What Is a Bank Reconciliation?
A bank reconciliation involves comparing a company’s cash accounting statements to the cash recorded in the bank’s records. This process is utilized to detect any errors and address discrepancies, ensuring an accurate depiction of the company’s cash position, including funds in transit.
Companies prepare bank reconciliation statements as a comprehensive tool for accounting comparisons. By aligning internal financial records with the bank account balance, organizations can confirm that all payments have been processed correctly. Additionally, these statements are crucial for identifying potential fraud or errors. An effective bank reconciliation statement should encompass all transactions affecting the company’s financial accounts.
Why Is It Important To Reconcile Your Bank Statements?
Reconciling your bank statements is vital as it allows you to identify and correct errors or discrepancies in your financial records. This practice can also act as an early detection system for fraud. By regularly reconciling your bank statements, businesses can uncover potential issues within their financial recording systems, facilitating swift resolution of these problems. These issues can range from simple mistakes, such as calculation errors or duplicate payments, to more serious concerns like theft and fraud. Comparing your company’s internal accounting records with your bank statement balance confirms the accuracy of your records and helps analyze any discrepancies.
When To Do a Bank Reconciliation
It’s recommended for a company to perform a bank reconciliation at least once a month. If your company receives bank statements more frequently, perhaps weekly, you may choose to reconcile your bank accounts accordingly. Conducting frequent reconciliations makes it easier to identify and correct errors. Companies might opt for additional reconciliations in situations involving large sums of money or unusual financial activities. Examples include significant payments and deposits, or alerts about suspicious activity from your bank. In such cases, performing an immediate reconciliation is advisable.
How To Do a Bank Reconciliation
At the end of each month, you receive a bank statement detailing all deposits and expenses. To reconcile your bank statement, follow these steps:
- Compare the Deposits: Match the deposits in your records with those on the bank statement. Verify amounts align on both sides and mark the matching items.
- Adjust the Bank Statements: Address discrepancies such as deposits in transit, outstanding checks, bank fees, and errors. Add deposits in transit to the bank statement and deduct outstanding checks from the bank balance. Correct any bank or accounting errors.
- Compare the Balances: After adjustments, the bank and book balances should match. If not, repeat the process. Once they align, adjust your book balance with journal entries.
- Adjust the Cash Account: Update your cash account for bank charges, interest, and errors. Deduct service fees and overdraft charges, add earned interest, and correct any errors.
Bank Reconciliation Example
Let’s take a look at a hypothetical company’s bank and financial statements to see how to conduct a bank reconciliation.
Greg’s Lawnmowers is performing its monthly bank reconciliation for January. Greg’s financial statement shows a cash balance of $100,000, whereas the bank statement shows only $88,000.
By comparing the two statements, Greg identifies $11,500 worth of checks for four orders of lawnmowers purchased near the end of the month. These checks are in transit and haven’t been deposited into the company’s bank account yet. Additionally, he found $500 in bank service fees that were not included in his financial statement.
To reconcile the differences, Greg adds the $11,500 of deposits in transit to his bank statement balance, bringing it to $99,500. He also subtracts the $500 in bank fees from his financial statement balance, bringing that to $99,500. With these adjustments, both balances align, successfully reconciling the two accounts.
Bank Reconciliation Process Flow
Outlined below are the fundamental steps for completing a bank reconciliation:
- Compare Statements: Review your bank statement alongside your company’s accounting records. Ensure that all payments, deposits, and the final balance are accurately recorded for the relevant period.
- Identify Discrepancies: Examine both statements to highlight any inconsistencies. Some transactions might take a few days to clear, so the transaction dates may not always match exactly.
- Make Adjustments: Identify the reasons for discrepancies, such as deposits in transit and bank fees not recorded in your company records. Adjust each statement accordingly.
- Reconcile Balances: After adjustments, both statements should show the same final balance. Any unresolved discrepancies could indicate errors or potential fraud requiring further investigation.
Benefits of Bank Reconciliation
1. Ensures Financial Accuracy and Cash Flow
Regular bank reconciliations keep your company’s financial records accurate and up-to-date. They help you anticipate and manage cash flow, ensuring all payments and orders are correctly processed.
2. Improves Fraud and Error Detection
Routine bank reconciliations detect fraud risks and financial errors early, including fraud, theft, accounting mistakes, insufficient funds, and duplicate payments. Immediate reconciliations for large sums or unusual transactions further enhance detection.
3. Maintains Positive Client Relationships
Accurate finances and regular reconciliations help maintain strong relationships with customers, employees, contractors, and suppliers by confirming all transactions are processed correctly.
4. Simplifies Tax Filing and Financial Reporting
Consistent bank reconciliations simplify tax filing and financial reporting by keeping records organized, reducing the burden of yearly reviews.
Challenges With Bank Reconciliations
Discrepancies in bank reconciliations can stem from data processing errors, bank delays, unclear fees, and unpredictable interest income.
- Data Processing Errors: Human error during data entry can result in incorrect amounts or miscalculations. While it cannot entirely eliminate such errors, accounting software can reduce their likelihood, facilitating more accurate financial statements.
- Bank Delays: Processing delays often cause discrepancies. Transactions processed late in the day or at the end of the month may not show on the bank statement promptly. Accounting for these delays is essential for accurate reconciliation.
- Bank Fees: Certain bank services, like expedited payments and bank drafts, may incur additional fees. If these fees are not recorded in the company’s financial records, they will only be spotted upon receiving the bank statement.
- Interest and Investment Income: Variable sources of income such as interest and investments can be challenging to predict. Exact amounts may not be included in financial statements before reconciliation. The final amounts listed on the bank statement help adjust and reconcile the business’s financial statements.
