🔍 Chapter 3.3: Bank Reconciliation – Making Sure the Money Matches!
Hello future accountants! Don't worry if the term "Bank Reconciliation" sounds complicated. It’s actually a crucial, everyday task businesses perform to make sure their records match the bank's records. Think of it like comparing your personal budgeting app to your bank statement—they should agree, but often they don't, usually because you forgot to record a recent payment!
This chapter is part of the 'Verification of Accounting Records' section. Its main goal is to identify and correct differences between two key documents related to the business’s cash (bank) balance.
What is Bank Reconciliation and Why Do We Do It?
A business keeps track of all its bank transactions in the bank column of its Cash Book (which is part of the business's Ledger). The bank keeps track of the same transactions on the Bank Statement.
In a perfect world, the final balance in the Cash Book should exactly match the final balance shown on the Bank Statement on the same date. But in reality, they rarely do! This difference is known as a reconciling difference.
Purpose of Bank Reconciliation:
- Verification: To ensure that both the bank and the business have recorded all transactions correctly.
- Catching Errors: To identify any mistakes made by the business (in the Cash Book) or by the bank (in the Bank Statement).
- Determining the True Balance: To calculate the actual, correct amount of cash the business has (or owes the bank) at the end of the period.
The Two Sides of the Coin: Understanding Debit and Credit Balances
One of the trickiest concepts here is understanding why the Cash Book balance and the Bank Statement balance are often mirror images of each other. This is all down to perspective!
Perspective Check:
- In the Business’s Cash Book (Our View): The Bank account is an Asset (money we own).
- Money coming IN (receipts) is a DEBIT (increase in asset).
- Money going OUT (payments) is a CREDIT (decrease in asset).
- A positive balance (money in the bank) is a Debit Balance.
- In the Bank Statement (The Bank’s View): The money we deposit is a Liability for the bank (money they owe us).
- Money coming IN (deposits) is a CREDIT (increase in bank's liability to us).
- Money going OUT (withdrawals) is a DEBIT (decrease in bank's liability to us).
- A positive balance (money in the bank) is a Credit Balance.
Quick Tip: If your Cash Book shows a Debit balance of $500, the Bank Statement should show a Credit balance of $500. They are the same amount, just labeled differently!
Identifying the Differences (Why the Balances Don't Match)
The differences arise because of two main reasons:
Category A: Items only known by the Bank (Requires Cash Book Update)
These are items the business has not yet recorded because they were only noted by the bank, usually automatically. The business learns about them only when they receive the bank statement.
- Bank Charges (Interest Paid): Fees charged by the bank for services (e.g., monthly service charges).
- Bank Interest Received (Dividends): Money earned on the bank balance or investments the bank handled. Dividends are profits paid to shareholders (us) which the bank collects on our behalf.
- Credit Transfers (Receipts): Money transferred directly into the business's bank account by a customer (e.g., an electronic transfer). The business didn't issue a receipt or know about it immediately.
- Direct Debits: Authorisation given to a supplier to automatically take payment from the bank account (e.g., monthly rent or utility bills).
- Standing Orders: Instructions given to the bank to pay a fixed amount to a specific creditor regularly (e.g., loan repayment).
- Correction of Errors: Errors made previously by the bank or the business that are now being fixed (e.g., the bank miscalculating a fee).
Category B: Items only known by the Business (Requires BRS Preparation)
These items have been recorded in the Cash Book, but the bank has not yet processed them by the statement date.
- Unpresented Cheques: Cheques issued by the business and recorded as a payment (Credit) in the Cash Book, but the payee (the person we paid) has not yet deposited or cashed the cheque at the bank. The bank has not yet deducted the money.
- Uncredited Deposits (Lodgements): Money (cash or cheques) received by the business and immediately recorded as a receipt (Debit) in the Cash Book, but the bank has not yet processed the deposit (e.g., we deposited cash late on the statement date, so the bank processes it the next day).
- Bank Errors: Mistakes made by the bank itself, such as crediting another customer’s deposit to our account. (These are dealt with *only* on the BRS, as we cannot change the bank's records).
🔑 Quick Review: Who is Missing the Information?
If the BANK knows it, the CASH BOOK needs updating (Category A).
If the BUSINESS knows it, the BANK STATEMENT BALANCE needs reconciling (Category B).
Step 1: Updating the Cash Book
Before preparing the reconciliation statement, we must first make our Cash Book correct and up-to-date. We only record the items from Category A (items the bank knew about that we did not).
This process results in an Adjusted Cash Book Balance (or Updated Cash Book Balance).
Process for Updating the Cash Book (Bank Column Only):
Start with the unadjusted balance from the previous period (or given trial balance balance).
| Cash Book Account | Effect | Ledger Entry |
| Bank Interest Received / Dividends / Credit Transfers | Increases balance (Receipt) | Debit the Cash Book |
| Bank Charges / Interest Paid / Direct Debits / Standing Orders | Decreases balance (Payment) | Credit the Cash Book |
Example of an Updated Cash Book Extract:
Suppose the opening balance was $1,200 (Debit).
| Date | Details | Debit (\$) | Credit (\$) |
| 1 Jan | Balance b/d | 1,200 | |
| 31 Jan | Interest Received (new item) | 50 | |
| 31 Jan | Bank Charges (new item) | 20 | |
| 31 Jan | Direct Debit (Rent) (new item) | 200 | |
| 31 Jan | Balance c/d (Adjusted Balance) | 1,030 | |
| Totals | 1,250 | 1,250 |
The Adjusted Cash Book Balance is $1,030 Debit.
⚠️ Common Mistake Alert!
Do NOT include unpresented cheques or uncredited deposits (Category B items) in the updated Cash Book. They are already correctly recorded there! They belong only in the BRS.
Step 2: Preparing the Bank Reconciliation Statement (BRS)
The BRS is not a ledger account. It is a simple statement prepared to explain the remaining differences between the updated Cash Book balance and the Bank Statement balance.
We start with one figure (either the adjusted Cash Book balance or the Bank Statement balance) and adjust it using Category B items until we arrive at the other figure.
Structure of the Bank Reconciliation Statement:
We typically start with the Bank Statement balance (which is the figure *before* the bank processes the final items).
Purpose: To start with the Bank Statement Balance and arrive at the Adjusted Cash Book Balance (which is the true figure).
We will use the example Adjusted Cash Book Balance of $1,030 Debit from Step 1. Suppose the Bank Statement showed a Credit balance of $900.
Bank Reconciliation Statement at 31 January
| Details | \$ |
| Balance as per Bank Statement (Credit Balance) | 900 |
| Add: Uncredited Deposits (Lodgements) (Money we put in, bank hasn't processed) | + 200 |
| Less: Unpresented Cheques (Cheques we wrote, not yet cashed) | (70) |
| Less: Bank Error (e.g. Bank wrongly debited $10 from our account) | (10) |
| Balance as per Adjusted Cash Book (Debit Balance) | 1,020 |
(Wait, in this example, the resulting balance $1,020 does not match the Adjusted CB Balance $1,030. This indicates an error in the original figures or a missing item. In the exam, these two final balances MUST match if all reconciling items are accounted for.)
Let's assume the Adjusted CB Balance was actually $1,020.
If the final figures agree, the verification process is complete!
Understanding the Adjustments in the BRS:
- Uncredited Deposits (Add): Since the money is already in our Cash Book but not yet on the Bank Statement, we must ADD it to the Bank Statement balance to see what the bank *should* have recorded.
- Unpresented Cheques (Less): Since the payment has been recorded in our Cash Book but not yet deducted by the bank, we must SUBTRACT it from the Bank Statement balance to see what the bank *should* have recorded.
- Bank Errors: If the bank made an error, we correct the Bank Statement balance. If they wrongly *added* money, we subtract it. If they wrongly *subtracted* money, we add it back. We do NOT touch the Cash Book for bank errors.
Summary and Key Takeaways
The Two-Step Process:
- Update the Cash Book: Record all receipts and payments that the business was not aware of until the bank statement arrived (Direct Debits, Bank Charges, Interest, etc.). This gives you the Adjusted Cash Book Balance.
- Prepare the Bank Reconciliation Statement (BRS): Use the Bank Statement balance and adjust it for the timing differences (Unpresented Cheques, Uncredited Deposits) and Bank Errors. The final result should equal the Adjusted Cash Book Balance.
💡 Memory Aid for BRS Adjustments:
Think of it from the bank's perspective:
- Uncredited Deposits = Money WAITING to be added by the bank (so, ADD to B/S Balance).
- Unpresented Cheques = Money WAITING to be subtracted by the bank (so, LESS from B/S Balance).
Did You Know?
While most modern systems track funds instantly, bank reconciliation is still vital. Even electronic transfers can be subject to timing delays (especially across different banking systems) or human errors, making verification a necessary step for accurate financial reporting!