What is Bank Reconciliation
Bank reconciliation is the process of matching the bank balances reflected in the cash book of a business with the balances reflected in the bank statement of the business in a given period. Such a process determines the differences between the balances as per the cash book and bank passbook.
Reconciling bank statements with cash book balances helps you, as a business, to know the underlying causes that lead to such differences. Once the underlying cause of the difference between the cash book balance and the passbook balance is determined, you can make the necessary corrections in your books of accounts to ensure accuracy.
Therefore, the bank reconciliation process should be carried out at regular intervals for all of your bank accounts. This is because reconciling the cash book with the passbook at regular intervals ensures that your business’s cash records are correct. In the absence of proper bank reconciliation, the cash balances in your bank accounts could be much lower than the expected level. This may result in bounced cheques or overdraft fees.
In addition to ensuring correct cash records, the bank reconciliation process also helps in keeping track of the occurrence of any form of fraud. Such insights would help you as a business to control cash receipts and payments in a better way.
Bank Reconciliation Terminology
Outstanding Deposits
Deposits in transit are also referred to as outstanding deposits. Such deposits are not showcased in the bank statement on the reconciliation date. This happens due to the time lag between when your business deposits cash or a cheque into its bank account and when your bank credits the same.
Your business records the increase in bank balance in its books of accounts the moment it deposits cash or cheque in its bank account. This means 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.
When referring to cashbook this can also your cloud software e.g Xero, FreeAgent etc.
Bank Service Charge
A bank charges various types of fees to you as an account holder. Such fees are charged to maintain your account with the bank. In addition to the maintenance fees, the bank charges a fee in respect of other specific transactions. Such fees may include:
- Cheque clearing charges
- Charges for fund transfer
- Collection charges, etc
These bank charges are charged to your account directly. This reduces your bank balance as reflected in your bank statement. It is important to note that such charges are not recorded by you as a business till the time your bank provides you with the bank statement at the end of every month.
As a result, the balance as per the bank statement is lower than the balance as per the cash book. Such a difference needs to be adjusted in your cash book before preparing the bank reconciliation statement.
Outstanding Cheques
An outstanding cheque refers to a cheque payment that has been recorded in the books of accounts of the issuing company. But, the cheque has not yet been cleared by the bank as a deduction from the company’s cash balance.
This means that the bank balance of the company is greater than the balance reflected in its cash book.
Cheques may not be relevant in most business and most businesses pay by bank transfer or bank direct payment via their internet banking.
Bank Reconciliation Procedure
Before discussing the procedure 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 cash book (company side) is higher than the passbook (bank side). In other words, 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’ meaning the reverse of the above i.e. withdrawals made by a company from a bank account exceed deposits. You can start reconciling your cash book balance with the passbook balance from any of the four balances:
Other Points to Remember
As per the rules mentioned above, balance as per the cash book is the starting point for preparing a bank reconciliation statement (BRS). However, you can also start with balance as per passbook for preparing a BRS. In case you do so, the treatment for all the items mentioned above shall be reversed. Accordingly:
- cheques issued but not yet presented are deducted from the balance as per the Statement.
- cheques deposited but not yet collected are added back to the balance as per the statement.
- dishonoured or bounded bills and cheques are added back to balance as per statement.
- charges in respect of interest on an overdraft are added back to balance as per statement.
There can be four different scenarios while preparing a bank reconciliation statement. These include:
- debit balance or favourable balance as per cash book is given and balance as per Statement needs to be determined.
- credit balance or unfavourable balance as per cash book is given and balance as per statement needs to be determined.
- credit balance or favourable balance as per passbook is given and balance as per cash book needs to be determined.
- debit balance or unfavourable balance as per passbook is given and balance as per cash book needs to be determined.
- Preparation of Bank Reconciliation Statement After Adjusting the cash book Balance
Typically, the difference between the cash book and Statement balance arises due to the items that appear only in the passbook. Therefore, it makes sense to first record these items in the cash book 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. In this way, the number of items that cause the difference between the passbook and the cash book balance gets reduced. Furthermore, it gets easier to ascertain the correct amount of balance at the bank in the balance sheet.
This means that only those items that cause a difference due to a time lag in recording appear in the bank reconciliation statement. These items may include:
- cheques issued but not yet presented.
- cheques deposited but not yet collected.
- error in passbook, etc.
Therefore, the bank reconciliation statement using this approach is prepared by following the steps below:
- specify the balance as per passbook as the first item in the bank reconciliation statement.
- add cheques issued but not yet presented for payment.
- deduct cheques deposited but not yet collected or credited.
- deduct cheques debited in error.
After adjusting all the above items what you get is the adjusted balance of the cash book.
Bank Reconciliation Problems
The purpose behind preparing the bank reconciliation statement is to reconcile the difference between the balance as per the cash book and the balance as per the passbook.
Now, the differences between the cash book and passbook balance occur primarily due to the following reasons:
Timing Differences in Recording of Transactions
When you compare the balance of your cash book with the balance showcased by your bank passbook, there is often a difference.
One of the primary reasons responsible for such a difference is the time gap in recording the transactions of either payments or receipts.
Various factors affect such a time gap. These include:
Cheques Issued by the Bank But Not Yet Presented for Payment
When your business issues a cheque to its suppliers or creditors, such amounts are immediately recorded on the credit side of your cash book.
However, there might be a situation where the receiving entity may not present the cheques issued by your business to the bank for immediate payment.
The bank will debit your business account only when the bank pays these issued cheques.
So, this means there is a time lag between the issue of cheques and its presentation to the bank.
Such a time lag is responsible for the differences that arise in your cash book balance and your passbook balance.
Cheques Paid into the Bank But Not Yet Collected or Credited
When your business receives cheques from its customers, such amounts are recorded immediately on the debit side of the cash book.
As a result, the balance as per the cash book increases. However, there may be a situation where the bank credits your business account only when the cheques are realised.
It is important to note that it takes a few days for the bank to clear the cheques. This is especially common in cases where the cheque is deposited at a bank branch other than the one at which your account is maintained.
Thus, such a situation leads to the difference between bank balance as per the cash book and balance as per the passbook.
Debits Made by the Bank on behalf of the Customer
At times, your bank may deduct certain amounts associated with various services directly from your bank account without your knowledge.
You come to know about such deductions only when you receive the statement from the bank.
The deductions may include:
- cheque collection charges
- incidental charges
- interest on overdraft
- unpaid cheques deducted by the bank (bounced cheques)
Thus, such debits made by the bank directly from your bank account lead to a difference between the balance as per cash book and the balance as per the passbook.
Direct Deposits into the Bank Account
At times, your customers directly deposit funds into your business’ bank account. But, your business entity does not receive any indication about this until the time it receives the bank statement.
In such a case, your bank has recorded the receipts in your business account at the bank. However, you did not record such a transaction in your cash book. As a result, the balance showcased in the bank passbook would be more than the balance shown in your company’s cash book.
Interest and Dividends Collected by the Bank
Your bank may collect interest and dividends on your behalf and credit such an amount to your bank account.
But, you will record such transactions only in your business’ cash book only when you receive the bank statement. Until then, your balance as per the cash book would differ from the balance as per the passbook.
Direct Payments Made by the Bank
At times, you might give standing instructions to your bank to make some payments regularly on specific days to the third parties. For instance, insurance premiums, telephone bills, rent, sales taxes, etc are directly paid by your bank on your behalf and debited to your account.
As a result of such direct payments made by the bank on your behalf, the balance as per the passbook would be less than the balance as per the cash book.
If you need help or want more information on bank reconciliations, please contact us:
Call 07795 425032
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