Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

6. Internal Controls and Reporting Cash

Bank Reconciliation

A bank reconciliation is an important Internal Control over the Cash account. By comparing the records in our accounting system to the statements received from the bank, we can ensure that our records are complete and error-free.



Bank Reconciliation:Bank Column

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Alright, so a great internal control over cash is the use of a bank reconciliation. This is where the company literally takes the monthly bank statement that they get from the bank and they check it to the company's records and make sure that everything's okay between the two. Alright, let's check it out. So cash. Well, cash is the most liquid asset, right? When we talk about liquidity. Well, liquidity is like how can how quickly can it be converted to cash? Well, cash is already cash, so it's so liquid, it's so easy to steal. Right? Anyone who has their hands who gets their hands on the cash might have an incentive to actually steal it. So we're gonna need specific internal controls over cash. And one is the bank reconciliation. Okay. Like I said, this is where we compare the bank statement that we get every month to the company records. Okay. But what we're going to notice is that the bank statement isn't, that is generally not gonna be the same as what we see in our company records and this difference is due to a time lag. Okay, So if you think about it right now for a company that's current, you know, constantly like receiving money from customers buying stuff, you know, having all sorts of expenses, there's all sorts of activity in the account. Well, if we were to stop at a certain point of time, you wouldn't there would still be things that hadn't been processed on either end, Right? So you could think about it, you know, maybe back in the day, you would get a check on payday and it wouldn't clear directly. Right? You'd have to go to the bank and deposit it and then have to wait for it to clear. Right? So, I think there's this time lag right. You might have recorded something on your books that the bank hasn't recorded yet, or the bank might have recorded something that you didn't know about until you go the monthly bank statement. So, let's see how this bank reconciliation works. The goal of the bank reconciliation is to get to an adjusted balance. We're gonna have some number from the bank that that's the number of the amount of cash in our bank account as of that date. And we're gonna have our accounting records that show us some amount as well. And we're gonna adjust those numbers for different items to end up at the same number on both both accounts. Okay? So, let's start with the bank column of the reconciliation. Okay? So this is when there's events recorded by the company. So, we recorded stuff by the company, but the bank does not before the bank records it. Okay? So, the company made some sort of record, but the bank hasn't made that record. So, let's see what these are. First. We have deposits in transit. Ok. So deposited in transit. This is where the company had received a check. So think about the customer had mailed a check to the company. The company received the check and they're like sweet. We got this money and they made an entry. Okay? We received cash. Credit accounts receivable, right? We got money from a customer and then they go deposited in the bank. But the bank hasn't cleared the check yet. Right. Maybe we're at that point in time where we're waiting for that check to clear. Okay? So that means that that deposit that we put on our books, right? We increase the cash balance on our books. Well, the bank hasn't increased its balance yet for those deposits. So what we need to do is add the deposits in transit to the bank side of the reconciliation. Okay. So that means that we recorded it on our books, but the bank has not recorded it yet. The opposite is an outstanding check. This is where we received an invoice from a supplier and we wrote a check right? So we wrote a check to say, okay, we're gonna pay the supplier. So we wrote that check and we made a journal entry to decrease our cash, right? Because we're gonna pay cash to our supplier. So we decreased our cash. But at this point in time that check hasn't cleared yet. Right? But maybe the supplier hasn't hasn't deposited in their account yet. Maybe the banks still waiting to clear it for whatever reason. The bank balance does not show that we pay this check yet. So we need to subtract this amount from the bank balance to make sure that we're getting to the correct adjusted balance and the last one for banks. So those are the two big ones. You're pretty much always gonna see deposits in transit and outstanding checks when you do a bank reconciliation. Those are like the two biggest ones. And just remember that those are always on the bank side of the reconciliation. There's nothing that's going to be done on the book side for those. Okay, the last one here is bank errors. Okay this they just love to make errors, especially In accounting problems. Um they love to make an error at the bank or on the books. They love to do it. So what we have to do is remove the effects of the air. Alright. Unfortunately this could kind of be anything. This is usually something where like they switch switch the numbers, oh they were supposed to make $150 payment but they made a $510 payment, right? Something like that is usually how these things work. Okay, so that's the bank side of the reconciliation. Let's pause and then we'll go over the book side of the reconciliation


Bank Reconciliation:Book Column

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Alright let's continue here with the book column of the reconciliation notice. There's a few more things here and it could be all sorts of things that the bank recorded. But the but we didn't know about it until we receive the bank statement. So this is literally us getting the bank statement at the end of the month and saying oh I didn't notice that the bank charged just a fee and then we would make a journal entry for the fee. Right? Things like that. So let's go ahead and see what those are. The first one is bank collections. This is where the bank collects money on our behalf. Sometimes we have a situation especially with customers that we have ongoing that they just deposit the money directly into your bank account, right maybe you're a landlord and you just have the customer deposit the rent. I know that's what I do. I just deposit my rent in the bank account. Oh speaking of which it's the third of the month. Uh Well anyways I deposited straight into my landlord's bank account and I don't give them any record. Eventually they're gonna check and be like oh there's the money. Okay cool so what do we have to do? We're gonna have to add the bank collections to the book because we're gonna look and say oh that customer paid us and then we'll make an entry to increase our cash. Okay the next one is electronic funds transfer. So these are E. F. T. Payments or E. F. T. Receipts. So this is basically automatic payments. This is the same logic as the bank collections where we didn't really know about it until we looked on the record. And these are like automatic payments. E. F. T. Is just like an automatic payment. So when we had an E. F. T. Receipt that means we received some sort of automatic payment that we didn't notice until we looked at the bank record. So we would add an E. F. T. Receipt right? Because we received money and we would subtract E. F. T. Payments from the book, right? Because we paid money. So that's pretty straightforward. Right on this side remember we're looking we're thinking about the company's records here. Okay so on the next one service charge right. We look on the bank statement. Oh they charge us a fee of $10 for you know whatever the bank wants to charge us fees for. Well the bank charges a fee but we never recorded it. So it's time to record it. We need to subtract the fees from the book balance right? We're gonna have to decrease our cash because of these fees interest revenue. Oh man. Maybe there were days where the banks actually paid us interest on our checking accounts. But I don't remember those days. Well interest revenue. This could be you had some money in the account and you earn interest and you check, look at that, we earned some interest on this account. Well we need to add the interest to the book right? We didn't know we had earned this money. This is more cash for the company. We would add that to the books. The next one is the N. S. F. Checks. Non sufficient funds. Okay so this one's pretty tricky because a lot of times students tend to think that non sufficient funds checks. This is a check that bounced a check that did not go through. So a lot of times students think that this is the company that wrote the check. But that's not true. This is the company received the check from a customer. So the customer paid the company and the company's like oh sweet we receive some money let's go ahead and increase our cash balance. But then when they go to deposit it, the bank actually tells them, hey that customer doesn't have money in that account. We can't cash that check. So what we have to do we recorded. So this is where it's tricky in our books. We had recorded that. We received money right? We we got the check and we recorded this receipt but we didn't receive it, write the check bounced. That money never actually was got into the bank account. So we have to subtract NSF checks. Okay, this is decreasing because we previously thought we got this money but actually we did not get this money. Okay so not sufficient funds check. This is receipts from customers that are bad. Right? So they didn't they didn't actually pay us. Okay, So the last one here. Book errors, just like the bank can make errors. The book makes errors, especially in accounting problems. They love to make errors. So again, we have to remove the effects of the heirs. It's hard to tell you uh you know what to expect, but it's generally you have to think, okay, if they had done this correctly, what what would have been the correct entry and then get it to that state, right? We have to change the incorrect entry to the correct entry. So, usually these bank errors and book errors, that's usually kind of the trickiest spot, because you have to kind of think logically what happened. All right. So, if I had to pick the things that are gonna show up the most. When you talk about uh bank reconciliations, I would say that the most common things that they talk about are your deposits in transit, your outstanding checks errors. I'm gonna say errors. Do they do like to do that? Because it makes you think a little critically. And then they love to do the not the the interest revenue, service charges interest revenue and not sufficient fund checks. I would say those are the most common things that come up when you talk about bank reconciliations, but not to say that all of these won't show up. Okay, So, it's nice to know about all of them. But those are the main ones that show up. All right, so, let's go ahead and uh let's go ahead and try a bank reconciliation and see how this works in practice. Alright, let's do that now.

A company has a current balance in its Cash account of $3,400. The bank statement arrived showing a bank balance of $5,900. Prepare the cash reconciliation noting the following events:

• Deposits in transit total $600

• EFT receipt of dividend revenue of $900

• Bank error:the bank deducted $100 for a check written by another company.

• Service charge $20

• NSF check from a customer $50

• Book error:Company Check no. 333 was recorded for $510. The actual amount paid on account was $150.

• Outstanding checks total $2,010

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