A correct bank reconciliation is important for good cash management but where do you start? Is the form on the backside of the bank statement what you really need? Does the preparation of a bank reconciliation cause a tightening in your stomach? It needn't. Those who prepare bank reconciliations often know the easiest way and a few tricks as well.
Clearly for good cash management you need to have an accurate beginning cash balance; a reconciliation provides that opening figure. But, even after the opening balance, the reconciliation assures you that nothing significant has happened to disturb your cash budgeting. Further, the reconciliation balance is the same amount needed for your general ledger cash account and, if a factor, your financial statement audit.
There are a number of approaches to bank reconciliations. Some reconcile the book balance (that's the general ledger balance) to the bank balance. However, that leaves to be desired a proof of the general ledger figure directly. Another approach is to reconcile the bank balance to the current book balance, but that is not very helpful either. My favorite is to reconcile the bank balance to an adjusted bank balance and reconcile the book balance to an adjusted book balance (the balance after all adjustments are made). This final approach is the most useful for cash budgeting and for financial statement presentation.
You begin this reconciliation with the bank's ending cash balance. While it is desirable that the statement cutoff date agrees with the end of the month date, it is not technically necessary. However, it is desirable that it not be more than about a week from the end of the month.
To the bank's ending cash balance add deposits in transit. Those are deposits your company made but do not appear on the bank statement. For audit purposes you should be able to prove with bank deposit receipts that the money is technically in the bank.
Next, you need to subtract the outstanding checks. Those are checks written (and supposedly sent) that have not cleared the bank. Again, these do not show up on the bank statement.
Under normal circumstances you have arrived at an adjusted bank balance. You are halfway there.
Next you begin with the ending adjusted book balance per your books from the prior month. If you are reconciling the month of September, you begin with the August ending adjusted book balance. This is the same balance that you would have from your last bank reconciliation. Don't get lost here. You are going to prove the September balance by showing all the transactions (in large pieces) during the month.
Next add all the deposits whether displayed on the bank statement or not to the ending prior month adjusted book balance. This addition is commonly referred to as the total from the cash receipts journal.
Next, subtract all the checks written during the month (again whether or not they are presented on the bank statement). This subtraction is commonly referred to as the total from the disbursements journal.
Review the bank statement for miscellaneous fees such as merchant fees, service charges, fees for returned items, etc.
Subtract these fees from the calculated book balance. Adjust for returned items.
If things have gone well you should arrive at the adjusted book balance. That is the same balance as the adjusted bank balance you calculated earlier. If they are the same, your reconciliation is done; everything is in balance.
But suppose it doesn't balance. Obviously there is an error. That means as well that there is a difference between the adjusted bank balance and the adjusted book balance. Here are some tips to finding errors.
A common error is a transposition. A transposition is where two figures have been incorrectly posted in their order. For instance, a 27 might be posted incorrectly as 72 or a 54 might be posted as 45. A quick way to determine a transposition is to divide the out of balance amount by 9 and see if it comes out even. If it does, it is likely the error is a transposition. Now before you go looking for a transposition, here is another hint to finding the specific incorrect posting. Let's use the 72/27 as an example.
The difference between 72 and 27 is 45. 45 is the out of balance figure - that is what we know. However, if you divide the 45 by 9 you arrive at 5. It is always the case that the distance between the numbers in a transposition problem is the difference divided by 9. So, not only does the even division of the difference tell you that you are probably dealing with a transposition, it further tells you the distance between the numbers.
Let's look a little more closely at this situation. If the difference divided by 9 is 5, it says that the numbers you are looking for are 5 digits apart. So, 1 and 6, 2 and 7, 3 and 8, 4 and 9 are the only possibilities. As it turns out, the figures are 2 and 7. All the other possibilities are eliminated. In this way you only concentrate on checking these numbers and no others.
If the out of balance amount is not a transposition, then it is likely it is either in the outstanding checks or the deposits in transit. Here is a way to eliminate those from consideration.
In this order, add the deposits in transit for this month to the credits per bank statement amount. From this figure subtract the deposits in transit last month. The resulting figure should agree with your cash receipts journal total. Be careful here that you don't include stuff that is not in your cash receipts journal. An adjustment to the credits per bank may be necessary to eliminate those un-booked items. If you have done all of this and it does not agree, you have in a problem in your deposits in transit calculation.
Similarly, for cash disbursements, add the outstanding checks this period to the debits per bank statement. From that figure subtract the outstanding check total from the previous month. The calculated figure should agree with your cash disbursements journal total for the month. The same caveat mentioned for cash receipts goes as well for cash disbursements. Eliminate any debits from the debits per bank amount that are not booked. If you have done all of this and it does not agree, you have in problem in your outstanding check list.
In both of the above approaches, the differences between the journal totals and the calculated amounts provide help in identifying the error.
Now for some closing thoughts. It is not a good idea to put too many different kinds of transactions into one bank account. It should be obvious from the above that mixing general disbursements, payroll and credit card transactions can quickly muddy the water. A reasonable cash management system separates major groups of transactions to more effectively manage cash and reconcile the respective accounts.
While preparing a bank reconciliation will probably never be on your favorite things to do list, at least now you have the tools to do it effectively and efficiently.
Clearly for good cash management you need to have an accurate beginning cash balance; a reconciliation provides that opening figure. But, even after the opening balance, the reconciliation assures you that nothing significant has happened to disturb your cash budgeting. Further, the reconciliation balance is the same amount needed for your general ledger cash account and, if a factor, your financial statement audit.
There are a number of approaches to bank reconciliations. Some reconcile the book balance (that's the general ledger balance) to the bank balance. However, that leaves to be desired a proof of the general ledger figure directly. Another approach is to reconcile the bank balance to the current book balance, but that is not very helpful either. My favorite is to reconcile the bank balance to an adjusted bank balance and reconcile the book balance to an adjusted book balance (the balance after all adjustments are made). This final approach is the most useful for cash budgeting and for financial statement presentation.
You begin this reconciliation with the bank's ending cash balance. While it is desirable that the statement cutoff date agrees with the end of the month date, it is not technically necessary. However, it is desirable that it not be more than about a week from the end of the month.
To the bank's ending cash balance add deposits in transit. Those are deposits your company made but do not appear on the bank statement. For audit purposes you should be able to prove with bank deposit receipts that the money is technically in the bank.
Next, you need to subtract the outstanding checks. Those are checks written (and supposedly sent) that have not cleared the bank. Again, these do not show up on the bank statement.
Under normal circumstances you have arrived at an adjusted bank balance. You are halfway there.
Next you begin with the ending adjusted book balance per your books from the prior month. If you are reconciling the month of September, you begin with the August ending adjusted book balance. This is the same balance that you would have from your last bank reconciliation. Don't get lost here. You are going to prove the September balance by showing all the transactions (in large pieces) during the month.
Next add all the deposits whether displayed on the bank statement or not to the ending prior month adjusted book balance. This addition is commonly referred to as the total from the cash receipts journal.
Next, subtract all the checks written during the month (again whether or not they are presented on the bank statement). This subtraction is commonly referred to as the total from the disbursements journal.
Review the bank statement for miscellaneous fees such as merchant fees, service charges, fees for returned items, etc.
Subtract these fees from the calculated book balance. Adjust for returned items.
If things have gone well you should arrive at the adjusted book balance. That is the same balance as the adjusted bank balance you calculated earlier. If they are the same, your reconciliation is done; everything is in balance.
But suppose it doesn't balance. Obviously there is an error. That means as well that there is a difference between the adjusted bank balance and the adjusted book balance. Here are some tips to finding errors.
A common error is a transposition. A transposition is where two figures have been incorrectly posted in their order. For instance, a 27 might be posted incorrectly as 72 or a 54 might be posted as 45. A quick way to determine a transposition is to divide the out of balance amount by 9 and see if it comes out even. If it does, it is likely the error is a transposition. Now before you go looking for a transposition, here is another hint to finding the specific incorrect posting. Let's use the 72/27 as an example.
The difference between 72 and 27 is 45. 45 is the out of balance figure - that is what we know. However, if you divide the 45 by 9 you arrive at 5. It is always the case that the distance between the numbers in a transposition problem is the difference divided by 9. So, not only does the even division of the difference tell you that you are probably dealing with a transposition, it further tells you the distance between the numbers.
Let's look a little more closely at this situation. If the difference divided by 9 is 5, it says that the numbers you are looking for are 5 digits apart. So, 1 and 6, 2 and 7, 3 and 8, 4 and 9 are the only possibilities. As it turns out, the figures are 2 and 7. All the other possibilities are eliminated. In this way you only concentrate on checking these numbers and no others.
If the out of balance amount is not a transposition, then it is likely it is either in the outstanding checks or the deposits in transit. Here is a way to eliminate those from consideration.
In this order, add the deposits in transit for this month to the credits per bank statement amount. From this figure subtract the deposits in transit last month. The resulting figure should agree with your cash receipts journal total. Be careful here that you don't include stuff that is not in your cash receipts journal. An adjustment to the credits per bank may be necessary to eliminate those un-booked items. If you have done all of this and it does not agree, you have in a problem in your deposits in transit calculation.
Similarly, for cash disbursements, add the outstanding checks this period to the debits per bank statement. From that figure subtract the outstanding check total from the previous month. The calculated figure should agree with your cash disbursements journal total for the month. The same caveat mentioned for cash receipts goes as well for cash disbursements. Eliminate any debits from the debits per bank amount that are not booked. If you have done all of this and it does not agree, you have in problem in your outstanding check list.
In both of the above approaches, the differences between the journal totals and the calculated amounts provide help in identifying the error.
Now for some closing thoughts. It is not a good idea to put too many different kinds of transactions into one bank account. It should be obvious from the above that mixing general disbursements, payroll and credit card transactions can quickly muddy the water. A reasonable cash management system separates major groups of transactions to more effectively manage cash and reconcile the respective accounts.
While preparing a bank reconciliation will probably never be on your favorite things to do list, at least now you have the tools to do it effectively and efficiently.
