Home / Part 3 / Chapter 8 / P2

Bank Reconciliation

🎯 Learning Objectives

  • Understand the purpose and importance of bank reconciliation
  • Identify the causes of differences between bank and book balances
  • Prepare a bank reconciliation statement
  • Record adjusting entries based on bank reconciliation findings
  • Explain why timing differences occur between bank records and company records
  • Apply proper procedures for outstanding checks and deposits in transit

📚 Background & Principles

Bank reconciliation is the process of comparing the bank statement balance to the cash balance in the company's books to identify and explain differences. This process ensures that the recorded cash balance is accurate and helps detect errors or unauthorized transactions.

Core Principle: The bank statement balance rarely equals the book balance due to timing differences (items recorded by one party but not the other) and errors. The goal is to adjust both balances to determine the TRUE cash balance.
💡 Key Insight: Think of it like comparing your checkbook register to the bank's statement—who is right? Neither! You both have incomplete information. The reconciliation shows the "true" cash balance by combining both views.

🔑 Key Concepts

Deposits in Transit

Deposits made but not yet recorded by the bank (added to bank balance).

Outstanding Checks

Checks written but not yet cleared by the bank (subtracted from bank balance).

Bank Service Charges

Fees charged by the bank for services (subtracted from book balance).

NSF Checks

Checks deposited but returned due to insufficient funds (subtracted from book balance).

Interest Earned

Interest credited by the bank (added to book balance).

Errors

Mistakes made by the bank or company that need correction.

🔍 Deep Dive

Explore bank reconciliation at different levels of depth:

🟢 Foundational Level

Understanding why reconciliations are needed.

The "Truth" Check

Who is right: You or the Bank?

Neither! Here's why:

Bank Side:

The bank doesn't know about the check you just wrote yesterday (Outstanding Checks) or the cash you put in the night drop (Deposits in Transit).

Book Side (You):

You don't know about the service fee they just charged or the customer check that bounced (NSF).

Goal:

Adjust both sides until they agree on the "True" Cash Balance.

Reconciliation Guide

ItemSideAction
Deposits in TransitBankAdd (+)
Outstanding ChecksBankSubtract (-)
Bank InterestBookAdd (+)
NSF Checks / FeesBookSubtract (-)
ErrorsEitherCorrection

🟡 Standard Level

Preparing the reconciliation statement.

Sample Bank Reconciliation

Company Name

Bank Reconciliation

October 31, 2025

Bank Statement Balance $2,050
Add: Deposit in transit 145
Less: Outstanding checks (710)
Adjusted Bank Balance $1,485
Book Balance $1,405
Add: Interest earned 40
Less: NSF check (50)
Less: Service charge (10)
Adjusted Book Balance $1,385

BALANCED! Both sides equal $1,385

🔴 Advanced Level

Recording adjusting entries and understanding controls.

Adjusting Entries from Bank Reconciliation

The book balance must be adjusted to match the "Adjusted Book Balance".

Date Account Title Debit Credit
Oct 31 Cash
  Interest Revenue		 $40
 		  
$40
Oct 31 Accounts Receivable
  Cash (NSF check)		 $50
 		  
$50
Oct 31 Miscellaneous Expense
  Cash (Service charge)		 $10
 		  
$10

🎨 Interactive: Adjusting the Balance

Adjust both sides to see if they reconcile:

Book Balance (Your Side)

Adjusted Book Balance: $1,385

Bank Balance (Their Side)

Adjusted Bank Balance: $1,485

🚫 Common Misconceptions & Professional Tips

❌ Misconception 1: "The bank statement balance should always equal the book balance."

✅ Reality: They rarely match! Timing differences and bank charges create discrepancies that the reconciliation identifies and explains.
❌ Misconception 2: "Outstanding checks are subtracted from the book balance."

✅ Reality: Outstanding checks are subtracted from the BANK balance (they're checks you've written but the bank hasn't processed yet).
❌ Misconception 3: "Bank reconciliations are optional."

✅ Reality: Bank reconciliations are a critical internal control. They detect errors, fraud, and unauthorized transactions. They should be done monthly.
💡 Professional Tip #1: Reconcile bank statements promptly each month—delays increase fraud risk and error accumulation.
💡 Professional Tip #2: Investigate any differences—no matter how small. Small errors often indicate larger problems.
💡 Professional Tip #3: Have someone other than the cash custodian perform the reconciliation for better internal control.

🧠 Memory Aids & Quick Reference

⚡ Quick Recall: Bank Reconciliation

BANK Side Adjustments:

Deposits in Transit (+), Outstanding Checks (-)

BOOK Side Adjustments:

Interest (+), Service Charges (-), NSF (-), Errors (+/-)

The Goal: Adjusted Bank = Adjusted Book

📍 Bank Side

Add Deposits in Transit, Subtract Outstanding Checks

📒 Book Side

Adjust for bank charges, interest, NSF, and errors

✅ Final Check

Adjusted Bank Balance = Adjusted Book Balance

📝 Aftermath

Record adjusting entries for book side items only

📖 Glossary

Bank Reconciliation

The process of comparing the bank statement balance to the book balance to identify and explain differences and determine the true cash balance.

Deposit in Transit

A deposit made by the company but not yet reflected on the bank statement due to processing time.

Outstanding Check

A check issued by the company that has not yet been presented to the bank for payment.

NSF Check

A check deposited and then returned by the bank due to insufficient funds in the payer's account.

Bank Service Charge

A fee charged by the bank for maintaining accounts or processing transactions.

Timing Difference

A difference between bank and book balances caused by items recorded by one party but not the other due to processing time.

Adjusted Bank Balance

The bank statement balance after adding deposits in transit and subtracting outstanding checks.

Adjusted Book Balance

The book balance after recording items shown on the bank statement (interest, charges, NSF).

🎯 Knowledge Check: Bank Reconciliation

Test your understanding of bank reconciliation:

Question 1: Deposits in transit are added to which balance?



Question 2: What is an NSF check?



Question 3: Outstanding checks are:



Question 4: Bank service charges are recorded on which side?



Question 5: After reconciliation, what should the two adjusted balances show?