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How To Do Bank Reconciliation In Four Steps?

I felt overwhelmed the first time I did an actual bank reconciliation for a company. I admit that I almost forgot the lessons I've learned in school on how to do bank reconciliation. Especially when it is the first time, you will not know what to do first. So here, we are going to discuss how to do bank reconciliation in four steps so a first timer can understand.

As an overview, we have to know first what is bank reconciliation. Bank reconciliation is the process of matching the cash account balances in the company's accounting records to the corresponding information in the bank statement. The goal of this process is to reconcile and ascertain the differences between the two, and to record the adjusting entries for the discrepancies and adjustments needed in the company's accounting records. The information on the bank statement is the bank's record of all transactions impacting the company's bank account during the past month. A bank reconciliation should be completed at regular intervals for all bank accounts, mostly in a monthly basis, to ensure that a company's cash records are correct.

So, what are records needed in the bank reconciliation? We need to obtain two records : book records of cash and bank records. The book records consist of the cash ledgers of receipts and disbursements. Basically, receipts are reflected in the summary of collections and deposits while disbursements are reflected in the report of checks issued. We have to understand that the company must be issuing checks in its disbursements so they are making monthly reports of checks issued. The bank records, on the other hand, consist of  the monthly bank statements and the returned checks from the bank. The bank reconciliation process will then reconcile the book records with the bank records. Any discrepancy will be reflected as adjustments and reconciling items.

We need to understand first the following terms so we can go on with the bank reconciliation:
  •  Deposit In Transit. These are  cash items or collections that are not yet deposited or if deposited but not yet reflected in the bank statements. Another term most analogous to deposit in transit is the undeposited collections or undeposited cash. It is in transit because it is awaiting for deposit. These items were already recorded in the books of the company but not yet reflected in the bank records. The deposit is not yet recorded in the bank statements so it becomes a reconciling item in the bank reconciliation. The item or items may have been deposited already but arrives at the bank too late for it to be recorded or included in the bank statements. Deposit in transit is a bank reconciling item.

  • Outstanding Checks. These checks are already issued by the company to its suppliers, or payee in this matter, but are not yet presented to the bank for encashment. As a result, these checks are not yet reflected in the bank statement for the month. These items were already recorded in the books of the company but not yet reflected in the bank records. Outstanding checks are bank reconciling items in the month-end bank reconciliation.

  • NSF Check. This check is received by the company from another company or person and then subsequently deposited to its bank but was dishonored and returned by the bank of the entity issuing the check on the grounds that the entity's bank account does not contain sufficient funds. NSF is an acronym for "not sufficient funds." The company attempting to cash an NSF check may be charged a processing fee by its bank. The entity issuing an NSF check will certainly be charged a fee by its bank. This item is recorded in the books but reflected as a deduction in the bank statement because it is dishonored by the issuing bank. NSF Check is a book reconciling item.

  •  Debit Memo. Refers to the deductions in the bank statement which are not yet reflected in the books of the company. NSF checks are one of them. Another examples of this are bank service charges, cost of checkbooks, processing fees, and bank collection fees. A debit memo is a book reconciling item.

  •  Credit Memo. Refers to the additions in the bank statement which are not yet reflected in the books of the company. Examples of this are the collection made by the bank in behalf of the company and interest earned. A credit memo is a book reconciling item.
There are three methods of presenting the bank reconciliation : book to bank method, bank to book method, and the adjusted book and bank balance method. We will be discussing here the third method, the adjusted balance method. The first two methods start the reconciliation from either book or bank and then end up in the reverse.

The following table shows how the bank reconciliation is presented:
Add : Credit Memo's
     Collections Made By Bankxxx
     Interest Income, net of taxxxx
Deduct : Debit Memo's
     Bank Service Chargesxxx
     Processing and Collection Feesxxx
     NSF Checksxxx
Add/Deduct : Book Errors, if anyxxx
Add : Deposit in Transitxxx
Deduct : Outstanding Checksxxx
Add/Deduct : Bank Errors, if anyxxx

We are now going to discuss the bank reconciliation process. Basically, a bank reconciliation process has four steps at the very least. We will described each process so we can understand how the bank reconciliation is done. We are using manual reconciliation here rather than an automated bank reconciliation so we can grasp the basic principles of bank reconciliation.

1. Adjusting the Balance per Bank

Using the bank statement, we need to clear first the returned checks from the bank against the bank statement in order to discover errors in the bank statement. The errors will be reported to the bank and will become reconciling items in our bank reconciliation. After clearing the returned checks, we are now going to adjust the balance per bank statement to the true, adjusted, or corrected balance. First, we have to look for the undeposited cash collections or deposit in transit by comparing the book collections with the bank credits one by one. Our focus here is on the book records. In this stage, we are going to identify the collections that are recorded in the books of the company but not reflected in the banks statement. These are our deposit in transit. Next, we are going to look for the checks that are already recorded in the books of the company but are not reflected in the bank statement. We are going this again manually one by one. These are our outstanding checks.

2. Adjusting the Balance per Books

The second step of the bank reconciliation process is to adjust the balance of the company's cash account so that it becomes the true, adjusted, or corrected balance. In this step, we are going to compare the book records with the bank records and look for items that were credited or debited by the bank which are not reflected in the books of the company. Our focus here is on the bank statement. We have to add all the items credited by the bank in our books and deduct all the the items debited by the bank so we can arrive at the adjusted book balance. Errors discovered in the books of the company will also form part of the reconciling items.

3. Comparing the Adjusted Balances

After adjusting the balance per bank (in step one) and the balance per books (in step two), the two adjusted balances should be equal. If they are not equal, you must repeat the process until the balances are identical. The balances should be the true, correct amount of cash as of the date of the bank reconciliation.

4. Preparing the Journal Entries

 The journal entries must be prepared for the reconciling items on the adjusted book balance (in step two). Adjustments to increase the cash balance will require a journal entry that debits Cash and credits another account. Adjustments to decrease the cash balance will require a credit to Cash and a debit to another account. Adjustments on the adjusted bank balance (in step one) need not journal entries but bank errors discovered will be reported to the bank.

That's it! You can now do monthly bank reconciliations by yourself. If you do like this article, please do not forget to subscribe below so you can read our posts in your email and you will never miss a single post. Thank you for reading and have a nice day.

Disclaimer : Opinions expressed in this article are that of the author and information provided are for general conceptual guidance for public information only and are not substitute for advice from qualified professional or an expert opinion. Contact support@cpadavao.com for more information and/or if you want to avail professional services from a qualified professional. This site accepts and publishes contributions from accountants and business professionals, especially articles that are of interest to the accountancy profession, in particular, and to the business community, in general. Please email your articles to publisher@cpadavao.com together with your bio and affiliations for publication in this website.

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About Vincent Perdiguez

CPADavao.com is a "business blog" maintained by Mr. Vincent C. Perdiguez. Vincent is an accountant by profession. He has a passion of writing about accounting, business and the profession. He is an alumnus of the Mindanao State University - Iligan Institute of Technology (MSU-IIT). He has been working as a bookkeeper and internal auditor of small and medium businesses here in Davao City and is currently working as a government employee. You can reach him through mobile at 0916-2764-585 (Globe) or by email to vincent.perdiguez@cpadavao.com. Thank you for subscribing to us.
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