Bank Reconciliation
Why is it necessary to prepare bank reconciliation? Bank reconciliation is necessary only for a demand deposit or checking account. It is very seldom that we find our cash balance per book equals or balances with the balance per bank statement. I guess you are familiar with what a bank statement is.
A bank statement is a monthly report of the bank to the depositor showing the cash balance per bank at the beginning, the deposits entered, the checks paid, other charges and credits and the daily cash balance during the month. Actually, it is an exact copy of the depositor’s ledger in the bank’s records.
To answer the question, let us illustrate some fundamental transactions affecting the depositor and the bank.
Assume that Quilts & Shams Corporation (depositor) collected $10,000 from a customer in settlement of an account. The collection is deposited at Manhattan Bank. On the books of the corporation, the entry to record the collection and deposit is:
Debit Cash or Cash in bank.. 10,000; Credit Accounts receivable.. 10,000
On the books of the bank, the entry is:
Debit Cash.. 10,000; Credit Demand deposit.. 10,000
(The same is posted to the subsidiary ledger of Quilts & Shams Corporation).
When the bank credits the account of the depositor, it recognizes liability to the depositor. The law acknowledges a debtor-creditor relationship between the bank and the depositor. The bank is the debtor and the depositor being the creditor. Hence, when the account of the depositor is increased the same is credited.
Let us assume further, Quilts & Shams Corporation issued a check for $3,000 in payment of accounts payable. On the books of the company, the entry is:
Debit Accounts payable.. 3,000; Credit Cash in bank.. 3,000
The entry on the books of the bank is:
Debit Demand deposit.. 3,000; Credit Cash.. 3,000
When the company issued check, the payee will present the same to the bank for payment. The depositor is actually ordering the bank to pay the payee or holder of the check out of its deposit in the bank. This is the reason the bank debits the account of the depositor thereby reducing its liability to the depositor. Thus, when the depositor’s account is decreased, the same is debited.
When the balances are extracted, the cash in bank account on the depositor’s book has a balance of $7,000 and Quilts & Shams on the book of the bank has also a balance of $7,000.
The two accounts have equal balances because they are reciprocal accounts. This means that when one account is debited, the other account is credited. The reason for this is that the two accounts cover or reflect the same items or transactions. Thus, if no errors are committed in recording, and the same information has been recorded by both accounts, the two must have equal or the same balances.
Most often, there are items on the depositor’s book which do not appear on the bank records as of the same date. For example, checks issued by the depositor are not yet presented for payment to the bank or deposits may have been made after the bank statement has sent out to the depositor.
Frequently, there are items on the bank records which do not appear on the depositor’s book. For example, the bank may have charged the depositor’s account with services charges which the depositor may not know about until a statement is received from the bank. Notes endorsed to the bank for collection may have been collected by the bank and credited to the depositor’s account but notice of collection has not yet received from the bank.
In view of the foregoing, it becomes necessary to reconcile the balances. A bank reconciliation statement is prepared that brings into agreement the cash balance per book and cash balance per bank. It is usually prepared monthly because the bank provides the depositor a bank statement at the end of every month.
