Most businesses have one or more bank accounts. These may include a cheque account, high-interest bearing savings account or at call investment account. The use of a business cheque account contributes significantly to the effective control of internal cash.
Each period (traditionally this would have been fortnightly, monthly or quarterly), but in Xero, we do this daily: the bank sends the account holder a bank statement detailing all of the transactions for the period. These transactions include:
- All deposits made into the bank account (shown as credits on the bank statement)
- All payments made from the bank account (shown as debits on the bank statement), and
- The opening and closing balances of the bank account (may either be debit or credit)
When the bank issues a bank statement, the bookkeeper should prepare a bank reconciliation. As the name suggests, the purpose of a bank reconciliation is to reconcile the closing cash at bank balance shown on the bank statement (ie what the bank says the cash balance is) to the 'cash at bank' account shown in the entity's general ledger account at that date.
There are several reasons why these two amounts may differ:
- Time lags between when the business records the transaction in its books and when the bank records the transaction. For example, a deposit may have been entered in the business' management accounts but the bank may not have processes the deposit. These are referred to as "outstanding deposits". Similarly, the business may have written a cheque and recorded the outgoing in the business' management accounts, although the payee has not yet presented the cheque to their bank. These are referred to as 'unpresented cheques'.
- Amounts reported on the bank statement that have not yet been entered into the records of the entity, such as bank charges, account keeping fees, interest earned or any other direct receipts/payments.
- Errors were made by the bank or the business. For example, a cheque may have been writted for $182; however the bookkeeper may have inadvertently entered it into the business' records as $128. The bank statement will correctly show an amount of $182, causing a discrepancy of $54 between the bank's balance and the entity's cash at bank balance.
Accordingly, the purpose of a bank reconciliation is to reconcile the closing cash balance that appears on the bank statement to the cash at bank balance shown in the entity's balance sheet. Specifically, bank reconciliation serves three important purposes:
- It allows the business owner to keep track of the cash flow
- It provides an important security measure - business owners can be sure all monies have been deposited as intended and that all cheques have been cleared - nothing has gone missing or remains unaccounted for
- It allows the bookkeeper to pick up any amounts shown in the bank statement that are not recorded in the books, such as bank charges levied by the bank, interest received and other direct receipts, and make appropriate adjustments in the entity's books.
Before performing a bank reconciliation, it is important to have the following documents on hand:
- The bank statement received from the bank (assume monthly statements)
- The most recent bank reconciliation prepared
- A printout of all cash receipts and cash payments for the month
- A printout of the balance showing the closing cash at bank balance at the end of the month
Once all of these documents are close at hand, the bookkeeper should perform the following steps as part of the reconciliation process:
Step 1: Refer to the previous bank reconciliation for any outstanding items
The first step is to refer to the bank reconciliation prepared for the previous month. Any outstanding items appearing in the previous bank reconciliation (eg. unpresented cheques or outstanding deposits) that now appear in the current month's bank statement (either on the debit or credit side) should be ticked off. These amounts have now been accounted for in the current month's bank statement. If any of these amounts still do not appear on the current months bank statement, they should be included as oustanding items in the current bank reconciliation.
Step 2: Compare cash receipts in the entity's books to the amounts appearing on the credit side of the bank statement
Compare the cash receipts for the month (which appear on the debit side of the "cash at bank" account in the general ledger) to the amounts shown in the credit side of the bank statement.
Items that appear in both sets of records should be ticked off. In other words, if a deposit for $1,440 appears as a cash receipt in the entity's books and on the credit side of the bank statement, both items should be ticked off. This means that the deposit has been picked up by the bank and recorded in the entity's books.
Conversely, if an amount appears in the entity's books as a deposit, but is not shown on the credit side of the bank statement, this is referred to as an "outstanding deposit". This means that while the deposit has been recorded in the entity's books, the bank has not yet processed the deposit, ie it has not yet been reflected in the bank's records. Outstanding deposits are noted in the bank reconciliation.
Step 3: Items that appear on the credit side of the bank statement but not in the entity's books
There may be amounts that appear on the credit side of the bank statement (ie deposits made to the entity's account) that do not appear in the "cash at bank" account in the general ledger. There are two common examples - interest received and direct receipts from customers.
Firstly, interest credited by the bank will appear as a deposit on the credit side of the bank statement. Typically, the amount of interest cannot be determined until the bank statement arrives. Hence, interest received will not appear in the entity's accounting records until the bookkeeper enters the amount from the bank statement.
Secondly, some customers may have paid their accounts directly into the entity's bank account via EFT or direct credit and have not notified the entity of this payment. In some cases, the customer may not identify the invoice number they have paid, so the bookkeeper may need to conduct further investigations to determine where these deposits have come from and ensure that they are credited.