Comprehensive Study Notes on Bank Reconciliation

Fundamentals of Cash and Cash Records

• Definition of Cash: Money that a person or business has available to use immediately for purchases, payments, or other expenses.

• Accounting Entries for Cash:

  • Cash Receipts: When a company receives cash, the Cash account is increased by debiting it.
  • Cash Payments: When a company pays cash, the Cash account is decreased by crediting it.

• Record Keeping:

  • The company's accountant or bookkeeper maintains the company's accounting records, including all cash and bank account transactions.
  • Simultaneously, the bank maintains an independent record of the company's account transactions.

• Reasons for Balance Discrepancies:

  • If a company's cash book balance is $\text{₱100,000}$ and the bank statement balance is $\text{₱95,000}$, it does not automatically mean an error occurred.
  • Discrepancies between the two cash records typically arise because certain transactions have been recorded on one side but have not yet been processed or recorded by the other.

Overview of Bank Reconciliation

• Definition: Bank reconciliation is the formal accounting process of comparing the company's cash balance per books with the cash balance per bank statement and explaining all differences between them.

• The Two Balances:

  • Balance per Bank: The cash balance indicated on the bank statement issued by the bank.
  • Balance per Books: The cash balance recorded in the company's Cash account or general ledger cash records.

• Primary Objective:

  • The ultimate goal of bank reconciliation is to adjust both balances to determine the true cash amount, satisfying the condition:   $\text{Adjusted Bank Balance} = \text{Adjusted Book Balance}$

• Importance of Bank Reconciliation:

  • Detect accounting or banking errors.
  • Identify missing transactions.
  • Detect unauthorized or fraudulent transactions.
  • Update the company's accounting records.
  • Determine the correct, usable cash balance.
  • Improve overall internal control over cash.

• Investigating Differences Example:

  • Suppose the bank statement shows $\text{₱80,000}$ and internal books show $\text{₱75,000}$.
  • It cannot be assumed that the $\text{₱5,000}$ variance is an error.
  • Detailed investigation may reveal that $\text{₱3,000}$ is a deposit in transit and $\text{₱2,000}$ is a bank collection not yet recorded in the company's books.

Common Reconciling Items and Treatments

• Deposit in Transit:

  • Definition: A deposit already recorded in the company's books but not yet processed or recorded by the bank.
  • Example: The company deposits $\text{₱10,000}$ and records it in its cash ledger, but the bank has not yet processed the deposit.
  • Treatment: ADD to the bank balance ($+\text{₱10,000}$).
  • Rationale: The company's internal records already include the deposit, but the bank statement balance does not.

• Outstanding Checks:

  • Definition: A check already issued and recorded by the company but not yet presented to or cleared by the bank.
  • Example: The company issues a check for $\text{₱8,000}$ and reduces its book balance, but the check has not yet cleared the bank.
  • Treatment: DEDUCT from the bank balance ($-\text{₱8,000}$).
  • Rationale: The book balance has already been reduced, but the bank statement has not yet deducted the check amount.

• Bank Service Charge:

  • Definition: Fees charged by the bank for account servicing or transactions.
  • Example: The bank levies a service charge of $\text{₱500}$.
  • Treatment: DEDUCT from the book balance ($-\text{₱500}$).
  • Rationale: The bank has already deducted this fee from the account balance, but the company has not yet recorded the expense in its books.

• Bank Collection:

  • Definition: Amounts collected by the bank directly on behalf of the company.
  • Example: The bank collects $\text{₱10,000}$ from a customer on behalf of the company.
  • Treatment: ADD to the book balance ($+\text{₱10,000}$).
  • Rationale: The bank has already added the funds to the bank balance, but the company has not yet entered the receipt into its accounting books.

• Interest Earned:

  • Definition: Interest earned on account balances that the bank credits to the account.
  • Example: Interest credited by the bank equals $\text{₱1,000}$.
  • Treatment: ADD to the book balance ($+\text{₱1,000}$).
  • Rationale: The bank statement balance includes the earned interest, but the company has not yet recorded the income in its internal books.

• NSF (Not Sufficient Funds) Check:

  • Definition: A customer check previously deposited by the company that is returned unpaid by the bank because the customer's account lacks sufficient funds.
  • Example: A customer check amounting to $\text{₱3,000}$ is returned by the bank as NSF.
  • Treatment: DEDUCT from the book balance ($-\text{₱3,000}$).
  • Rationale: The company previously recorded the check as cash received. Because it was returned unpaid, the cash must be deducted from the books, and the amount owed must be restored to accounts receivable.

• Bank Error:

  • Treatment: Adjust on the Bank side (Add or Deduct depending on the specific error).

• Book Error:

  • Treatment: Adjust on the Book side (Add or Deduct depending on the specific error).

Summary Matrix and Adjusting Journal Entries

• Reconciling Item Location & Action Summary:

  • Deposit in transit: Adjust Bank $\rightarrow$ Add
  • Outstanding checks: Adjust Bank $\rightarrow$ Deduct
  • Bank service charge: Adjust Books $\rightarrow$ Deduct
  • NSF check: Adjust Books $\rightarrow$ Deduct
  • Bank collection: Adjust Books $\rightarrow$ Add
  • Interest earned: Adjust Books $\rightarrow$ Add
  • Bank error: Adjust Bank $\rightarrow$ Add or Deduct depending on error
  • Book error: Adjust Books $\rightarrow$ Add or Deduct depending on error

• Requirement for Journal Entries:

  • Items that have not yet been recorded in the company's books (book-side adjustments such as bank service charges, NSF checks, bank collections, and interest earned) usually require adjusting journal entries to update the cash balance in the general ledger.

Comprehensive Practice Problems and Step-by-Step Solutions

• Worked Example 1: Calculating Adjusted Bank Balance:

  • Given Data:
  • Balance per bank statement: $\text{₱100,000}$
  • Deposit in transit: $\text{₱15,000}$
  • Outstanding checks: $\text{₱20,000}$
  • Objective: Determine the adjusted bank balance.
  • Solution Steps:
  • Start with Balance per bank = $\text{₱100,000}$
  • Add Deposit in transit = $+\text{₱15,000}$
  • Subtract Outstanding checks = $-\text{₱20,000}$
  • Calculation:     $\text{₱100,000} + \text{₱15,000} - \text{₱20,000} = \text{₱95,000}$
  • Final Output: Adjusted Bank Balance = $\text{₱95,000}$

• Worked Example 2: Full Reconciliation for XYZ Company:

  • Given Data:
  • Balance per bank statement: $\text{₱120,000}$
  • Balance per books: $\text{₱110,000}$
  • Deposit in transit: $\text{₱15,000}$
  • Outstanding checks: $\text{₱20,000}$
  • Bank service charge: $\text{₱1,000}$
  • Bank collection: $\text{₱6,000}$
  • Step 1: Bank Side Adjustment:
  • Balance per bank: $\text{₱120,000}$
  • Add Deposit in transit: $+\text{₱15,000}$
  • Less Outstanding checks: $-\text{₱20,000}$
  • Calculation:     $\text{Adjusted Bank Balance} = \text{₱120,000} + \text{₱15,000} - \text{₱20,000} = \text{₱115,000}$
  • Step 2: Book Side Adjustment:
  • Balance per books: $\text{₱110,000}$
  • Add Bank collection: $+\text{₱6,000}$
  • Less Bank service charge: $-\text{₱1,000}$
  • Calculation:     $\text{Adjusted Book Balance} = \text{₱110,000} + \text{₱6,000} - \text{₱1,000} = \text{₱115,000}$
  • Conclusion:
  • $\text{Adjusted Book Balance} = \text{₱115,000}$
  • $\text{Adjusted Bank Balance} = \text{₱115,000}$
  • Both adjusted balances are equal; therefore, the bank reconciliation is complete.

• Worked Example 3: Discrepancy Investigation for LMN Company:

  • Given Data:
  • Balance per bank statement: $\text{₱90,000}$
  • Balance per books: $\text{₱84,000}$
  • Deposit in transit: $\text{₱7,000}$
  • Outstanding checks: $\text{₱10,000}$
  • Bank service charge: $\text{₱500}$
  • Bank collection: $\text{₱9,500}$
  • Bank Side Computation:
  • Balance per bank: $\text{₱90,000}$
  • Add Deposit in transit: $\text{₱7,000}$
  • Less Outstanding checks: $\text{₱10,000}$
  • Calculation:     $\text{Adjusted Bank Balance} = \text{₱90,000} + \text{₱7,000} - \text{₱10,000} = \text{₱87,000}$
  • Book Side Computation:
  • Balance per books: $\text{₱84,000}$
  • Add Bank collection: $\text{₱9,500}$
  • Less Bank service charge: $\text{₱500}$
  • Calculation:     $\text{Adjusted Book Balance} = \text{₱84,000} + \text{₱9,500} - \text{₱500} = \text{₱93,000}$
  • Rule for Unmatched Balances:
  • Never force the two balances to agree.
  • If the adjusted bank balance ($\text{₱87,000}$) does not equal the adjusted book balance ($\text{₱93,000}$), investigate further to locate omitted items or errors.