How to do a bank reconciliation step by step, with an example

The situation

At Palm Gate Logistics, the ledger says the main bank account holds AED 501,500 on the last day of the month. The bank statement says AED 530,000. Yousef, the chief accountant, asks Farida to explain the difference before anyone signs the month-end pack.

Farida's first thought is that one of them is wrong. Usually neither is. The two records see the same cash at different moments and through different eyes, and a reconciliation is the document that shows exactly how they connect.

The explanation

Cash is the most exposed asset a company has, and IAS 7 describes cash as cash on hand plus demand deposits, which is what a current account holds. The company's ledger and the bank each keep a record of it. A bank reconciliation compares them and explains every difference. It is a control: it catches errors, delays and fraud, and it should be done at least monthly.

Differences come in three families.

Timing. The company recorded something that the bank has not yet processed. Cheques issued and not yet cashed are outstanding cheques. Money banked late in the day and not yet credited is a deposit in transit. These clear by themselves in the next period.

Items the bank knows and the company does not. Bank charges, interest, direct debits and receipts from customers that nobody identified. These need an entry in the ledger.

Errors. A transposed number, a duplicate posting, or a wrong amount, on either side. These need a correction in whichever record is wrong.

The method has six steps:

• Take the closing balance from the ledger and the closing balance from the bank statement for the same date.
• Tick every item that appears in both records.
• List the items that appear only in the ledger: outstanding cheques and deposits in transit.
• List the items that appear only on the statement: charges, interest and unknown receipts.
• Adjust the statement balance for the ledger-only items, and the ledger balance for the statement-only items.
• Check that the two adjusted balances agree. If they do not, look for errors before you post anything.

Only the statement-only items and errors produce journal entries. The timing items do not, because the ledger is already right about them.

Worked example

Palm Gate Logistics, AED. The statement shows 530,000 and the ledger shows 501,500.

Ledger-only items: cheques issued but not yet cashed total 40,000, and a deposit of 10,000 banked on the last evening is not yet on the statement.

Statement-only item: bank charges of 1,500 that the company has not yet recorded.

Adjust the statement for the timing items: 530,000 less 40,000 plus 10,000 equals 500,000. Adjust the ledger for the charges: 501,500 less 1,500 equals 500,000. Both agree, and the reconciled cash balance is 500,000.

The difference of 28,500 is fully explained: 40,000 of outstanding cheques less the 10,000 deposit in transit less the 1,500 of charges. The journal entry is only one line: debit bank charges 1,500 and credit bank 1,500. The cheques and the deposit need no entry, they will clear on the statement next month.

Keep the reconciliation as evidence. It shows the date, the two balances, each item with its reference, the preparer and the reviewer. Next month, the outstanding items must clear. An item that stays on the list is an item to chase.

The common mistake

The most common mistake is to force the reconciliation: to post a balancing entry so the difference disappears. That hides what is wrong and can hide fraud. Every difference must be a named item, either timing, a missing entry or an error.

The second mistake is to reconcile once a quarter. By then the list has hundreds of items and nobody remembers them. Monthly is the minimum for important accounts, and busy accounts need it weekly or daily.

The third is having the person who records receipts and payments also prepare the reconciliation. The control works best when a different person prepares it, or at least a different person reviews it.

Checklist

• The ledger and statement balances are for the same date.
• Every item is ticked or listed with a reference.
• Outstanding cheques and deposits in transit have dates.
• Statement-only items have a journal entry posted.
• Adjusted balances agree to the cent, with no balancing entry.
• Old unreconciled items are chased and aged.
• A preparer and a different reviewer sign and date it.

Go further

Watch the full episode ACC-E14 Bank reconciliation and use the template in the lesson ACC-E14 Bank reconciliation, which classifies each item and shows its age.

Companies and figures in this article are fictional. Masar-Fintech is independent and not affiliated with any professional body or tax authority.