What is bank reconciliation?

     Before we answer the question, let us have a background on the matter of opening a demand deposit or checking account. Incidentally, of the three kinds of deposit, a bank reconciliation is necessary only for a demand deposit or checking account.

     When an account is opened at the bank, the person authorized to draw checks against the account will be required to sign cards furnished by the bank, to show the specimen signatures to be used on the checks.

     These specimen signatures will be filed by the bank so that any teller who may be unfamiliar with a depositor's signature can test the authenticity of a check by comparing the depositor's signature on the card with thge signature on the check.

     If the depositor is a corporation, the bank will request that the director pass a resolution authorizing certain officers of the corporation as signatories of checks and that copy of this resolution be filed with the bank.






Bank Reconciliation

     A bank reconciliation is a statement which brings into agreement the cash balance per book and cash balance per bank. It is usually prepared monthly because the bank provides the depositor with the bank statementat the end of every month.

     A bank statement is a monthly report of the balance to the depositor showing the cash balance per bank at the beginning, the deposits acknowledged, the checks paid, other charges and credits and the daily cash balance per bank during the month. Actually, the bank statement is an exact copy of the depositor's ledger in the records of the bank.

     When the bank statement is received, attached thereto are the depositor's canceled checks and any debit or credit memoranda that have affected the depositor's account. The canceled checks are the checks issued by the depositor and paid by the bank during the month. They are called canceled checks because thay are literally canceled by stamping or punching toi show that they have been paid.


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Reconciling Items

     At the end of every month, comparison between the cash records of the depositor and the bank statement received from the bank will yield the following reconcilinmg items:

1. Book reconciling items:

    a. Credit memos

    b. Debit memos

    c. Errors

2. Bank reconciling items:

    a. Deposit in transit

    b. Outstanding checks

    c. Errors

Typical examples of credit memos are:

   a. Notes receivable collected by the bank in favor of the depositor and credited to the account of the depositor.

   b. Proceeds of the bank loan credited to the account of the depositor.

   c. Matured time deposits transferred by the bank to the current account of the depositor.

Typical examples of debit memos are:

   a. NSF or no sufficient fund checks

   b. Technically defective checks

   c. Bank service charges

   d. Reduction of loan

Deposit in transit include:

   a. Collection already forwarded to the bank for deposit but too late to appear in the bank statement.

   b. Undeposited collections or those still in the hands of the depositor. In effect, these are cash on hand awaiting delivery to the bank for deposit.

Outstanding checks include:

   a. Checks drawn and already given to payees but not yet presented for payment.

   b. Certified checks


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Forms of Bank reconciliation


The following formats may be used in reconciling the book balance and the bank balance:

   a. Adjusted Balance Method - Under this method, the book balance and the bank balance are brought to correct cash balance that must appear on the balance sheet.

   b. Book to Bank Method - Under this method, the book balance is reconciled with the bank balance or the book balance is adjusted to equal the bank balance.

   c. Bank to Book Method - Under this method, the bank balance is reconciled with the book balance or the bank balance is adjusted to equal the book balance.

The first method is preferred over the other two.


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Proforma Reconciliation


   a. Adjusted Balance Method

Book balancexx
Add: Credit memosxx
Totalxx
Less: Debit memosxx
Adjusted Book Balancexx
Bank Balancexx
Add: Deposits in transitxx
Totalxx
Less: Outstanding Checksxx
Adjusted Bank balancexx

     The adjusted balance method means that the book balance and the bank balance are adjusted to equal the correct cash balance.

     Credit memos already increased the bank balance but have no effect on the book balance because the credit memos are not yet recorded by the depositor. Consequently, the book balance is understated in relation to the correct cash balance. Hence, credit memos are added to the book balance.

     Debit memos already decreased the bank balance because the debit memos are not yet recorded by the depositor. Consequently, the book balance is overstated in relation to the correct cash balance. Hence, debit memos are deducted from the book balance.

     Deposits in transit already increased the book balance but have no effect on the bank balance because the deposits are not yet recorded by the bank. Consequently, the bank balance is understated in relation to the correct cash balance. Hence, deposits in transit are added to the bank balance.

     Outstanding checks already dcreased the book balance but have no effect on the bank balance because the checks are not yet paid by the bank. Consequently, the bank balance is overstated in relation to the correct cash balance. Hence, outstanding checks are deducted from the bank balance.


   b. Book to Bank Method

Book balancexx
Add: Credit memosxx
Outstanding Checksxx
Totalxx
Less: Debit memosxx
Deposits in transitxxxx
Bank balancexx

     When the reconciliation starts with the book balance and ends with the bank balance, the usual book reconciling items are treated in the same manner they are treated in the "adjusted balance method", that is, credit memos are added and debit memos are deducted. However, with respect to the bank reconciling items the treatment is simply "reversed". Thus, since the deposit in transit is added to the bank balance, it is now deducted from the book balance, and since the outstanding check is deducted from the bank balance, it is now added to the book balance.

     The explanation for the "reversal rule" on the treatment of the bank reconciling items may be stated as follows:

     The book to bank method means that the book balance is adjusted to equal the bank balance.

     Deposits in transit already increased the book balance but have no effect on the bank balance because the deposits are not yet recorded by the bank. Consequently, the book balance is overstated in relation to the bank balance. Hence, deposits in transit are deducted from the book balance following the book to bank method.

     On the other hand, outstanding checks already decreased the book balance but have no effect on the bank balance because the checks are not yet paid by the bank. Consequently, the book balance is understated in relation to the bank balance. Hence, outstanding checks are added to the book balance, following the book to bank method.


   c. Bank to Book Method

Bank balancexx
Add: Deposits in transitxx
Debit Memosxx
Totalxx
Less: Outstanding checksxx
Credit Memosxx
Book balancexx

     When the reconciliation starts with the bank balance and ends with the book balance, the usual bank reconciling items are treated in the same manner they are treated in the "adjusted balance method", that is, deposit in transit is added and outstanding check is deducted.

     However, with respect to the book reconciling items, the treatment is simply "reversed". Thus, since the credit memos is added to the book balance, they are now deducted from the bank balance, and since the debit memos is deducted from the book balance, it is now added to the bank balance.

     The explanation for the "reversal rule" on the treatment of the book reconciling items may be stated as follows:

     The bank to book method means that the bank balance is adjusted to equal the book balance.

     Debit memos already decreased the bank balance but have no effect on the book balance because the deposits are not yet recorded by the depositor. Consequently, the bank balance is understated in relation to the book balance. Hence, debit memos are added to the bank balance.

     On the other hand, credit memos already increased the bank balance but have no effect on the book balance because they are not yet recorded by the depositor. Consequently, the bank balance is overstated in relation to the book balance. Hence, credit memos are deducted to the bank balance.


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Preparation of adjusting entries

     Only the book reconciling items require adjusting entries on the book of the depositor. This is but understandable. The adjustments are necessary to bring the cash bank balance to its correct balance for balance sheet purposes. In the given problem, the pertinent adjustments are:

a. To record the note collected by bank:
Cash in bankxx,xxx
   Notes receivablexx,xxx
b. To record the returned check or NSF check:
Accounts receivablexx,xxx
   Cash in bankxx,xxx
c. To record the bank service charge:
Bank service chargexx,xxx
   Cash in bankxx,xxx

     In preparation of adjustments, an item added to the book balance is debited to cash and an item deducted from the book balance is credited to cash.


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Some errors and their treatment.

a. Understatement of cash receipts on the book of depositor.

   For instance, the collection from customer which is deposited amounts to    P10,000 but recorded in the book only as P1,000. There is an understatement    of cash receipt of P9,000. The error is added to the book    balance and adjusted as follows:

Cash in bank9,000
   Accounts receivable9,000

b. Understatement of checks drawn by depositor.

   For instance, a check in payment of account payable amounting to P20,000 is    recorded in the book as P2,000. There is an understatement of cash    disbursement and a consequent overstatement of book balance in the amount of    P18,000. The error is deducted from the book balance and adjusted, as follows:

Accounts payable18,000
   Cash in bank18,000

c. Deposit of another company is credited by the bank to own account.

   This is a deduction from the bank balance because it erroneously increased    our account balance in the bank. No adjustment is necessary on the book of the depositor.

d. Check of another company charged to our account.

   This is an addition to the bank balance because it erroneously decreased our    account balance in the bank. No adjustment is necessary on the book of the depositor.