How to Do Bank Reconciliations Step by Step

A bank reconciliation is a process that compares a company’s internal cash records with the balances and transactions reported by its bank. This comparison helps to identify and explain any differences between the two sets of records. The fundamental purpose of performing a bank reconciliation is to ensure the accuracy of a company’s financial information related to cash. It is a systematic way to verify that all cash transactions have been properly recorded and accounted for, reducing the risk of financial misstatements. This regular review also helps in detecting potential errors or even fraudulent activities, thereby supporting the overall financial health and integrity of a business’s reporting.

Understanding the Components for Reconciliation

Before starting the reconciliation process, gathering specific financial documents is necessary to ensure a comprehensive comparison. The two primary components for a bank reconciliation are the bank statement and the company’s internal cash ledger. These documents provide distinct but complementary views of cash activity.

A bank statement is an official document provided by a financial institution, typically monthly, that outlines all financial transactions and activities of an account over a specific period. It details the beginning balance, all deposits made, withdrawals, checks cleared, any bank service charges, interest earned, and the ending balance for the period. This statement serves as the bank’s record of the account holder’s transactions, showing what the bank has processed. It is crucial because it reflects the bank’s perspective of the cash balance.

The company’s internal cash ledger, often referred to as a cash book or cash account in the general ledger, is the business’s own detailed record of all cash inflows and outflows. This ledger records every cash receipt and payment as they occur from the company’s perspective. It includes information such as the date of the transaction, a description, and the amount, ensuring all cash movements are documented. This internal record provides the company’s view of its cash position, detailing transactions the business has initiated or received, regardless of when the bank processes them. Having both the bank’s and the company’s records allows for a thorough comparison during reconciliation.

Step-by-Step Bank Reconciliation Process

The bank reconciliation process systematically compares the company’s internal cash records against the bank’s statement to resolve any differences and arrive at a true cash balance. Begin the reconciliation by noting the ending cash balance from both the bank statement and the company’s cash ledger for the same period. These two balances will almost always differ due to timing differences or errors.

Next, compare all deposits listed on the bank statement with the deposits recorded in the company’s cash ledger. Any deposits recorded by the company but not yet appearing on the bank statement are known as “deposits in transit.” These typically occur when deposits are made late in the day, on weekends, or at month-end, meaning the bank has not yet processed them. These deposits will be added to the bank statement balance during the reconciliation.

Following this, compare all withdrawals, checks, and other payments recorded in the company’s ledger with those that have cleared the bank, as shown on the bank statement. Any checks or payments issued by the company but not yet presented to or processed by the bank are “outstanding checks.” These payments have been deducted from the company’s cash balance but not yet from the bank’s, so they will be subtracted from the bank statement balance in the reconciliation.

Additionally, review the bank statement for any items that have been processed by the bank but not yet recorded in the company’s cash ledger. Common examples include bank service charges, such as monthly maintenance fees, transaction fees, or wire transfer fees. Interest earned on the account is another item the bank records that the company may not have yet. Similarly, non-sufficient funds (NSF) checks, which are checks deposited by the company that bounced due to insufficient funds, will appear as deductions on the bank statement.

These bank-recorded items require adjustment to the company’s cash ledger balance. Bank service charges and NSF checks will be subtracted from the company’s ledger balance, while interest earned will be added. Finally, identify any errors made by either the bank or the company. For example, a company error might involve recording an incorrect amount for a transaction, or the bank might incorrectly debit or credit an account.

Once all identified items are accounted for, adjust the bank statement balance by adding deposits in transit and subtracting outstanding checks. Separately, adjust the company’s cash ledger balance by subtracting bank service charges and NSF checks, adding interest earned, and correcting any company errors. The objective is to ensure that the adjusted bank balance equals the adjusted ledger balance, indicating a successful reconciliation.

Addressing Common Discrepancies

After reconciliation, certain common discrepancies require specific accounting actions to fully resolve them and ensure accurate financial records.

Outstanding checks are payments recorded by the company but not yet cleared by the bank. These checks remain outstanding until the payee deposits them and the bank processes the transaction. They represent a timing difference. No direct journal entry is needed on the company’s books, as they are already accounted for and are adjustments to the bank side of the reconciliation.

Deposits in transit are funds recorded by the company but not yet processed by the bank. These are timing differences, similar to outstanding checks. No journal entry is required on the company’s books, as the cash has already been recorded.

Bank service charges are fees deducted by the bank for services like monthly maintenance or transaction fees. A journal entry is necessary to record this expense and reduce the cash balance in the company’s ledger. This involves debiting “Bank Service Charges Expense” and crediting “Cash.”

Interest income is money earned on the bank account balance, credited directly by the bank. To reflect this increase in the company’s records, a journal entry debits “Cash” and credits “Interest Revenue” or “Interest Income.”

NSF checks, or bounced checks, occur when a customer’s check deposited by the company is returned due to insufficient funds. The bank deducts this amount from the company’s account and may charge an NSF fee. The company must make a journal entry to reverse the original cash receipt, debiting “Accounts Receivable” and crediting “Cash.” A separate entry may be needed for any bank-imposed NSF fee.

Bank errors are mistakes made by the financial institution, such as incorrect debits or credits. These are identified during reconciliation and adjusted on the bank side. The company should contact the bank to report the error and request correction; no journal entry is made on the company’s books for bank errors.

Company errors are mistakes in the company’s own record-keeping, such as recording an incorrect amount or overlooking a transaction. When identified, these errors require a correcting journal entry in the cash ledger to bring the balance to the correct amount. For instance, if a payment was recorded for too high an amount, a correcting entry would debit cash and credit the expense account for the difference.