Reconciling your accounts
Stan Snyder, CPA and expert bean counter
Your bank account is your most liquid asset and the account that is most susceptible to errors, theft, or fraud. No accounting system has been invented that can prevent errors or fraud, but a detailed review of the bank statement and the reconciliation report each month is one of the best ways of finding errors — both innocent and intentional.
If done regularly, reconciling your bank account is a quick and easy task that tells you more about the state of your accounting system than any other single task you perform. However, because it is often thought of as an onerous task, it may be put off or delegated to the bookkeeper. If the owner of the business is not the person reconciling the bank account, the owner should be reviewing the printed reconciliation report since it is the quickest way to get an overview of your accounting system's accuracy.
The heart of your accounting system
The bank account is the heart of your accounting system. Virtually all transactions affect the bank account, either directly or indirectly. Cash sales are deposited into the bank account; sales on account affect accounts receivable. Subsequent payments on accounts receivable are posted to the customer's accounts receivable record and deposited in the bank account.
If there is an error in posting to the accounts receivable account, it may often be discovered in reconciling the bank account. Conversely, errors found by customers on their accounts receivable statements may uncover errors in the bank account. The same is true for cash disbursements: Payments to vendors and employees should be made out of the bank account — as opposed to the owner's personal account, or cash payments out of pocket — and all vendor statements should be verified to the accounts payable register. Reconciling vendor statements to your accounts payable register may also uncover errors in the bank account.
Proper accounting procedures dictate that all cash received should be deposited in the bank account, and all expenditures should be made from the bank account. When this principle is followed, reconciling the bank statement to the books verifies that all transactions have been recorded, and in the proper amount. Note that the reconciliation does not verify that all transactions have been properly coded to the correct accounts, only that the amounts recorded in the check register match the amounts that cleared the bank. Reviewing and reconciling the remaining general ledger accounts will then verify the accuracy of the account coding.
The reconciliation process
The reconciliation process, while often involving a lot of detail, is in concept quite simple.
Verify that all deposits appearing on the bank statement agree with the deposits recorded in the check register, and that there are no deposits in the check register that have not cleared the bank, with the exception of deposits in transit at the end of the month.
Verify that all disbursements on the bank statement agree with what has been entered in the check register. This is often the area where discrepancies appear, because of transactions that were not known about until the bank statement was received, such as bank service charges or electronic funds transfers.
During the reconciliation, it is a simple matter to add any missing transactions to the register, or to add adjustments for any variances found between the bank statement and the check register.
Editing transactions and entering adjustments
When a variance is found between the company's register and the bank statement, it may require either a change to an existing transaction or an adjustment in the form of a new transaction. The difference between the two depends on what type of transaction you are correcting.
Here's an example of a change to an existing transaction: A check was written to ABC Company in the amount of $123.59, which cleared the bank for $123.95. Upon reviewing the original document, it is obvious that it was written for $123.95 but was incorrectly recorded in the check register as $123.59. The last two digits were transposed when the transaction was entered in the check register. You need to correct the amount in the check register to match what happened in the real world.
If the transaction was coded to an expense account, it is a simple matter to edit the transaction by changing the amount to the correct number. However, if this transaction paid a bill in the accounts payable register, the correction will be a bit more complex; the original bill must be corrected as well. Correcting payroll transactions becomes even more complex, since payroll transactions affect several liability accounts, and the effect on all of these accounts must be considered.
The other way to correct for a legitimate variance is to create a new transaction that records new information to reflect what actually happened. This is called an adjustment. An example of an adjustment is a bank charge for credit card processing fees. Until the bank statement is received, the amount of the processing fees is unknown; after the statement is received, you need to enter an adjustment to reflect the expense, and to adjust the check register to the correct balance.
When to edit a transaction vs. entering an adjustment
A general rule of thumb is to edit transactions that have been entered incorrectly and use adjustments to enter new information. However, with more complex transactions — such as payroll checks and accounts payable checks — it may be simpler to enter an adjustment rather than a correction. This requires an examination of the original entry to determine which financial accounts were affected and an adjustment that corrects the proper accounts. When correcting payroll transaction errors, it is often easier to correct minor errors with an adjustment rather than editing the original transaction.
In either case, Microsoft Office Accounting keeps a complete audit trail of the original entry, any corrections, and the adjusting entry.
If the bank made a mistake
When bank errors are discovered, record the error in your check register. If the error is small, that may be all that is required. However, if a significant error is uncovered, it is still important to record it in your register, even if your banker promises to fix the error immediately.
When the bank discovers an error, they don't just erase the error; they make an offsetting entry to correct the error. You should make an entry to record the error and a separate entry to record the error correction. The guiding principle is to record everything that happened to your account in your check register. Your register will then show your correct current balance and when the bank makes the correction to your account, you will have a corresponding entry to make your reconciliation come out properly.
Review the reconciliation report
The reconciliation report is a very useful tool. It shows:
The beginning balance per the bank statement
The ending balance per the bank statement
All deposits that cleared the bank
All checks that cleared the bank
The ending balance per your books
It also shows what the bank doesn't know about yet: the outstanding checks, any deposits in transit at the end of the month, and the true ending balance of the bank account once all outstanding transactions have cleared the bank.
Review the outstanding checks and any deposits in transit carefully. There should not be any uncleared deposits older than two or three days before the bank cut-off date. Any older deposits represent a mistake, either by the bank or in the check register. Deposits to the bank account should take no more than 24 hours to clear the bank, with the exception of weekends and holidays. If there are uncleared deposits in the register with an older date, they may have been deposited to the wrong bank account, entered in the register with an incorrect date, or perhaps lost in transit. In any case, they need to be investigated and corrected.
Outstanding checks that have not cleared the bank pose the same, if somewhat less serious, problem as uncleared deposits. Often checks are not cashed or deposited immediately. They may be delayed in the mail or by a negligent bookkeeper. Having outstanding checks is not a cause for alarm, unless they represent old outstanding balances with a key supplier, or the balance of taxes due to federal or state authorities. These may also need follow-up investigation to keep vendors happy and avoid penalties and interest on tax payments.
After you have completed the reconciliation process:
All deposits on the bank statement match the deposits in the register.
Disbursements per the bank statement match the disbursements in the register.
The ending balance per the bank statement matches the reconciled balance.
Now, print a copy of the reconciliation report as a permanent record of the details you have reviewed. Once they are reconciled, cleared transaction amounts should never change. If they do change, it will be very useful to have a printed reconciliation report showing transactions as they were at the time of the reconciliation to compare to the transactions in your register.
When you discover the benefits of reconciling your bank accounts on a regular schedule, you may be motivated to reconcile all of your balance sheet accounts on a monthly basis — which is also a good accounting practice.
About the author
Stan Snyder is a certified public accountant with over 25 years experience dealing with the accounting and computer problems that small business owners face. He teaches computerized accounting classes at Colorado Mountain College, and regularly consults with small business owners using accounting software of all types. If you have questions about this topic or another accounting topic, send Stan some feedback by responding to the question below "Was this article helpful?" Stan may use your questions or topic ideas in an upcoming column.