A Key Note on Bank Reconciliation

In this article, we will talk about bank reconciliation, its importance, meaning and methods of preparing a bank reconciliation statement, and the reasons for errors between the cash book and the bank passbook.

In accounting, bank reconciliation is the process by which an entity’s accounting records for a cash account are compared to its respective information in the bank statement. A bank statement, also known as a passbook in general terms, is a copy of the bank account of the entity, as shown by the bank records. It allows the customers to check their funds and keep a record of their transactions. 

Ideally, the balance shown in the passbook should match the balance of the cash book. However, that is not the case usually. There can be differences in the bank passbook and cashbook due to several reasons. This is where bank reconciliation comes to use. 

Significance of Bank Reconciliation

• It helps in finding errors such as missed payments, faulty payments, errors in calculation, etc.
• It helps to keep a track of bank deductions such as penalties and fees.
• It is useful in identifying fraudulent activities and theft. 
• It is useful in keeping a record of transactions and funds. 
• It helps to identify the possible reasons for the delay in payments and keep a check on information on the bank statement. 

Bank Reconciliation Statement

• A bank reconciliation statement refers to the summarised version of the process of reconciliation. 
• It confirms statements about processed payments and cash collections deposited into a bank account.
• A bank reconciliation statement accounts for all the deductions and fees charged on an account that might have been missed during the initial report.
• After all the adjustments are made, the balance on a bank reconciliation statement should equal the ending balance of the bank account.

Methods of Preparing Bank Reconciliation Statement

After identifying the reasons for the errors, there are two methods of preparing a bank reconciliation statement. 

Preparation of the statement without adjusting the cash book balance.

Under this approach, the balance as per the cash book or passbook is the first item on the bank reconciliation statement. Debit balance as per cash book or credit balance as per passbook refers to the balance of funds held at the bank. It refers to the favourable balance as per the cash book or passbook. It exists when the deposits made are more than the withdrawals. Credit balance as per cash book or debit balance as per passbook refers to bank overdraft, where withdrawals made are more than the deposits. It refers to the unfavourable balance as per the cash book or passbook.

Under favourable balance-

In this case, the first item mentioned above is the bank’s beginning cash balance. Then the following adjustments are made-

• Cheques that were issued for payment but are yet to be collected; direct deposits made to the bank account; credits made to the bank account such as interest, dividend, etc., are added to the balance.
• Cheques that were deposited but are yet to be collected; all the payments made directly by the banks such as insurance premiums, made under prior instruction; all the fees and deductions made by the bank that was not entered in the cashbook are subtracted from the balance. 
• These adjustments are made according to the principle of rectification of errors. After these changes are made the balance as per the cash book should match the balance as per the passbook. 
• If the balance mentioned in the beginning is as per the passbook, all the adjustments mentioned above will be reversed. 

Under unfavourable balance-

Unfavourable balance refers to a negative balance or overdraft.

Any or every deduction that is to be made, as well as the cheques that are yet to be collected and other payments that are recorded as being subtracted from that negative balance, increase the overdraft. 

All the payments that are received, cheques presented for payment but not yet collected, as well any income received or wrong debits made by the bank are recorded as being added to that negative balance, decreasing the overdraft. 

Preparation of the statement after adjusting the cash book balance

While preparing a bank reconciliation statement, we find various adjustments that are partial to the passbook. Under this approach, these adjustments are already recorded in the cash book before the preparation of the statement and the balance is called the amended balance. A bank reconciliation that is later prepared adjusts only the errors that are caused due to the time gap. 

Example of Bank Reconciliation Statement

Question- From the following particulars of ABC and co. prepare a bank reconciliation statement as on March 31, 2020.

• Bank balance as per cash book Rs. 50,000
• Cheques issued but not presented for payment Rs. 6,000
• The bank had directly collected a dividend of Rs. 8000 and credited it to the bank account but it was not recorded in the cash book.
• Bank charges of Rs.400 were not entered in the cash book.
• A cheque of Rs. 6000 was deposited but not collected by the bank. 
• The Reasons For Errors Between The Cash Book And The Bank Passbook
• There are two main reasons for the difference between the cash book and the passbook. These are-
• Timing differences While comparing the cashbook and the passbook, there is a time difference in recording the transactions regarding either the payments or receipts.

The factors that affect the time difference are as follows-

• Cheques issued by the bank that are yet to be presented for payment
• Cheques that are paid to the bank but are yet to be collected.
• Direct deductions that are made by the bank on behalf of the entity like fees payments or interest on overdraft.
• Amounts that are deposited into the bank account directly.
• Dividends and interest collected directly by the bank.
• Payments that are made by the bank directly like an insurance premium.
• Dishonoured cheques and discounted or dishonoured bills. 

Differences due to errors

Sometimes there is an error while recording the transactions. The factors are as follows-

• Errors committed by the bank while recording the transaction like calculation errors, omissions or wrong recording, etc. 
• Errors committed by the entity while recording the transaction like calculation errors, omissions or wrong recording, etc. 

Conclusion

Bank reconciliation helps in comparing cash books and passbooks. It keeps a check on business transactions and helps to keep fraudulent activities at bay. It also helps in keeping a record of funds. There are two methods of maintaining a bank reconciliation statement – preparation without adjusting the cash book and preparation of bank reconciliation statements after adjusting the cash book. Both methods have their merits and demerits. There are two main reasons for the differences in the cashbook and passbook – time gap that leads to a lot of unrecorded transactions and errors while recording that result in recording omissions or wrong calculations and sometimes even double recording.