Bank Reconciliation: What Is It, Best Practices, and How to Reconcile a Bank Statement?

Running a business includes more than just tracking sales, costs, and payments. It is also important to ensure that the transactions in your accounting system match those in your bank statement. This is where bank reconciliation can help. 

Bank reconciliation is a normal accounting task carried out to match a company’s records within its accounting system with its financial records from the bank. Where the two balances are equal, the reconciliation process helps explain why it may just be a timing difference, or it may be an accounting difference. 

We will discuss more about account reconciliation in this blog!

What is Bank Reconciliation? 

Reconciling a bank is a way of matching a period’s transactions and balances to the bank’s reporting of those transactions and balances during the same period. 

Ideally, the adjusted balance in the company’s books should correspond with the adjusted bank balance. However, the differences are natural, as the business and the bank may be processing the transaction at different times. 

For example, a company may make a payment to another company and make the entry in the books at the time of payment. Several days after making the transaction, it might show up in the company’s books but not yet on the bank statement if the supplier has not issued or processed the payment. 

Similarly, a bank might pay a service fee or credit interest prior to the business entering the transaction into its accounting system. 

Reconciliation is not just about matching two numbers; it’s about aligning two numbers to the same quantity to recognize, describe, and account for all differences. 

Why is Bank Reconciliation Important? 

Keeping accurate cash records is a crucial part of financial reporting and day-to-day decision-making. A company may think it has a lot more cash on hand than it does, which means that it can make wrong payment or spending decisions. 

Bank reconciliation is a process that can benefit businesses regularly when there is regular reconciliation: 

• Better Cash Visibility: A reconciled balance will give a more accurate representation of cash on hand. 
• Error Detection: Errors can be found during reconciliation, such as duplicate entries, incorrect amounts, missing transactions, or posting errors. 
• Identify Unauthorized Transactions: Unusual withdrawals, transfers, or payments may be traced in time. 
• Maintain Accurate Financial Statements: Ensure that cash balances are accurate to help ensure more reliable financial reporting. 
• Keep Track of Banking Costs: Recurring service charges, transaction fees, and interest can all be determined and examined. 
• Improved Internal Controls: There must be a documented reconciliation procedure in place, which brings in another layer of documentation that will act as a control on cash payments. 

The better the value of reconciliation, the more transactions it handles. A company that handles several hundred transactions per month will have many more errors than a company that only handles a few transactions. 

Differentiating Points of Bank and Book Balances 

There is no penalty for a discrepancy between the bank statement and accounting records if someone did not make a mistake. Some discrepancies are due to the normal processing time. 

The following are common reconciling items: 

• Outstanding Payments: A payment may have been made in the company’s books but not yet cleared by the bank. It frequently happens with checks but can also happen with some electronic payments. 
• Deposits in Transit: A business could recognize a customer’s payment when it has it in its bank account, and the bank may make the deposit a few days later. The transaction can be booked, but until the bank posts it, it does not show on the statement. 
• Bank Fees: The institution charges account maintenance, wire transfer, and other fees that may not be reflected in the company’s accounting records. 
• Interest Income: The interest earned by the bank can be credited to the statement prior to when the business records the income in its books. 
• Accounting Errors: It is possible for an employee to double-enter a transaction, enter the wrong amount, post a transaction to the wrong account, or skip a transaction altogether. 
• Bank Errors: There is a possibility of posting or processing errors from time to time in banks. If there is evidence that the bank is responsible, the business should not just update its own records but contact the bank. 

How to Reconcile a Bank Statement? 

A clear and uniform process facilitates reconciliation, and it helps prevent the loss of a crucial transaction. 

1. Collecting the Records 

Begin with the bank statement and the accounting records for the period to be reconciled. 

Supporting information can be any of the following, depending on the business: 

• Cash ledger/general ledger
• Previous reconciliation 
• Deposit records 
• Payment records 
• Invoices and receipts 
• Electronic payment confirmations 
• Details of bank charges and interest 

It’s crucial to use records from the same period as the statement date because transactions that took place after that date might cause other discrepancies. 

2. Compare Transactions 

Review the bank statement and reconcile transactions to the company’s books. Balance deposits, withdrawals, transfers, payments, and other credits and debits. Identify transactions where there are two or more records to look at later and see what is happening. 

When comparing amounts and transaction dates, it may be helpful to compare these instead of only relying on the description, as the wording may be different in the bank than in the accounting system. 

3. Acknowledge and Find Differences 

After the matching process is done, review all unmatched transactions. 

See if the difference is 

• A normal timing difference 
• A transaction that is not included in the books. 
• An accounting error 
• A bank error 

A transaction by someone you don’t know or are not authorized to do. 

It is important to note the differences, as not all reconciling items should be recorded in a journal. 

An exceptional payment, for example, will just need to be watched till it is paid. The fee, which is not recorded in the accounting records, however, is usually recorded. 

4. Make Necessary Adjustments 

Adjust the books so that they reflect legitimate transactions that have been on the bank statement but are not reflected in the books. 

This may be bank fees, interest earned, bank returns, or any transactions that have been processed by the bank. 

Make corrections for any bookkeeping errors found in the review. When a transacted amount is not familiar, don’t simply write down an adjustment, but find out what it is. 

5. Check the Recalculated Balances 

Once all the necessary adjustments are complete, compute the adjusted balances. 

Differences after this should be due to legitimate timing variations such as deposits in transit or outstanding payments. If the adjusted book balance and the adjusted bank balance match, then the reconciliation is complete. 

Record the reconciliation and keep the documents for future reference.

Check Out: What Does Accounts Payable Mean? – Example, Best Practices, and More

Bank Reconciliation Example 

Suppose the business has $25,000 in its bank statement and the accounting books reflect $24,300 in the business. 

In reconciliation, the accountant checks for the following: 

• The books show a customer deposit of $1200, but this amount is not yet reported on the bank statement. 
• The business paid its supplier $1,500, which is recorded in the books but has not yet cleared the bank.
• The bank applied a service charge of $100 but did not record it in the bank’s books. 
• The bank credited $200 of interest income, which was also missing from the books. 

The difference in timing is taken into account in the bank balance:

• Bank statement balance: $25,000
• Add: Deposit in Transit: $1200
• Less: Outstanding payment: $1,500
• Adjusted bank balance: $24,700

The book balance is then updated for any transactions that the bank has already processed: 

• Book balance: $24,300
• Add: Interest income: $200
• Less: Bank fee: $100
• Adjusted book balance: $24,400

In this example, the balances still don’t agree, and there is a difference of $300. This means the reconciliation process is not completed. The accountant should not make the figures add up. 

An important principle of reconciliation is that a difference that has no explanation should remain an item of investigation until the cause of the difference is determined. 

How Often Should You Reconcile? 

There is no single number or frequency to determine what is best. For a small company that does not have a lot of transactions, monthly bank reconciliation might be sufficient. Weekly or even daily reconciliation might be more suited for businesses that are making payments often, have multiple accounts, have a high number of transactions, or have a short cash-flow cycle. 

The more often it gets reconciled, the fewer transactions will have to be investigated simultaneously. Plus, it also reduces the window of opportunity between the occurrence of an unusual transaction and its discovery. 

However, consistency is important regardless of what kind of schedule a business decides on. An infrequent reconciliation is not as helpful as a well-stated procedure employees should follow at each interval. 

Common Mistakes of Bank Reconciliation 

While performing the reconciliation regularly, there are some errors that can make the reconciliation less effective. 

A frequent error is considering all differences as errors. Banking and accounting are time-sensitive processes, and timing differences are expected and should be identified and tracked, not improperly changed. 

Another is not conducting a review of reconciling items. When a payment has been outstanding for an unusually long period of time, it may suggest a bookkeeping issue, payment cancellation, or another issue that needs to be addressed. 

It is also a bad idea for businesses to make arbitrary changes to ensure balances match up when they don’t. Each adjustment should be accompanied by an explanation and, if applicable, documentation. 

Last but not least, the reconciliation process should not be seen as simply an administrative procedure. Any patterns found during the reconciliation process can indicate problems with payment procedures, recordkeeping, and internal controls. 

Best Practices for Effective Reconciliation 

Here are a few simple tips to improve the reliability and speed of the process: 

• Establish a regular reconciliation cycle that is appropriate for the number of transactions and business needs. 
• Ensure unusual transactions are easily traced back with supporting documents in order. 
• Check on periodic reconciling items to see if there are ways to improve processes. 
• Wherever possible, clear up responsibilities so that people conducting the reconciliation will not have to deal with cash alone. 
• When transactions occur that you don’t recognize, investigate them properly, especially if the payment or withdrawal is for an amount that is unfamiliar to you. 
• Take advantage of accounting software and bank feeds to minimize repetitive data entry. 
• Maintain reconciled and adjustment records in the company’s accounting records. 

Final Words 

Bank reconciliation is not just a monthly reconciliation of two balances. It’s a fiscal management device that allows companies to see where their cash is and whether their books are correct with their banking activity. 

Regularly comparing transactions helps businesses ensure that transactions are free of timing errors, that they are recorded correctly, that certain adjustments are recorded, and that transactions that cannot be explained are investigated. 

Read Next: Going Concern Assumption: Meaning, Principle, Examples, and Importance in Accounting

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