Although banks have highly sophisticated systems, there is a possibility that they make a mistake. At the end of every month, a bank supplies its customers with records (bank statements) arranged by its representatives. An organization requires its accountant to update the general ledger all the time. Mistakes that may happen incorporate recording wrong amount and charging to a wrong account holder.

In addition, regardless of the fact that both the bank and the organization record their transactions effectively, contrasts between the bank statement and the organization’s cash book may occur as a consequence of the time lag in recording transactions. A basic internal control compares the items shown on the bank statement with the cash book entries. This is accomplished by setting up a schedule called a bank reconciliation statement.

When comparing the things in your records and the things appeared on the bank statement, you may see that a few things indicated accurately on the bank statement may not show up in your records. Similarly, a few things indicated accurately in your records may not show up on the bank statement.

Bank can make deductions from the organization’s account on the basis of the following typical reasons:

  • interest charges on a loan
  • repayment of a bank loan
  • bank charges
  • electronic fund transfers (EFTs): automated cash payments

Bank can make deposits to the organization’s account on the basis of the following typical reasons:

  • interest income directly deposited to the account
  • payment directly deposited to the account
  • EFTs: automated cash receipts

Direct Deposit to the Bank Account

The bank may make a direct deposit to the organization’s account, for example, interest earned on the bank balance. The organization would be ignorant of the amount until it gets the bank statement.

bank reconciliation 1Above bank statement shows that the bank has made a direct deposit to the organization’s account with interest income of $5. But the organization is unaware of this transaction until it gets a bank statement from the bank at the end of the month. Bank has made this transaction on Jun 30th. Since this transaction is not yet recorded in the general ledger or cash book of the organization, balance on the bank statement and on general ledger do not match. General ledger shows a balance of $3500 while the bank statement shows $3505. Now the bank reconciliation statement would look like this:

bank reconciliation 2The adjusting entry in the general ledger would be as follows:

adjusting entry for interest revenue

Direct Charge to the Bank Account

As direct deposits, there may be direct charges to the bank account. Bank may charge the organization’s account with monthly bank charges, SMS service charges or an annual charge. The organization will be unaware of such charges until it gets the bank statement.

For example, organization’s general ledger-bank shows a balance of $3500 while the bank statement shows $3450. All other transactions are recorded in both general ledger account and bank account except the bank charges that the bank charge to the organization’s account on Jun 30th. Organization’s accountant should update the ledger account after comparing the ledger account and the bank statement.

bank reconciliation 4The bank reconciliation would look like this:

bank reconciliation for bank chargesThe adjustment to the general ledger would be made with the following entry:

adjusting entry for bank charges

Non-Sufficient Funds (NSF)

Sometimes this happens that a customer makes the payment through check but the organization cannot collect the payment due to insufficient balance in the customer’s bank account.

For example, the organization receives a check amounting to $500 from one of its customers and deposit it to the organization’s bank account for collection. But unfortunately, bank returns the check to the organization mentioning the reason NSF and also charges an additional amount of $10 as service charges to the organization’s bank account. In this situation the bank reconciliation would be as follows:

bank reconciliation for non-sufficient fundsThe journal entries should also be made to general journal and ledger account to reflect this fact. See the entries given below:

journal entries for non-sufficient funds

Outstanding Deposits

An outstanding deposits are those deposits that have been recorded in the organization’s general ledger however not appeared on the bank statement. This can happen when the organization makes a deposit in the bank account on the last day of the month, however the bank does not record the deposit until the next business day. The organization’s ledger account and the bank statement may look like the following:

bank reconciliation outstanding depositsbank reconciliation outstanding deposit

As you can see bank statement shows a balance of $3500 while the organization’s ledger account shows $4500. The reason is that a deposit amounting to $1000 is recorded in the ledger account successfully but bank did not yet recorded the deposit of $1000 because it was deposited on the last working day i.e. June 30. It will be processed by the bank on the next working day and will be shown in the bank statement on the July 1st.

Now the bank reconciliation may be look like following:

bank reconciliation 11

In this case no adjustment is required because organization’s ledger account is already updated, only the bank account is required to be adjusted. Therefore just bank account column is adjusted with $1000 in the bank reconciliation statement of ABC company as on June 30, 2010. There is only a time lag between recording the transaction, outstanding deposit will be shown in the bank statement on the next business day (i.e. 1st July).

Outstanding Checks

Outstanding checks are those check which are issued by the organization for the payment to the suppliers. When the organization issues the check, it mail the check to the supplier and the supplier may take about 2 to 3 business days to deposit the check to his bank  for collection.

In the following ledger account, three checks have been reflected on 28,29,30 June amounting to $400,$800,$700 respectively.

bank reconciliation 12

All the three checks have not been recorded by the bank yet. Therefore these three checks are outstanding.

In this case the bank reconciliation will be as follows:

bank reconciliation outstanding deposits

In this case no adjustment is required because the organization’s ledger account is already updated and reflect all the outstanding checks only the bank column in the bank reconciliation is adjusted with the outstanding checks.

Bank Errors

Bank errors are the mistakes by the bank. The organization’s ledger shows the correct balance and the bank have to correct the mistake or error. This can happen when the bank erroneously charge other organization’s check to our organization’s bank account.

Consider the following;

bank reconciliation 14 In the above bank statement, the bank has charged the organization’s bank account with “check #108” which belongs to another company or organization. In this case the organization’s accountant will contact the bank and inform about the bank error. Now the bank reconciliation will be as follows:

bank reconciliation bank errors

Also in this case no adjustment is required as the organization’s ledger is showing the correct balance.

Recording Errors

As banks can make mistakes, the organization’s account can also make mistake. Such mistakes are called recording errors. These errors appear only in the organization’s records and not in the bank account. For example, the accountant recorded $950 check but the correct amount was $590. The bank has recorded it correctly as $590 in the bank account. As can be seen below:

bank reconciliation recording errorsIn the bank reconciliation the account will have to cancel the wrong amount and record the correct amount as follows:

bank reconciliation 17As the correction was made in the ledger column, an adjusting entry must also be passed (assume that the check was issued for the payment of inventory) as follows:

bank reconciliation 18Any other differences between the balances of bank statement and the organization’s ledger account should be carefully analyzed and corrected. So this is all about the bank reconciliation statement.