Principles of Financial Accounting: Internal Control and Cash - Bank Reconciliation, Purpose Steps Adjusting Entries

What It Is

A bank reconciliation is a process used to ensure that a company's cash account balance in its general ledger matches the balance in its bank statement. This is crucial for accurate financial reporting and to prevent errors in cash management. For example, if a company has a cash account balance of $20,000 in its general ledger but the bank statement shows a balance of $22,000, the reconciliation process would identify the discrepancy and determine the cause, such as outstanding checks or deposits in transit.

Key Concepts & Formulas

• Bank Reconciliation: The process of comparing the company's cash account balance in the general ledger with the balance in the bank statement.
• Outstanding Checks: Checks that have been written but have not yet cleared the bank.
• Deposits in Transit: Deposits that have been made but have not yet been posted to the bank statement.
• NSF (Non-Sufficient Funds) Checks: Checks that are returned by the bank due to insufficient funds in the account.
• Bank Charges: Fees charged by the bank for services such as overdrafts or wire transfers.
• Interest Earned: Interest earned on the company's cash balance in the bank.
• Interest Paid: Interest paid on loans or overdrafts.
• Cash Balance: The current balance of cash in the company's bank account.
• Bank Statement Balance: The balance of cash in the bank account as shown on the bank statement.
• Reconciliation Difference: The difference between the cash balance and the bank statement balance.

Journal Entry Examples

Example 1: Outstanding Check

Dr. Cash $1,000 Cr. Accounts Payable $1,000

Explanation: The company has an outstanding check for $1,000 that has not yet cleared the bank. To record this, we debit the cash account to reduce the balance and credit the accounts payable account to increase the liability.

Example 2: NSF Check

Dr. Cash $500 Cr. NSF Check Expense $500

Explanation: The company has a NSF check for $500 that was returned by the bank. To record this, we debit the cash account to reduce the balance and credit the NSF check expense account to increase the expense.

Example 3: Bank Charge

Dr. Cash $25 Cr. Bank Charges Expense $25

Explanation: The bank has charged the company a fee of $25 for an overdraft. To record this, we debit the cash account to reduce the balance and credit the bank charges expense account to increase the expense.

Common Mistakes

• Mistake: Confusing debits and credits for expense accounts.
• Correction: Remember that debits increase assets and expenses, and credits increase liabilities and equity.
• Mistake: Not considering the effect of outstanding checks and deposits in transit on the reconciliation difference.
• Correction: Always consider the effect of outstanding checks and deposits in transit when reconciling the bank statement.
• Mistake: Not recording bank charges and interest earned/paid as separate transactions.
• Correction: Record bank charges and interest earned/paid as separate transactions to accurately reflect the company's financial position.

Exam Tips

• Tip: Always start the reconciliation process by comparing the cash balance and the bank statement balance.
• Tip: Consider the effect of outstanding checks and deposits in transit on the reconciliation difference.
• Tip: Record bank charges and interest earned/paid as separate transactions.

Quick Practice

Problem 1

The company has a cash account balance of $15,000 in its general ledger but the bank statement shows a balance of $17,000. What is the adjusting entry for the reconciliation difference?

Answer: Dr. Cash $2,000 Cr. Reconciliation Difference $2,000

Explanation: The company has a reconciliation difference of $2,000, which is the difference between the cash balance and the bank statement balance.

Problem 2

The company has an outstanding check for $1,500 that has not yet cleared the bank. What is the adjusting entry for the outstanding check?

Answer: Dr. Cash $1,500 Cr. Accounts Payable $1,500

Explanation: The company has an outstanding check for $1,500 that has not yet cleared the bank. To record this, we debit the cash account to reduce the balance and credit the accounts payable account to increase the liability.

Problem 3

The bank has charged the company a fee of $10 for an overdraft. What is the adjusting entry for the bank charge?

Answer: Dr. Cash $10 Cr. Bank Charges Expense $10

Explanation: The bank has charged the company a fee of $10 for an overdraft. To record this, we debit the cash account to reduce the balance and credit the bank charges expense account to increase the expense.

Last-Minute Cram Sheet

• Dividends are NOT an expense – they go directly to retained earnings.
• Cash Balance: The current balance of cash in the company's bank account.
• Bank Statement Balance: The balance of cash in the bank account as shown on the bank statement.
• Reconciliation Difference: The difference between the cash balance and the bank statement balance.
• Outstanding Checks: Checks that have been written but have not yet cleared the bank.
• Deposits in Transit: Deposits that have been made but have not yet been posted to the bank statement.
• NSF (Non-Sufficient Funds) Checks: Checks that are returned by the bank due to insufficient funds in the account.
• Bank Charges: Fees charged by the bank for services such as overdrafts or wire transfers.
• Interest Earned: Interest earned on the company's cash balance in the bank.
• Interest Paid: Interest paid on loans or overdrafts.