Definition and explanation:
Bank reconciliation statement is a statement that depositors prepare to find, explain and understand any differences between the balance in bank statement and the balance in their accounting records.
All transactions between depositor and the bank are entered separately by both the parties in their records. These records may disagree due to various reasons and show different balances. The purpose of preparing a bank reconciliation statement is to find and understand the reasons of this difference in account balance.
Reasons of difference between bank records (bank statement) and depositor’s accounting record:
Usually, the balance on the monthly bank statement does not agree with the depositor’s accounting record. The usual reasons of this disagreement are explained below:
Outstanding checks (also known as unpresented checks and uncleared checks) are the checks that have been issued by the company to a creditor but have not yet been presented for payment. The amount of these checks are recorded by the company but no entry is made by the bank before the end of the month.
You issued a check to Mr X (one of your creditors) for $500 on 30th January 2015 and entered it immediately in your accounting records . Mr. X did not present or deposit that check in his account before the end of January. Your bank statement for the month of January would not show the entry for that $500 because Mr. X did not present this check before the end of January. It would create a difference of $500 between the balance in your accounting records and the balance in the bank statement.
Deposit in transit:
Deposit in transit means the cash received from a party has been recorded by the depositor but has not been entered by the bank in the bank statement. It usually occurs on the last day of the month.
You received $800 from Mr. Y (one of your debtors) on 31 January 2015 and recorded it immediately in your accounting records. You then sent this cash to your bank to be deposited into your account but it reached too late to be entered in your bank statement for the month of January. The balance in your accounting record would be different from your bank statement.
Credits for interest earned:
Banks pay interest on some accounts. If this interest is credited in the depositor’s account without intimating to the depositor, the bank statement and the depositor’s record will not agree.
Banks provide various services to its customers and deduct service charges from their accounts. The depositors usually are not aware of such deductions. These charges create a difference of balance between bank statement and the depositor’s record.
NSF stands for Not Sufficient Funds. When a customer deposits a check in his account, the bank immediately credits his account with the amount of the check. Sometime such checks are not honored because the person issuing the check does not have sufficient funds in his account. In such a situation, the bank reduces the balance of the customer. The dishonored check is returned to the depositor as NSF check.
You received a check from Mr. X for $5000. You entered it immediately in your accounting records and deposited the the check into your account. After depositing the check, your bank immediately credited your account by $1000. Afterward your bank told you that Mr. X’s bank did not honor the check because there were not sufficient funds in his account. Your bank reduced your account by $1,000 and returned the dishonored check of $1,000 to you as NSF check. The balance in your accounting records will differ from the balance in your bank statement.
Steps in preparing a bank reconciliation statement:
Step 1 – Find the deposits in transit: The first step is to see if one or more deposits are in transit. You can do so by comparing the deposits in your accounting record with the deposits shown in your bank statement. If you find a deposit in your accounting record that has not been shown in the bank statement, it means that deposit is in transit.
Add to the bank statement balance all deposits that are in your accounting record but have not been entered in the bank statement.
Step 2 – Find outstanding/unpresented checks and deduct from bank statement balance: Find all checks that you have issued but have not been presented for payment. You can do so by comparing the checks issued in your accounting record with the checks paid in your bank statement. If your accounting record shows that a check has been issued and your bank statement does not show a corresponding entry for that check, it means it is an outstanding or unpresented check.
Deduct from the bank statement balance all the checks that you have issued and entered in your accounting record but have not been paid by the bank.
Step 3 – Find and add credit memorandum to your accounting record: Bank issues a credit memorandum when it collects a note receivable on behalf of the depositor. Find if there is any credit memorandum issued by the bank that you have not entered in the accounting record.
Add to your accounting record any credit memorandum not entered in your accounting record.
Step 4 – Find and deduct debit memorandum from your accounting record: Bank provides various services to its depositors such as printing checks, processing NSF checks and collecting notes receivables etc. Bank deducts charges from depositor’s account for these services and intimates him or her about such deductions by issuing a debit memorandum. Find any debit memorandum not recorded in your accounting record.
Deduct from your accounting record any debit memorandum issued by the bank but not entered in the accounting records.
Step 5 – Are the adjusted balances equal? See whether adjusted balance of your accounting record is equal to the adjusted balance in your bank statement.
Step 6 – Make appropriate journal entries: The final step in a bank reconciliation is to prepare appropriate journal entries for the items that you have not recorded yet in your accounting records.
For better explanation and understanding, consider the following example.
The bank statement of the Fast Company shows a balance of $10,000 on 31 January 2015 whereas the company’s ledger shows a balance of $8,525. The following reasons have been identified for this discrepancy.
- An amount of $822 sent to the bank for deposit on January 31, 2015 does not appear in the bank statement.
- The following checks issued during the month of January have not yet been cleared by the bank.
Check No: 201, Issue date: 15 January 2015, Amount; $200;
Check No: 212, Issue date: 19 January 2015, Amount; $20;
Check No: 216, Issue date: 25 January 2015, Amount; $610;
- A note receivable amounting to $1,588 has been collected by bank for the company.
- The bank statement shows that interest amounting to $50 has been earned on average account balance during January.
- The bank has charged $10 for the collection of a note.
- A check of $100 deposited by the company has been charged back as NSF.
- An amount of $25 has been deducted by bank as service charges for the month of January.
- The check no. 220 is issued to electricity company. The check is in the amount of $95 but is erroneously recorded in the cash payments journal as $59.
Required: Prepare a bank reconciliation statement for the Fast Company using above information. Also make journal entries to update the accounting records of the company.
(a). Bank reconciliation statement
(b). Journal entries to update company’s accounting record
To record cash receipts:
To record cash payments:
Note: I have made two journal entries to update the accounting records of Fast company – one for cash receipts and one for cash payments. Alternatively, separate journal entries for each item or only one compound entry can be made to update the accounting records of depositor.