Bank reconciliation

Why the two figures differ

The business keeps a cash book; the bank keeps a statement. They record the same account from opposite sides, so on any date they disagree for two quite different reasons, and the two reasons need opposite treatments.

Reason one: the bank knows something the business has not recorded. These items appear on the statement only, and the business learns about them when it arrives.

• Bank charges and interest charged.
• Interest received.
• Standing orders and direct debits.
• Credit transfers paid straight into the account.
• Dishonoured cheques, where a customer's cheque has bounced.

Reason two: the business knows something the bank has not processed yet. These are timing differences.

• Unpresented cheques: cheques written and entered in the cash book, not yet paid out by the bank.
• Outstanding lodgements, also called uncredited deposits: money paid in and entered in the cash book, not yet credited by the bank.

The order of work

Step 1: update the cash book. Enter everything from reason one, and correct any errors the business made in its own cash book. Debit the receipts (interest received, credit transfers in) and credit the payments (charges, standing orders, direct debits, dishonoured cheques). Then balance the cash book. This gives the corrected cash book balance, and this is the figure that goes into the statement of financial position.

Step 2: prepare the reconciliation statement. This deals only with the timing differences from reason two, and it changes no ledger figure at all.

Doing step 2 first, or putting bank charges into the reconciliation statement instead of the cash book, loses most of the marks on the question.

The reconciliation statement

Starting from the bank statement:

Check the arithmetic: 3 260 plus 940 is 4 200, less 1 450 is $2 750.

The signs make sense if you think about what the bank has yet to do. It has not added the lodgement, so add it. It has not taken the unpresented cheques out, so subtract them.

Starting from the cash book instead reverses every sign: subtract lodgements and add unpresented cheques to arrive at the bank statement figure. Either direction is acceptable, and the question sometimes specifies. Decide which end you are starting from before writing anything, because switching direction halfway gives a plausible but wrong answer.

Overdrafts

An overdraft is a credit balance in the cash book and appears as an overdrawn figure on the statement. Treat it as a negative number and apply the same rules.

A statement showing an overdraft of $800, with lodgements of $600 and unpresented cheques of $350, gives negative 800 plus 600 minus 350, which is an overdraft of $550 per the cash book.

Why it matters

• It checks the cash book against a record produced independently by the bank.
• It finds errors, made by the business and occasionally by the bank.
• It discovers items the business had no other way of knowing about, such as charges and dishonoured cheques.
• It discourages fraud, because unrecorded payments show up.
• It shows the true bank balance for the statement of financial position.

A dishonoured cheque deserves its own note: as well as crediting the cash book, the customer's account must be debited again, because the debt has not actually been settled.

Common mistakes

• Putting bank charges or standing orders in the reconciliation statement instead of the cash book.
• Reversing the treatment of unpresented cheques and outstanding lodgements.
• Using the original cash book balance in the reconciliation rather than the corrected one.
• Forgetting to reinstate the customer's debt when a cheque is dishonoured.
• Getting the sign wrong on an overdraft.
• Showing the bank statement balance in the statement of financial position instead of the corrected cash book balance.

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