Nowadays, all deposits and withdrawals undertaken by a customer are recorded by both the bank and the customer. The bank records all transactions in a bank statement, also known as passbook, while the customer records all their bank transactions in a cash book.
The balance recorded in the passbook or the bank statement must match the balance reflected in the customer's cash book. It is up to you, the customer, to reconcile the cash book with the bank statement and report any errors to the bank.
In this article, you will learn about Bank Reconciliation, the Bank Reconciliation Procedure, the Purpose of Bank Reconciliation, and an example of Bank Reconciliation.
A bank reconciliation is the process of matching the bank balances reflected in a business' cash book with the balances reflected in the business' bank statement in a given period in order to determine the differences between balances.
Reconciling bank statements with cash book balances helps your business know the underlying causes of these balance differences. Once the underlying cause of the difference between the cash book balance and the passbook balance is determined, you can then make the necessary corrections in your books to ensure accuracy.
The bank reconciliation process should be carried out at regular intervals, across all your bank accounts, because running a reconciliation at regular intervals ensures that your business’ records are correct. In the absence of proper bank reconciliation, the cash balances in your bank accounts could be much lower than expected, which may result in bounced checks or overdraft fees.
In addition to this, the reconciliation process also helps keep track the occurrence of fraud, which can help you control your business' cash receipts and payments.
Deposits in transit, or outstanding deposits, are not showcased in the bank statement on the reconciliation date. This is due to the time delay that occurs between the depositing of cash or a check and the crediting of it into your account.
Your business will record the increase in bank balance in its books of accounts the moment it deposits cash or check into its bank account, meaning that the balance as per the cash book is greater than the balance as per the passbook until the time the bank processes the deposit.
These outstanding deposits must be deducted from the balance, as per the cash book, in the bank reconciliation statement.
A bank will charge various fees in order to maintain your account with the bank. Outside of the maintenance fees, a bank may also charge fees that relate to other specific transactions. These fees may include:
These fees are charged to your account directly, and reduce the reflected bank balance in your bank statement. These charges won't be recorded by your business until your bank provides you with the bank statement at the end of every month.
As a result, the bank statement balance will be lower than the cash book balance, so the difference will need to be adjusted in your cash book before preparing the bank reconciliation statement.
Not-sufficient funds (NSF) refers to a situation when your bank does not honour a check, because the current account, on which the check is drawn, has insufficient funds.
In addition to this, the NSF may also occur when an individual intends to purchase with a credit card but is unable to do so due to insufficient funds in the associated bank account.
NSF checks are an item to be reconciled when preparing the bank reconciliation statement, because when you deposit a check, often it has already been cleared by the bank. But this is not the case as the bank does not clear an NFS check, and as a result, the cash on hand balance gets reduced.
An outstanding check refers to a check payment that has been recorded in the books of accounts of the issuing company, but has not yet been cleared by the bank as a deduction from the company’s cash balance.
This means that the company's bank balance is greater than the balance reflected in the cash book.
Before starting to reconcile the cash book balance with the passbook balance it is important to note that ‘debit balance as per cash book’ is the same as ‘credit balance as per passbook’, meaning the deposits made by the company into a bank are higher than withdrawals.
Likewise, ‘credit balance as per cash book' is the same as ‘debit balance as per passbook’ means the withdrawals made by a company from a bank account exceed deposits made.
You can start reconciling your cash book balance with the passbook balance from any of the four balances:
There are two ways in which you can undertake bank reconciliation once you identify the reasons for the difference:
If you want to prepare a bank reconciliation statement using either of these approaches, you can use the balance as per the cash book or balance as per the passbook as your starting point.
The debit balance as per the cash book refers to the deposits held in the bank, and is the credit balance as per the passbook. This balance exists when the deposits made by your business at your bank are more than the withdrawals and indicates that you have a favourable balance as per the cash book or a favourable balance as per the passbook.
Whereas, credit balance as the cash book indicates an overdraft or the excess amount withdrawn from your bank account over the amount deposited. This is also known as an unfavorable balance as per the cash book or an unfavorable balance as per the passbook.
Several items can cause a difference between cash book and passbook balances, these items are typically only reflected in the passbook. The following are adjustments that you need to make in order to prepare the bank reconciliation statement:
After adjusting all the above items, you'll end up with the adjusted balance as per the cash book, which must match the balance as per the passbook.
It is important to note here that adjusting the cash book balance before preparing the bank reconciliation statement will reduce the number of items that could cause a difference between the cash book and passbook balances.
Therefore, such adjustment procedures help in determining the balance as per the bank that will go into the balance sheet.
However, there can be situations where your business has overdrafts at the bank, which is when a bank account goes into the negative as a result of excess withdrawals.
Now, such a figure will be shown as a credit balance in your cash book, however, in the bank statement, that balance will be showcased as a debit balance and is known as the debit balance as per the passbook.
Therefore, an overdraft balance is treated as a negative figure on the bank reconciliation statement.
As per the rules mentioned above, the balance as per the cash book is the starting point for preparing a bank reconciliation statement (BRS). However, you can also start with the balance as per passbook when preparing a BRS, but the treatment for all the items mentioned above shall be reversed. Accordingly:
There can be four different scenarios while preparing a bank reconciliation statement, including:
Typically, the difference between the cash book and passbook balance arises due to the items that appear only in the passbook. So it makes sense to record these items in the cash book first in order to determine the adjusted balance of the cash book. Once the adjusted balance of the cash book is worked out, then the bank reconciliation statement can be prepared.
This way, the number of items that can cause the difference between the passbook and the cash book balance is reduced. And as a result, it gets easier to ascertain the correct balance in the balance sheet.
This means that only those items that can cause a difference due to a time delay in recording appear in the bank reconciliation statement. These items may include:
Therefore, the bank reconciliation statement, using this approach, is prepared by following the steps below:
After adjusting all the above items what you'll get is the adjusted balance of the cash book.
