What Are the Three Methods of a Bank Reconciliation?

Bank reconciliation is a fundamental accounting process that ensures the accuracy of a company’s cash records. It involves comparing the cash balance in a company’s general ledger with the balance reported on its bank statement. This reconciliation helps identify and resolve differences, providing a clear picture of the true cash position.

The Purpose of Bank Reconciliation

Bank reconciliation serves several purposes. It acts as an internal control mechanism, helping to detect and correct errors in both the company’s records and the bank’s records. This process can also uncover unauthorized transactions or even fraud, safeguarding a business’s assets. Regular reconciliations ensure that the cash balance reported on financial statements is accurate, which is important for informed decision-making and compliance with financial reporting standards.

Differences between the bank and book balances often arise due to timing discrepancies or errors. Common reconciling items include deposits in transit, which are funds a company has recorded as received but the bank has not yet processed. Conversely, outstanding checks are those the company has written and recorded, but which have not yet been presented to or cleared by the bank.

Banks also deduct service charges and may add interest earned, which the company might not have recorded yet. Non-Sufficient Funds (NSF) checks occur when a customer’s check deposited by the company is returned because the payer’s account lacks sufficient funds. Errors made by either the bank or the company’s accounting staff also contribute to discrepancies.

Reconciling from the Bank’s Perspective

One method of bank reconciliation begins with the balance shown on the bank statement. This approach adjusts the bank’s reported balance to determine the company’s true cash position.

To achieve this, deposits in transit are added to the bank statement balance. These are amounts the company has deposited, often at the end of a business day, that have not yet appeared on the bank’s records. Outstanding checks are then subtracted from the bank balance. These are checks the company has issued that have not yet been cashed by the recipient, meaning the bank has not yet deducted them from the account. Correcting any errors the bank may have made, such as incorrectly posting a deposit or withdrawal, also involves adjustments to the bank statement balance.

Reconciling from the Company’s Perspective

Another approach to bank reconciliation starts with the cash balance as recorded in the company’s accounting records, often referred to as the book balance. This method adjusts the company’s internal balance to reflect transactions the bank has processed but the company has not yet recorded.

Adjustments to the company’s book balance include adding interest earned on the account, which the bank credits directly but the company may not have recorded until receiving the statement. Bank service charges, which are fees for account maintenance or specific transactions, are subtracted from the book balance. These charges, ranging from monthly maintenance fees to transaction-specific fees, are deducted by the bank automatically. Non-Sufficient Funds (NSF) checks, which represent customer checks that bounced due to insufficient funds, are also subtracted from the company’s cash balance. Additionally, any errors made by the company when recording transactions, such as incorrect amounts or duplicate entries, are corrected by adjusting the book balance.

The Adjusted Balance Approach

The adjusted balance approach is widely used and provides a comprehensive view of a company’s cash position. This method involves independently adjusting both the bank statement balance and the company’s cash book balance until they agree on a single, correct cash balance. This reconciled balance represents the true amount of cash available to the business at a specific point in time.

On the bank side, the process begins with the ending balance from the bank statement. Deposits in transit are added, as these funds have been received by the company but not yet recorded by the bank. Outstanding checks are subtracted because the bank has not yet cleared these payments. Any bank errors are also corrected on this side.

Simultaneously, on the company’s book side, the reconciliation starts with the cash balance from the company’s general ledger. Interest earned is added, while bank service charges and NSF checks are subtracted. Errors made by the company are also corrected on the book side. After all necessary adjustments are made to both the bank and book balances, the two adjusted figures should be identical, confirming the accuracy of the cash records.