- Demonstrate journal entries related to bank reconciliations
Let’s start by reviewing the two-part bank reconciliation for My Company from the previous section:
| Description | Amount | Total |
|---|---|---|
| Ending Bank Balance | $27,395.00 | |
| Add: 9/30 Deposit | $6,700.00 | |
| Single Line | $34,095.00 | |
| Subcategory, Subtract: | ||
| O/S Ck #2004 | $1,000.00 | |
| # 2008 | $650.00 | |
| # 2009 | $200.00 | |
| # 2012 | $5,500.00 | |
| Single Line | $7,350.00 | |
| Adjusted Bank Balance | Single Line$26,745.00 Double Line | |
| Ending Book Balance | $24,457.00 | |
| Add: Interest | $3.00 | |
| Note Collected | $3,000.00 | $27,460.00 |
| Subcategory, Subtract: | ||
| Bank Fee | $5.00 | |
| Customer NSF | $350.00 | |
| CK 2005 Error | $360.00 | |
| Single Line | $715.00 | |
| Adjusted Book Balance | Single Line$26,745.00Double Line | |
The additions and subtractions to the bank balance to account for timing differences, usually deposits in transit and outstanding checks, are not “adjustments” in the sense of the accounting cycle—they only help us arrive at our target balance: what we believe the GL balance should be if the bank is right (and it usually is). Bank internal accounting controls are rigorous (but not foolproof), so the bank statement serves as our best external objective verification of the actual GL account balance once we take those timing differences into account.
Occasionally we discover a bank error, such as a deposit we have proof of making that did not get “credited” to our account. (Remember that our demand deposit with the bank is a liability to the bank, just as it is an asset to us, so the bank increases our account with a credit entry). If that kind of error happens, we have to do some research and contact the bank to make sure it gets corrected, but we do not have to change our books.
However, all the items in the second half of the reconciliation (or on the right side, if you are preparing the bank reconciliation in two side-by-side columns) need to be recorded in our GL. We do this recording with either (a) regular journal entries or (b) adjusting journal entries. As you may have realized by now, there really isn’t much difference between the two in an old-fashioned paper system. However, in an automated system, the normal daily transactions would be entered through various forms and processes, such as the cash receipts module or accounts payable and cash disbursements. If you come to the end of the period and you find you have to make adjustments, you also have to decide if you will record them as journal entries or go through the automated process you would have used if you’d known about the transaction when it happened. This decision is a combination of (a) the system you are using, (b) your internal accounting process, and (c) internal control constraints. Usually, a staff member is not allowed to make journal entries or process transactions outside of his or her normal sphere of duties in order to prevent theft or mistakes.
In any case, those items that reconcile the general ledger (book balance) to the adjusted bank balance (the target) have to be recorded. For purposes of this lesson, we’ll prepare journal entries.
If we added an item in the bank reconciliation, we will DEBIT the checking account (because a debit increases an asset account in a GL). If we subtracted something, we will CREDIT the checking account.
The first reconciling item was $3 in interest income.
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20– | ||||
| Sept 30 | Checking Account | 1011 | 3.00 | |
| Sept 30 | Interest Revenue | 4310 | 3.00 | |
| Sept 30 | To record interest revenue per Sept bank statement |
The second item was a $3,000 credit (deposit) that the bank showed in our account that we had no idea was there. It turns out, after a call to the bank and examining some supporting documents, a customer owed us $3,500 and we had almost given up on it, but the bank’s collection department had gone after the customer and recovered the outstanding debt (because we had asked them to). They kept $500 as a fee for doing that work for us and put $3,000 in our account. The debt to us on our books was recorded as a note receivable (which we will study later). Probably what had happened was either the customer bought something big from us and promised to pay later, or owed us money in the regular course of business (called accounts receivable) but had trouble paying and so re-negotiated the debt from a regular accounts receivable (account payable on the customer’s books) to a note, which means they signed a promise to pay with interest. Not surprisingly then, they defaulted, and so we hired the bank to go after them.
Scratching all of this scenario out on T accounts, we’d see that we need to credit Notes Receivable for the full amount of the debt, debit cash for $3,000, and then debit an expense account for $500 to balance the entry:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20– | ||||
| Sept 30 | Checking Account | 1011 | 3,000.00 | |
| Sept 30 | Bank Fee | 5755 | 500.00 | |
| Sept 30 | Notes Receivable | 1600 | 3,500.00 | |
| Sept 30 | To record collection of past due note and related collection fee |
We didn’t create a new account for the collection fee; we just used our existing bank fees account. However, if this kind of thing happened a lot, we might want to have a tracking account for those collection fees specifically.
Also note that two accounts will be updated when we post the $3,500 credit to Notes Receivable: (1) the general ledger control account # 1600 and (2) a subsidiary ledger that agrees to the GL control account, which lists the amount owed to us by each debtor. The GL account will go down by $3,500, and we will “write off” the $3,500 debt in the subsidiary ledger, even though we only got $3,000 because the maker of the note paid $3,500. The other $500 was a fee we paid.
Recording the bank fee of $5 is relatively straightforward:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20– | ||||
| Sept 30 | Bank Fee | 5755 | 5.00 | |
| Sept 30 | Checking Account | 1011 | 5.00 | |
| Sept 30 | To record Sept bank fee from stmt |
The bank fee is an expense (cost of doing business) and an expense is shown by an entry on the left side of a ledger (because it decreases our equity), meaning the checking account was decreased as well.
This next one might be tricky. We deposited a check for $350 from a customer and it bounced. Suppose the original entry was a credit of $350 to Service Revenue and a debit of $350 to Checking Account to record services performed in exchange for cash. In reality, that particular check was probably part of a much larger deposit; however, when the check bounces, the bank adjusts our account by subtracting that dishonored check from our balance. Now we have to go out and try to get that money from the customer. In any case, we earned the revenue, so now the customer owes us the money. We’d record the entry like this:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20– | ||||
| Sept 30 | Accounts Receivable | 1200 | 350.00 | |
| Sept 30 | Checking Account | 1011 | 350.00 | |
| Sept 30 | To record NSF check |
Guess what else we do when we post this $350 to Accounts Receivable? Right. We update the subsidiary ledger to match the GL control account. The subsidiary ledger is a list of all customers, alphabetically (most likely) and the amount each one owes. The GL is organized not by customer, but by date (chronologically).
Lastly, someone in My Company made an error posting a check #2005. The check was written for $5,843, but recorded in our books at $5,483. That’s a transposition error—accidentally switching two numbers. Something to remember about a transposition error is that it is always divisible by 9.
Let’s scratch this out with T accounts:
| Debit | Credit |
|---|---|
| 5,483.00 | |
| 360.00 | |
| Double line | Double line 5,843.00 |
| Debit | Credit |
|---|---|
| 5,483.00 | |
| 360.00 | |
| Double line 5,843.00 | Double line |
The correct amount of the equipment purchase was $5,843. It’s understated by $360 (divisible by 9) right now because of the recording error, and cash is overstated because we didn’t record the check correctly. We need to decrease cash and increase the asset Equipment.
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20– | ||||
| Sept 30 | Equipment | 1200 | 360.00 | |
| Sept 30 | Checking Account | 1011 | 360.00 | |
| Sept 30 | To correct error on Ck # 2005 |
Once these entries are posted, the accountant will verify that the GL balance equals the adjusted bank balance:
| Date | Item | Post. Ref. | Debit | Credit | Balance | ||
|---|---|---|---|---|---|---|---|
| Debit | Credit | ||||||
| Bal fwd | 16,850.00 | ||||||
| Sept | 1 | 1,500.00 | 18,350.00 | ||||
| Sept | 1 | 750.00 | 17,600.00 | ||||
| Sept | 5 | 980.00 | 16,620.00 | ||||
| Sept | 5 | 275.00 | 16,345.00 | ||||
| Sept | 8 | 1,000.00 | 15,345.00 | ||||
| Sept | 10 | 5,483.00 | 9,862.00 | ||||
| Sept | 14 | 2,514.00 | 12,376.00 | ||||
| Sept | 15 | 350.00 | 12,726.00 | ||||
| Sept | 15 | 333.00 | 12,393.00 | ||||
| Sept | 20 | 500.00 | 12,893.00 | ||||
| Sept | 20 | 480.00 | 12,413.00 | ||||
| Sept | 20 | 650.00 | 11,763.00 | ||||
| Sept | 22 | 200.00 | 11,563.00 | ||||
| Sept | 24 | 10,000.00 | 21,563.00 | ||||
| Sept | 28 | 2,571.00 | 18,992.00 | ||||
| Sept | 28 | 235.00 | 18,757.00 | ||||
| Sept | 28 | 4,500.00 | 23,257.00 | ||||
| Sept | 30 | 6,700.00 | 29,957.00 | ||||
| Sept | 30 | 5,500.00 | 24,457.00 | ||||
| Sept | 30 | 3.00 | 24,460.00 | ||||
| Sept | 30 | 3,000.00 | 27,460.00 | ||||
| Sept | 30 | 5.00 | 27,455.00 | ||||
| Sept | 30 | 350.00 | 27,105.00 | ||||
| Sept | 30 | 360.00 | 26,745.00 | ||||
The number highlighted in green is our ending GL balance before we did the bank reconciliation and before we then posted our reconciling entries.
The ending cash balance on the GL is now reconciled to the adjusted bank statement balance.
When a company maintains more than one checking account, it must reconcile each account separately with the balance on the bank statement for that account. The depositor should also check carefully to see that the bank did not combine the transactions of the two accounts.
Within the internal control structure, segregation of duties is an important way to prevent fraud. One place to segregate duties is between the cash disbursement cycle and bank reconciliations. To prevent collusion among employees, the person who reconciles the bank account should not be involved in the cash disbursement cycle. Also, the bank should mail the statement directly to the person who reconciles the bank account each month. Sending the statement directly limits the number of employees who would have an opportunity to tamper with the statement.