Bank service charges are fees charged by the bank for maintaining the company's account, such as monthly maintenance fees, overdraft fees, or wire transfer fees
• Interest income is earned on the company's bank balance and is credited to the account by the bank
• Bank service charges are subtracted from the book balance, while interest income is added to the book balance when reconciling

Book errors vs bank errors

• Book errors are mistakes made by the company in recording transactions, such as omitting a transaction, recording an incorrect amount, or posting a transaction to the wrong account
• Bank errors are mistakes made by the bank, such as incorrectly debiting or crediting the company's account or omitting a transaction
• Book errors are corrected by making adjusting entries to the company's books, while bank errors are corrected by the bank and adjusted on the bank reconciliation

Preparing journal entries

For deposits in transit

• Deposits in transit require no journal entry because they have already been recorded in the company's books
• However, they are added to the bank balance on the bank reconciliation to arrive at the adjusted bank balance

For outstanding checks

• Outstanding checks require no journal entry because they have already been recorded in the company's books
• However, they are subtracted from the book balance on the bank reconciliation to arrive at the adjusted book balance

For bank service charges & interest

• Bank service charges are recorded as an expense in the company's books with a debit to Bank Service Charges Expense and a credit to Cash
• Interest income is recorded as revenue in the company's books with a debit to Cash and a credit to Interest Income
• These journal entries adjust the book balance to match the adjusted bank balance

For book errors

• Book errors are corrected by making adjusting entries to the company's books
• The specific adjusting entry depends on the nature of the error (omission, incorrect amount, wrong account)
• These adjusting entries correct the book balance to match the adjusted bank balance

Bank reconciliation examples

Scenario with deposits in transit

• ABC Company has a book balance of $10,000 and a bank balance of$8,000 as of March 31
• Upon review, it is discovered that a $2,000 deposit made on March 31 was not credited by the bank until April 1
• The $2,000 deposit in transit is added to the bank balance, reconciling the book and bank balances to$10,000

Scenario with outstanding checks

• XYZ Company has a book balance of $5,000 and a bank balance of$7,000 as of April 30
• Upon review, it is discovered that three checks totaling $2,000 were written and recorded in April but did not clear the bank until May
• The $2,000 in outstanding checks is subtracted from the book balance, reconciling the book and bank balances to$5,000

Scenario with bank & book errors

• LMN Company has a book balance of $15,000 and a bank balance of$14,500 as of May 31
• Upon review, it is discovered that the bank incorrectly debited the company's account for $100, and the company failed to record a$400 check written in May
• The $100 bank error is added to the bank balance, and the$400 book error is subtracted from the book balance, reconciling both balances to $14,900

Internal controls over bank reconciliations

Segregation of duties

• The person responsible for preparing the bank reconciliation should be independent of the person responsible for recording cash transactions and signing checks
• This segregation of duties helps prevent and detect errors or fraud by ensuring that no single individual has control over the entire cash process

Timely preparation & review

• Bank reconciliations should be prepared and reviewed on a timely basis, typically monthly or more frequently for high-volume accounts
• Timely preparation allows for prompt identification and correction of errors or discrepancies
• Timely review by a supervisor or manager ensures that the reconciliation is accurate and complete

Proper documentation & approval

• Bank reconciliations should be properly documented, including a list of outstanding items, adjustments made, and any discrepancies investigated
• The reconciliation should be signed and dated by the preparer and reviewer to evidence their approval
• Proper documentation and approval provide an audit trail and support the accuracy and completeness of the reconciliation

Common bank reconciliation issues

Unrecorded transactions

• Unrecorded transactions are cash receipts or disbursements that have not been recorded in the company's books
• These may include bank charges, interest income, or transactions that were overlooked or misplaced
• Unrecorded transactions are identified during the bank reconciliation process and require adjusting entries to correct the book balance

Transposition & calculation errors

• Transposition errors occur when digits are reversed or transposed when recording a transaction (e.g., recording $1,234 as$1,243)
• Calculation errors occur when amounts are incorrectly added, subtracted, or otherwise miscalculated
• These errors are identified during the bank reconciliation process and require adjusting entries to correct the book balance

Improper cut-off procedures

• Cut-off refers to the process of ensuring that transactions are recorded in the proper accounting period
• Improper cut-off can result in deposits in transit, outstanding checks, or other reconciling items that cross over accounting periods
• Proper cut-off procedures, such as recording transactions based on the transaction date rather than the posting date, help minimize reconciling items and ensure accurate financial reporting

Bank reconciliation in financial reporting

Proper cash balance for balance sheet

• The bank reconciliation process ensures that the cash balance reported on the balance sheet is accurate and properly stated
• The adjusted book balance from the bank reconciliation should match the cash balance reported on the balance sheet
• Any unreconciled differences may indicate errors or misstatements in the financial statements

Detecting & preventing fraud

• Bank reconciliations can help detect and prevent fraudulent activities, such as unauthorized transactions, embezzlement, or check tampering
• Regular reconciliations can identify unusual or suspicious transactions that warrant further investigation
• Timely detection of fraud can minimize financial losses and reputational damage to the company

Importance for audit purposes

• Bank reconciliations are a key audit procedure that provides evidence of the existence, completeness, and accuracy of a company's cash balances and transactions
• Auditors typically review bank reconciliations and supporting documentation to assess the effectiveness of internal controls over cash and to identify any material misstatements
• Properly prepared and reviewed bank reconciliations can help streamline the audit process and reduce the risk of audit adjustments or modifications to the auditor's opinion