Bookkeeping – Bank Reconciliations (Lesson 47)

An essential task of bookkeeping is making sure the ledger accounts for cash reconcile to the bank. Your average person believes that this is a monthly task. Well in the private world, this may be true. But in small business, this is a daily task. If performed daily, it shouldn’t take more than 10 minutes per cash account to reconcile. Once you have done it several times, you learn what to expect and your speed increases dramatically.

The primary purpose of frequent reconciliation is to have insight as to the respected cash balances for all accounts. In addition, there are several positive benefits:

• Identification of unexpected withdrawals from the bank account;
• Having knowledge of available balance of cash;
• Aids in tracking cash; AND
• Ensures compliance with minimum cash balances for loan terms.

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This article introduces the basic steps involved in reconciling a ledger account to a bank account. Once done I encourage you to read another article that covers the multi-step procedure and includes an Excel spreadsheet for download that can be used in your daily reconciliation process. Please read: Basic Bank Reconciliation. The Excel spreadsheet is free. The article explains and walks the reader through the spreadsheet.

To understand the bank reconciliation process, I explain some terminology and required documents. Next I’ll illustrate how to balance the bank side first and finally how to adjust the ledger side. Once done, you’ll have both the bank account and the ledger register in balance.

Terminology and Documents

The process of reconciliation begins by pulling two important documents. The first is from the bank and it is the activity statement for the account in question. With business accounts, banks allow two forms of log-ins. One is the administrator and the other is as a viewer. The viewer mode allows the user to see the transaction activity and open the individual documents in PDF mode. Bookkeepers should have a viewer access as a function of their job. Open the account and review the most recent activity and current bank balance.

The second document required is the ledger of the bank account with the last 30 days of transaction activity. Most accounting software programs allow the user to view this on-screen. Many packages actually have a built-in reconciliation program. On of the better small business accounting software programs is QuickBooks which allows the user to reconcile daily.

Most often the two documents do not have the same balance. Usually it is due to two common items:

1. Outstanding Items – From the bank’s perspective, they have no idea of the checks written that are in the mail or in the hands of a payee. All they know is that they have paid checks presented. In addition any deposits in transit (sitting in the night box or in a safe for physical transfer to the bank) are also not recorded to their ledger for this account. Banks use the term ‘outstanding’ as they are not aware of these items.
2. Unrecorded Items – Similar to how banks address their issues, bookkeepers must address items on a bank statement but not in the ledger. There are many common bank items that are withdrawn from the account and do not exist in the ledger for the business. Examples include fees, interest paid, loan payments or overdraft penalties. ‘Unrecorded’ refers to the fact that the item is not recorded to a journal in the business books of record.

Balance the Bank Account

Remember I stated that the bank is unaware of checks written by the business or any deposits in physical transit. They can’t change the balance until an actual legal document is presented, i.e. a check or deposit slip with money. The balance in the account as the bank reports excludes these items. Simply identify the missing checks and/or deposits. Take the existing bank balance and add any deposits in transit.

A deposit in the physical form, while in transit, may exist on the desk of the bookkeeper, office manager or with the owner. I’ve found them in the trunk of a car or in the possession of the owner’s son. Just because you’ve recorded the deposit to the books of record doesn’t mean the physical process is complete.

Next, subtract any outstanding checks or existing debits. The checks are simply those checks processed in the accounting software during cash disbursements that also have physically not made it to the bank for presentation. Invariably there are some common issues with outstanding items that exist in small business; they are as follows:

1. Aged Outstanding Checks – Often vendors and employees don’t’ cash their checks right away. Give them a call and ask them to please deposit the checks into their accounts so you can clear them in your books. Sometimes they lose the checks and are embarrassed to ask for a replacement.
2. Held Checks – At the other end of this spectrum is the owner, I’ve seen them hold checks for several different reasons. I mean they refuse to hand them out or mail them. But mostly they hold them because they know they will overdraw their bank account and they are simply waiting on a deposit. This is a poor business habit and not a good example of accounts payable management.

Another form of outstanding deductions from the bank account are open (or non presented) debits. These are authorized electronic deductions. The most common are tax authority payments. Examples include payroll tax payments, income tax payments and state sales/meal taxes. Other forms of debits exist too. They include:

• Automatic withdrawals for insurance, bank loan payments and other types of bills; AND
• Instant debits that you are aware of such as fuel purchases or supply purchases.

Again, the key is that you have recorded them to the business books or record; but they have not been electronically presented to the bank.

Once you have balanced the bank account for all outstanding deposits, checks and debits you have a hard value that is 99.99% correct. That is, you can rely on this as the correct and true cash account balance.

Adjust the Ledger Value

Reconciliation requires two parts, above I illustrated the bank account issues and the outstanding items affecting the physical account. Now it is time to address the book’s ledger for that account. There are two types of transactions affect the ledger. The first type is unrecorded debits.

Unrecorded debits are rare increases in the value of the account. Most deposits are processed through the accounting office. An actual deposit in the bank account without your knowledge is uncommon, but they do happen. Here is a short list of the more unusual items:

1. A customer that owes the company money makes the payment by directly depositing the money.
2. Payments are made via the website and you are unaware of the existence of the transaction.
3. Governmental taxing authorities refund monies from overpayments.
4. The owner makes a deposit as a function of additional capital.

These deposits are easy to identify because the bank has physically received them and they are not in your ledger. Simply click on the transaction in the bank’s online software application and review the underlying source documents for more information.   Record the entry to the correct journal to update the ledger.

In my 22 years of accounting experience I’ve only seen one unrecorded deposit that I initially didn’t expect or understand. It turned out the to be the owner depositing his own payroll check back into the business account by accident. He simply used the business account number instead of his personal account number.

The more uncommon unrecorded transaction items are credits. These are values reducing the account balance. Here is a long list of the more common deductions unrecorded in the ledger.

• Loan Payments – In modern banking, loan payments are automatic and rarely use the check presentation method. Most bookkeepers use an accounting software’s recurring entry subprogram to get the entries posted to the books.
• Bank Fees – Monthly bank fees change from month to month bu do occur on a particular day.
• Overdraft Fees – When the bank’s customer spends more than the balance in the account the bank will assess an overdraft fee for causing the account to go negative. Most banks charge $35 per overdraft. Tracking cash reduces or eliminates overdraft fees.
• Debit Card Transactions – Modern banking allows the account holder to use a debit card instead of writing checks. These unrecorded deductions appear on the bank statement but not on the books. The solution is mandatory daily drop off of debit receipts so you can match up the particular credit to the proper expense account.
• Line of Credit Transfer Payments
• Hand written checks by the owner are often not recorded to the books of record but will definitely appear on the bank statement when cash by the payee.

Once you record all the activities the ledger balance should match the bank balance. Invariably, there will always be discrepancies.

Discrepancies

If the two balances do not match then something is wrong. To find the discrepancy walk through the reconciliation process again. Over the years I’ve seen several transposition errors on the bank’s side. This means the check paid amount is different from the check written amount. Basically the teller transposed two numbers. Transposition errors are easy to identify because the difference is always divisible by 9. Here are two examples:

Example 1 – The check is written for $742.17 and the bank transposes the one and two; so the actual amount paid is $741.27. The bank underpays by 90 cents ($742.17 – 742.27). 90 cents is divisible by 9. Try it, any two numbers side by side, then reversed and you’ll get a value divisible by 9.

Example 2 – A deposit is made for $673.45 and the bank credits the account for $637.45. The difference is $36. 36 is divisible by 9.

Other common discrepancies include:

• Errors in deposits whereby the bank issues a notice of the accounting error to the customer. This notice takes several days to physically receive in the mail, but is instantly corrected via an electronic debit or credit to the account. This is common with high volume transaction businesses; think of retail and medical offices.
• An unusual deduction due to a legal action is also common. Governmental taxing authorities will issue levies instantly removing funds from the bank account. This is a serious matter and I encourage bookkeepers to communicate with owners and the company’s CPA in regard to pending legal actions.
• Another common discrepancy is the owner or owner’s spouse taking money without notifying you or the accountant. Don’t forget, it is their money but they should agree to follow a process to prevent overdrafts or having inadequate funds for disbursements or payroll.

Summary – Bank Reconciliations

Bank reconciliations are a daily task and easy to process if done regularly. Modern technology allows access to the bank’s information about the respective account. By comparing the bank’s information against the ledger for the cash account the bookkeeper can easily figure out the correct balance.

On the bank side, simply add any outstanding deposits and subtract any outstanding checks or debits to the account. As for the ledger, look at the recent activity in the bank’s presentation for any unrecorded transactions. Enter these items in the respective journals to finally reconcile the bank account. Act on Knowledge.

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