Bank reconciliations are made by a business to reconcile any differences between the bank statement of a business and its bank books.
These differences can exist due to many reasons. Bank reconciliations are used to identify any errors or attempts at fraud.
Bank reconciliations are carried out to reconcile the differences between the balance in the bank book (also known as the cash book or bank ledger) of a business and the balance in the bank statement of a business.
These are two different documents and, therefore, it is crucial that the differences between these two documents should be clear first.
Bank Book vs Bank Statement
The bank book and the bank statement of a business are both made up of the information about the bank balance of the business.
The bank book of the business is an internally prepared document and is prepared by the management of the business, or specifically the accounting department.
The bank statement, however, is prepared by the bank in which the account is held. The bank statement is sent to the business at the start of each month detailing all the transactions that took place in the account for the prior month.
Transactions in the bank statement are presented the opposite of transactions in a bank book. For example, a receipt will be a Debit in the bank book while it will be presented as a Credit in the bank statement.
A business can have many different bank accounts in different banks and, therefore, will receive multiple statements from each bank for each account of the business.
Therefore, it is a good practice for businesses to also have a separate bank book for every account so it is easier for them to find any differences between the balances and reconcile them.
Since the bank book is an internal document and the bank statement is an external document, there are bound to be differences between the two.
The business has to identify any differences between the balances in these two documents and reconcile them in order to ensure proper control over it bank balances.
There are a limited number of reasons due to which differences may exist. These might be either due to unrecorded differences or timing differences.
Apart from these types of differences, errors may also occur on either the business’ side of the records or the bank’s side of the records.
Basically, any difference that cannot be justified by either unrecorded differences or timing differences are errors that must be rectified.
Types of Differences
As discussed above, the differences between the bank book and bank statement of a business can be classified into two categories, unrecorded differences and timing differences.
The differences are classified in one of these two categories based on which document, the bank book or the bank statement has the difference and the differences must be adjusted against.
Unrecorded differences, as the names suggests, are differences that are not recorded. These are differences that are recorded in the bank statement of a business but not in the bank book of the business.
When performing a bank reconciliation, unrecorded differences are recorded in the bank book of the business to arrive at an adjusted bank book balance.
Examples of unrecorded differences are any type of bank charges, taxes, direct deposits, standing orders, dishonored cheques, or a customer deposited an amount but didn’t notify the business, etc.
These differences mainly occur because the bank, in which the account is held, updates the accounts but the business does not know about the updates until the start of next month when the bank statement is received.
Therefore, once the business gets the bank statement and identifies these differences, these are recorded in the bank book of the business.
Timing differences are differences due to timing of different transactions. These are differences that are already recorded in the bank book of the business but do not appear on the bank statement of the bank account.
Timing differences, unlike unrecorded differences, are not recorded in either the bank book or the bank statement.
These differences are adjusted against the bank statement balance but are not recorded in the bank statement. These are differences that will appear in the bank statement after some time, most probably in the next bank statement.
For example, if a business pays a cheque to a supplier but the supplier does not cash the cheque in the bank in that month.
For the business, the transaction will already have been recorded in the bank book because the cheque was issued. For the bank, because there was no cheque presented, the transaction never occurred. These are called outstanding payments.
Another example is a cheque that the business received from the customer but hasn’t yet taken to the bank or did take to the bank, but the bank did no clear the cheque before the end of the month. These are called outstanding lodgments.
Any difference that is not an unrecorded difference or a timing difference is an error. As previously mentioned, errors can occur on both sides, the bank book or the bank statement.
For example, the bank credited the business account for a transaction that did not relate to the account. Errors are generally rectified promptly if they are caused due to an error in the bank book.
For errors in the bank statement, the bank is contacted and details are given about the transaction.
Mostly, errors occur in the bank book of the business rather than the bank statements. These errors are then investigated properly to ensure they were not committed intentionally.
This is one of the reasons bank reconciliations are a major part of a business’ internal control procedures.
Bank Reconciliation Step By Step
To prepare a bank reconciliation, it is important that both the bank book and the bank statement of the business are available.
Once both these documents are available, the following steps must be followed to prepare a bank reconciliation statement.
1) Compare the balance from the bank statement with the bank book
Once the bank statement is received, the business must check the balance on the bank statement against the balance on the bank book.
It must ensure that the bank book balance is taken for the last date of the previous month or the month for which the bank statement is considered.
For example, if a bank statement is received for August, the bank book balance taken should be the closing balance on August 31.
Once the balances are compared, if no differences exist, the bank reconciliation statement is not prepared. However, that is highly unlikely. The balances will almost always be different and, therefore, the next step is followed.
2) Identify the type of differences
Once it is established that the bank reconciliation statement should be made, it is then important to identify the type of differences that exist between the bank book and the bank statement.
These differences, as discussed above, will either be due to unrecorded or timing differences.
3) Adjust the bank book and bank statement balances
Once the types of differences are identified, they should be taken and adjusted against the relevant document balance.
Unrecorded differences will be adjusted and recorded in the bank book and timing differences will be adjusted against the bank statement balance.
4) Compare the balances again
Once the types of differences are identified and adjusted against their relevant balances, the balances should be compared again.
At this point, there should be no differences remaining. However, if differences still exist, it either means that the type of those differences was not correctly identified or there are errors in either of the two balances.
A business, ABC Co. received their bank statement from XYZ Bank Ltd. for the month of May20xx. The statement is as below:
Its bank book for the month of May 20xx was as below:
The bank reconciliation of the ABC Co. for the month of May 20xx can be prepared by using the steps above.
#1 Compare the balance from the bank statement with the bank book
First of all, the balance from the bank statement is compared with the bank book. The balance in the bank statement is $500 while the balance on the bank book is $2,350.
This means there is a difference of $1,850 between the two balances. Since there is a difference between the two, the next step should be followed.
#2 Identify the type of differences
As apparent, there are differences between the two statements. First of all, the unrecorded differences are identified and recorded.
These are differences that exist in the bank statement but are not recorded in the bank book.
As apparent from the bank statement, the following differences are unrecorded in the bank book:
Therefore, these must be recorded. The bank book of ABC Co. will be credited with the above amounts because they are all payments from the bank account.
There are no unrecorded Receipts (Cr.) but if they did exist, they would be debited to the bank book. The other side of the entries will be taken to their relevant accounts, for instance, bank charges account.
Next, timing differences are identified. These are differences that are recorded in the bank book but do not exist in the bank statements. These are as below:
|10-May||Cheque # 1131 paid to supplier||–||2,000|
|28-May||Cheque received from customer||4,200||–|
|30-May||Cheque # 1133 paid to supplier||–||2,000|
#3 Adjust the bank book and bank statement balances
The bank book of ABC Co. must be adjusted for the unrecorded differences. This will be:
|Bank book balance before adjustments||2,350|
|Adjusted Bank Book Balance||400|
Similarly, the timing differences need to be adjusted against the bank statement balance.
|Bank Statement balance before adjustments||200|
|Outstanding payments (Chq # 1131)||(2,000)|
|Outstanding payments (Chq # 1133)||(2,000)|
|Adjusted Bank Statement Balance||400|
#4 Compare the balances again
Now that the adjustments have been made, the balances can be compared again.
Since the adjusted balance for both the bank book and bank statement is $400, it means there are no extra items that need to be reconciled.
The above bank reconciliation can also be presented as following:
|Balance as per bank book||2,350|
|Adjusted Bank Book Balance||400|
|Outstanding payments (Chq # 1131)||2,000|
|Outstanding payments (Chq # 1133)||2,000|
|Balance as per Bank Statement||200|
Bank reconciliations are an important part of a business’ internal control system. Bank reconciliations must be performed to find the differences between the bank book balance of a business and its bank statement balance.
These differences can be classified into unrecorded differences or timing differences. Bank reconciliations are performed by comparing the balances from the bank book and bank statement and identifying differences and the types of those differences.
Once the types of differences are identified, these differences are adjusted against the respective document balance. Finally, the balances are compared again, at which point, both should be equal.