Bank Reconciliations
What is the purpose of a bank reconciliation? To calculate the difference between the bank balance and the book balance for cash. Why do they need to be reconciled? Because there are certain items that the accounting records know about that the bank doesn’t know about, and there are certain items that the bank knows about that the accounting records don’t know about.
Consider an outstanding check, which is when we have sent out a check for payment, but it hasn’t cleared the bank yet. Even though it hasn’t cleared the bank, we still have to decrease our cash balance. The books already know about the outstanding, but it hasn’t cleared the bank yet, so the bank doesn’t know about it.
Now consider a bank fee (e.g., your bank charges you a $12 monthly service fee). The books don’t know about this fee, so we need to make a manual journal entry to decrease the book cash balance.
Study Tip: For bank reconcilations, ask, “What do the accounting records know that the bank doesn’t know about?”
Items that the Accounting Records Know About, Bank Doesn’t Know About
Outstanding Checks
Deposits in Transit
Items that the Bank Knows About, Accounting Records Don’t Know About
Bank Fees
Bank Credits
Non-Sufficient Funds Checks
Errors
A deposit in transit is when we have a deposit we have sent to the bank, but it hasn’t cleared the bank yet. We have money coming into our account, but it hasn’t cleared our account yet. Even though it hasn’t cleared the bank, we increase the book cash balance as soon as we send it to the bank.
Bank credits are increases to the bank account such as cashback rewards and interest in- come. The bank knows about bank credits, but the books don’t know about them. We need to do a manual journal entry to record these bank credits.
Non-sufficient funds checks are checks that didn’t clear the bank because there weren’t enough funds in the bank. The bank knows that the check didn’t clear the bank, but the accounting records already decreased the cash when the check was sent (as an outstanding check). Since the check didn’t clear the bank, the books should be adjusted to add back the check.
Errors refers to recording a check for the incorrect amount in the accounting records (e.g., recording an outstanding check for $150 when it was actually for $105). The bank knows that the correct amount is $105, but the accounting records show $150, decreasing the accounting records by $45 too much. Therefore, the error should be added back to the accounting records to fix the error.