In bookkeeping, bank reconciliation is the process of reconciling the bank account balance recorded in an entity’s books of account with the balance reported by the financial institution in the latest bank statement. The purpose of reconciliation is to identify and examine differences between the two balances.
The bank balance appearing in the books of an entity may not always agree with the balance shown in the bank statement. Whenever a difference exists between these two figures, the difference must be examined and, where appropriate, rectified.
Thus, bank reconciliation helps an entity compare its own accounting records with the records maintained by the bank or financial institution.
Bank Statement and Reconciliation Process
A bank statement is generally produced routinely by the financial institution. It contains information relating to transactions recorded by the bank in the account of the account holder.
Account holders use bank statements to perform their bank reconciliations. The transactions and balance appearing in the bank statement are compared with the accounting records maintained by the entity, particularly the cash book.
Modern financial institutions may also provide facilities for the direct download of financial transaction information into the accounting software of account holders. Such transaction information is commonly provided using the .csv file format.
The direct transfer of financial transaction information into accounting software can assist the account holder in performing the reconciliation process.
Reasons for Differences between Cash Book and Bank Records
Differences between the balance recorded in an entity’s books of account and the balance shown in the bank’s records mainly arise for three reasons:
- Differences due to timing in recording entries.
- Transactions recorded by the bank but not recorded by the account holder.
- Errors in recording accounting entries.
These differences must be identified during the bank reconciliation process.
Timing Differences
A timing difference arises when a transaction is recorded in the books of the entity and the bank’s records at different times.
The entity may record a transaction immediately in its accounting records, while the same transaction may be processed or recorded by the bank at a later time. Similarly, the bank may record a transaction before the entity records it in its own books.
Such timing differences can result in different balances even though the accounting records may not necessarily contain an error.
Transactions Recorded by the Bank but Not by the Account Holder
A difference may arise when a transaction has been recorded by the bank but has not yet been recorded in the entity’s books of account.
Since the bank has already included the transaction in its records, the bank statement balance changes. However, the balance in the entity’s cash book remains unchanged until the transaction is recorded.
Such transactions must be identified during reconciliation and, where necessary, appropriate adjustments should be made in the cash book.
Errors in Recording Entries
Differences may also arise because of errors in recording transactions. An incorrect amount or other recording mistake may cause the bank balance in the books of account to differ from the balance shown by the bank.
The reconciliation process helps identify such recording errors. Once an error is discovered, the necessary correction should be made in the relevant accounting records.
Process of Identifying Reconciliation Differences
In some cases, the difference between the two balances can be reconciled easily by examining transactions appearing in the bank statement since the previous reconciliation and comparing them with the entity’s own accounting records or cash book.
The entity may examine whether one transaction or a combination of transactions equals the amount of the unexplained difference. If the transactions match the difference, the reason for the disagreement between the balances can be identified.
However, if the difference cannot be identified easily, it may be necessary to examine and match every transaction appearing in both sets of records since the last bank reconciliation.
Each transaction in the bank statement is compared with the corresponding transaction in the cash book. Transactions that appear in both records are matched, while the transactions that remain unmatched are separately identified.
These unmatched transactions generally explain the difference between the bank statement balance and the balance recorded in the books of account.
Adjustment of Reconciliation Differences
After identifying the reasons for the difference, the necessary adjustments should be made.
Where a transaction has not been properly recorded in the entity’s accounting records, an appropriate adjustment should be made in the cash book.
If the difference has arisen because of an issue or error in the bank’s records, the matter should be reported to the bank or financial institution.
Where the difference is caused by timing, the timing difference should be recorded or noted so that it can be considered during future bank reconciliations.
Thus, reconciliation differences may require correction in the cash book, communication with the bank, or proper recording of timing differences.
Frequency of Bank Reconciliation
Bank reconciliation should be performed at reasonably frequent intervals.
Frequent reconciliation reduces the number of transactions that must be examined at one time. It also makes it easier to identify and explain differences between the accounting records and the bank statement.
If reconciliation is delayed for a long period, a large number of transactions may need to be compared and matched. This can increase the amount of work required.
Therefore, regular bank reconciliation is considered a good accounting practice and helps minimise the work involved in identifying differences.
Bank Reconciliation Statement
A Bank Reconciliation Statement (BRS) is a statement prepared by an entity as part of the bank reconciliation process to show the entries that have caused the difference between the balance in the entity’s books and the balance reported by the bank.
The statement explains the reasons why the two balances do not agree. It identifies the transactions or entries responsible for the difference.
For example, a Bank Reconciliation Statement may show outstanding cheques. Outstanding cheques are cheques that have been issued by the entity but have not yet been presented to the bank for payment.
Since the entity may already have recorded the issued cheque in its books but the bank has not yet processed the payment, a difference arises between the cash book balance and the bank statement balance.
The Bank Reconciliation Statement records and explains such differences so that the relationship between the two balances can be understood.
Rectification of Discovered Discrepancies
When discrepancies are identified during bank reconciliation, the entity may need to make correcting entries in its books of account.
Except in the case of outstanding cheques, entries made to correct discovered discrepancies are generally recorded on a subsequent date or in a subsequent accounting period. These entries are normally not backdated.
This means that when an error or omitted transaction is discovered, the correction is generally recorded at the current or subsequent date rather than changing the original date of the accounting record.
Treatment of Stale Cheques
A cheque may become stale when it becomes out of date.
When a cheque becomes stale, the accounting entry relating to the cheque is generally reversed rather than cancelled.
Reversal of the entry removes the accounting effect of the earlier cheque transaction from the books. Therefore, the proper accounting treatment of a stale cheque is generally to reverse the relevant entry.
Exam Focus
Bank reconciliation is the process of comparing and reconciling the bank account balance in an entity’s books of account with the balance shown in the latest bank statement. Any difference between the two balances must be examined and, where appropriate, rectified.
The three main reasons for differences are timing differences, transactions recorded by the bank but not by the account holder, and errors in recording entries.
The reconciliation process involves comparing the bank statement with the cash book, matching transactions, and identifying unmatched transactions. Necessary adjustments may be made in the cash book, errors in bank records may be reported to the bank, and timing differences may be recorded for future reconciliation.
A Bank Reconciliation Statement (BRS) explains the entries causing the difference between the cash book balance and the bank statement balance. An outstanding cheque is a cheque that has been issued but has not yet been presented to the bank for payment.
Bank reconciliation should be carried out at reasonably frequent intervals to minimise the work involved in identifying and reconciling differences. When cheques become stale or out of date, their accounting entries are generally reversed rather than cancelled.