Study: Prepare and Understand a Bank Reconciliation

Read the Topic Learning Resources beneath the black bar below. You should also watch the "Bank Reconciliations and Journalizing" video included in there as well (approximately 15m). Note: I did not create my own custom videos for this topic, I wrote the text and referred to the "Bank Reconciliations and Journalizing" video created by someone else as noted in the Topic Learning Resources.
Take the topic quiz, by clicking here or clicking the "Next" button at the bottom right of this page.

Score at least 4 out of 5 on the quiz before moving on. If you do not score at least 4 out of 5 on the quiz, restudy the material and try again. I will keep your highest score.

What are bank reconciliations and why are they necessary?
A bank reconciliation Links to an external site.is the process by which a company ensures that the amount of cash it thinks it has (i.e. per books) agrees with the amount of cash the bank thinks the company has (per bank). If the bank has recorded something that the books should have recorded, the books will need to be updated so they "reconcile". If the books have recorded something that the bank should have recorded, the balance per bank will need to be updated so they "reconcile".

A properly prepared bank reconciliation is essential to the running of a successful business because it can:

help the company compute it's "true" cash balance so it can rely on it to make appropriate cash business decisions
help the company compute its ending cash balance to be reported on the company's balance sheet Links to an external site.
identify and correct cash recording errors and irregularities per books or per bank
reduce the likelihood of fraud involving cash

Proper internal control dictates that companies should:

reconcile their bank statements AT LEAST once a month
review each bank reconciliation SOON after it is prepared. Management is responsible to ensure that these reviews are performed. They can be performed by supervisors, managers, internal auditors, or the owner.

I hope this lesson encourages you to have your bank accounts reconciled at least every month AND have them reviewed by someone other than the preparer every month. You will be surprised at how many errors and irregularities, and how much fraud a properly prepared and reviewed bank reconciliation can prevent, detect and correct.

Many of you probably already have a checking or a savings account. Some of you may already be reconciling your bank statements every month, if that is the case, congratulations, the rest of the lesson should be pretty straightforward for you. However, If you are not currently reconciling your bank account(s) every month the following lesson should help you learn how and hopefully commit you to do it.

How to prepare a bank reconciliation
In order to prepare a bank reconciliation you will need the following information:

Bank statement for the most recent month showing beginning balance, additions, subtractions and ending balance
Cash general ledger Links to an external site. account for the most recent month showing beginning balance, additions (the details of which can be found in a cash receipts journal), subtractions (the details of which can be found in a cash disbursements journal) and ending balance
Bank reconciliation template (which you can create by hand, create in Excel, or find as a built-in reconciliation feature in your accounting software)

1) The bank statement (per bank)
During any given month most students (and companies) withdraw cash using Automated Teller Machine cards (ATM), make charges using debit cards, write out and send checks, pay fees electronically, make deposits and earn interest. The cash transactions that clear the bank before the end of the month are then reported to you on a monthly bank statement that might appear as follows:

Beginning cash (per bank)
+ Additions (such as deposits cleared and interest earned)
- Deductions (such as checks cleared, bank fees charged, bounced checks which are also known as NSF or non sufficient funds checks)
= Ending cash (per bank)

Or maybe the same information will appear on the bank statement in the following format:

Date	Description	Deposits	Withdrawals	Balance
12/1/X2	Beginning balance			$3,341.87
12/5/X2	Deposit	$2,100.00		$5,441.87
12/7/X2	Payment		$1,600.00	$3,841.87
12/10/X2	Etc. etc. etc.	etc.	etc.	etc,

At any rate, both presentations use the same math and will arrive at the same ending cash balance per the bank.

2) The Cash General Ledger Account (per books)
Every company should keep a running total of how much cash it thinks it has, this running total is tracked in the company's cash general ledger account. For you personally, you might keep track of cash balance in the little, paper cash ledger book that your bank gave you when you opened your bank account. At any rate, whenever you pay cash, or write a check to make a payment, you should record it in your cash ledger account and deduct it from your running cash balance. Whenever you deposit cash in the bank, you should record it in your cash ledger account and add it to your running cash balance. Assuming you have successfully recorded all of your known cash deposits and all of your known cash payments and updated your ending cash balance accordingly, you will be able to compute your ending cash balance per books as follows:

Beginning cash (per books)
+ Additions (such as recorded deposits and interest, all should be recorded in the cash receipts journal)
- Deductions (such as recorded checks, bank fees, and NSF or nonsufficient funds checks, all should be recorded in the cash disbursements journal)
= Ending cash (per books)

You could also use the following cash ledger presentation to compute ending cash per books. The running cash balance is tracked off to the far right-hand side. Then, whenever the company records a deposit to increase its cash, it will be recorded on the left-hand side of the cash ledger (i.e. debits = left). Whenever the company records a payment to decrease its cash, it will be recorded on the right-hand side of the cash ledger (i.e. credits = right). By constantly updating the cash ledger account, the company will always know how much cash "the company thinks it has" which amount will then need to be reconciled with how much cash the bank "thinks the company has".

Date	Description	Debit	Credit	Balance
12/1/X2	Beginning balance			$3,341.87
12/5/X2		$2,100.00		$5,441.87
12/7/X2			$1,600.00	$3,841.87
12/10/X2	Etc. etc. etc.	etc.	etc.	etc.

As you can see, in this example both the per bank amount and per book amount as of 12/7/X2 is $3,841.87 and unless a reconciliation shows that they are both wrong, the two would be said to "reconcile". Don't you wish that all bank reconciliations were this easy? I know I do.

The sad thing is that bank reconciliations are not always this easy, in fact, they can often be quite complicated because sometimes the bank has recorded things that the books haven't recorded yet, or the books have recorded things that the bank hasn't recorded yet, or the bank has recorded an error or irregularity that needs to be discovered and corrected on the banks records, or the books have recorded an error or irregularity that needs to be discovered and corrected on the books records.

Example:
The following example will step you through a relatively straightforward bank reconciliation.

Background:
Imagine that your company's month-end bank statement showed an ending cash balance per bank of $1,000, and your company's cash general ledger account, showed an ending cash balance per books of $900.

Based on your review of all the cash transactions recorded on the bank statement, and your review of all the cash transactions posted to your cash general ledger account, you found that you were unable to match the following items:

Items recorded "per bank", BUT NOT recorded "per books":

The bank collected and deposited $150 on a note receivable that someone owed to the company
The bank charged the company $25 in bank fees
The bank returned a $175 check from customer Jay Little originally deposited last month, that "bounced" due to non-sufficient funds (i.e. an NSF check)

Items recorded "per books" BUT NOT recorded "per bank":

The company made a $50 overnight deposit that the bank has not yet recorded
The company wrote, and deducted from its cash, a $200 check that has not yet cleared the bank

Required: Use the information provided above to:

1) reconcile the company's ending cash balance per its cash general ledger account to its ending cash balance per its bank statement.

2) determine what adjustments, if any, the company should make to its cash ledger account (adjusted per books) to agree with its "true" cash per the bank (adjusted per bank).

Solution: Please watch the following video solution to learn how to successfully complete this and other bank reconciliations. Please also review the bank reconciliation below which provides the completed solution:

Bank Reconciliations and Journalizing Links to an external site.

Summary
I strongly encourage you to study the bank reconciliation video and the solution diagram provided above. Please keep in mind that through the bank reconciliation process you are trying to solve for the company's "true" cash balance. The company's "true" adjusted cash balance is the amount of cash that, if both the books and the bank were to know everything that the other one knew, they would both agree on the same ending cash balance. After all necessary adjusting entries have been made, a company's adjusted cash balance will be the amount that should appear in the company's cash general ledger account and should also appear on the company's ending balance sheet.

Good luck on the quiz.

Additional Resources:
Here is another discussion of the Bank Reconciliation process, this one by the Accountingcoach.com, that you might also find to be helpful (read Part 1 Links to an external site. and Part 2 Links to an external site.)