The Ultimate Guide to Bank Reconciliation: Why It Matters and How to Do It Right
When you think of financial management, “bank reconciliation” might not be the most exciting term that comes to mind. However, it’s a crucial process that can save your business from potential financial mishaps. So, let’s break down what bank reconciliation is, why it matters, and how you can do it right without tearing your hair out.
What is Bank Reconciliation?
The bank transactions are recorded in the bank book and the bank records the same transactions in the account statement of the depositor. For consistency reasons, balance in the bank book and bank statement should be the same. But in reality, it may not be. There are some cases, which are recorded in the bank books on a particular date but may not be recorded in the bank statements.
Example: John Smith received a check from a receivable which he deposited in the bank on 28th February 20xx and he will make an entry in his bank book on the same day. But the bank transferred the money a day later showing the deposit of John Smith’s check on 1 March 20xx. Since the bank has collected the amount of the check on 1 March 20xx, an entry will be made in the depositor’s bank statement on that date. This is why there is a difference between the bank book balance and the bank statement balance. A reconciliation statement prepared to showing the reasons for the difference between the bank book balance and the bank statement balance on a particular date is called bank reconciliation statement.
Objectives of Bank Reconciliation Statement
1. Determining the Reason for the Discrepancy: The bank maintains the account of the depositor. So, the bank book balance of the depositor should match the bank statement balance. For some transactions, there is a discrepancy with the balance of both on a particular date. Such as a.c. payee check deposits, bank charges, sanctioned interest, etc. All entries for which discrepancies occur need to be found and adjusted.
2. Determining the Actual Bank Balance: The entries in the bank book and the bank account statement which are different should be found out. The actual bank balance can then be determined by reconciling those entries.
3. Arithmetic Accuracy of Calculations: As discrepancies between the two books are observed for some entries, arithmetical accuracy of calculations can be proved by reconciling those entries.
4. Internal Control: Main objective of the bank reconciliation statement is for internal control.
5. Assist to the Audit Work: Audit work cannot be carried out if the accounts are not properly maintained. Therefore, by preparing the bank reconciliation statement, it becomes easier to carry out the audit work.
6. Detection of Inaccuracies: It is easy to trace out the entries that cause differences between the bank book and bank statement balances. The main purpose of this report is to detect errors and make corrections.
7. Preparation of Accurate Financial Statements: One of its main objectives is to prepare accurate financial statements by correcting errors.
8. End of Misunderstandings: Depositors and bank officials sit together and analyze the causes of discrepancies in bank book and bank statement balances. This ends the misunderstanding between the two parties.
Reasons for Bank Reconciliation:-
The depositor records his banking transactions in the bank book. Similarly, the bank also records those transactions in the account statement of the client. Even if the bank book balance and the client’s bank statement balance are supposed to be equal on a particular date, they may not actually be. All the reasons that differ between the two are discussed in detail below:
1) Deposited Cheque: When the depositor remits the check to the bank for encashment, he enters it on the debit side of his bank book. As a result, the balance in the bank book increases. But the check is not credited to the client’s bank statement until it is cashed. This is why the two calculations differ.
2) Issued Cheque: When the depositor issues a check to the creditor, depositor enters the issued check amount on the credit side of his bank book. As a result, the bank book balance decreases. The bank does not record its client’s bank statement until the creditor presents the check to the bank. Hence the discrepancy between the two calculations is created.
3) Direct Collection by the Bank: The bank directly collects the dividend, investment interest, account receivable money on behalf of the depositor and credits it to the depositor a.c. The amount of money in the bank increases. But the depositor cannot debit his bank book until he knows about this fact. As a result, there is a difference between these two balances.
4) Direct payment by the Bank: The bank debits the account of the client by paying the accounts payable like – gas bill, water bill, electricity bill etc. on behalf of the depositor or on his standing order i.e. reduces the bank balance of the depositor. But the depositor cannot credit his bank book until he knows this fact. This results in a discrepancy between the two calculations.
5) Dishonor of Deposited Cheque: When the depositor deposits the check in his bank for encashment, he debits his bank book. But if the check is not cashed, the bank does not record it to the depositor a.c. As a result, there is a discrepancy between these two calculations.
6) Dishonor of Issued Cheque: When a check is issued, depositor makes an entry on the credit side of his bank book. For some reason(electricity cut out, internet slow down, insufficient fund) the bank cannot pay the amount of the cheque, i.e. if the depositor is not debited, there is a difference between the two accounts.
7) Allowed Interest: Surplus money deposited as a depositor’s bank a.c.; The bank grants interest at a fixed rate on that deposited money and credits it as such. The depositor does not make a debit entry in his bank book until he is aware of this fact. As a result, difference between two balances arises.
8) Bank Charges: Banks provide services to depositors. In return for this service some money is deducted from his account. The depositor cannot credit his bank until this fact is known. As a result, there is a difference between the two balances.
9) Mistakes in Bank Book or Bank Statement: Discrepancies will arise if the depositor makes a wrong entry in his bank book or enters the same event twice. Again, if the bank enters wrong number into depositor’s a.c. or if the same event is entered twice, there will be a difference.
Generally, Bank Reconciliation Statement is prepared in three ways.
i) Traditional Method
ii) Double Balance Correction Method
iii) Cash Balance Amendment Method
The Bank Reconciliation Process
Bank reconciliation might seem frightening at first, but once someone get the hang of it, it becomes a routine task. Here’s the step-by-step guide to bank reconciliation process:
1. Gather Records: Collect all bank statements and internal records, which could be in the form of accounting software reports, spreadsheets, or ledger books.
2. Compare Transactions: Start comparing each transaction in the bank statement with those in internal records. Look for matching amounts, dates, and descriptions.
3. Identify Discrepancies: Any difference between the two sets of records is a discrepancy. Common discrepancies include:
i) Outstanding Checks: Checks written that haven’t been cashed yet.
ii) Deposits in Transit: Deposits made that haven’t yet appeared on bank statement.
iii) Bank Errors: Mistakes made by the bank.
iv) Bookkeeping Errors: Mistakes in internal records.
4. Adjust Records: Make necessary adjustments to internal records to correct any discrepancies. This might involve adding missed transactions, correcting errors, or updating amounts.
5. Reconcile the Balance: After making adjustments, the balance in the records should match the balance on bank statement. If they do, accounts are reconciled. If not, need to investigate further to find and correct the discrepancies.
6. Repeat Regularly: Regular reconciliation (monthly is a good frequency) ensures records stay accurate and manageable.
More Resources
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