CHAPTER 2

BANK RECONCILIATION

TECHNICAL KNOWLEDGE

To understand the need for a bank reconciliation.

To know the reconciling items affecting the cash in bank per ledger.
To know the reconciling items affecting the cash in bank per bank
statement.
To be able to prepare a bank reconciliation.
To be able to prepare the necessary adjusting entries to reconcile the
cash in bank per ledger with the cash in bank per bank statement.

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 Bank deposits
There are three kinds of bank deposits, namely demand
deposit, saving deposit and time deposit.

Demand deposit

The demand deposit is the current account or checking account or

commercial deposit where deposits are covered by deposit slips and
where funds are withdrawable on demand by drawing checks against
the bank.

A demand deposit is noninterest bearing.

Saving deposit

In a saving deposit, the depositor is given a passbook upon the initial

deposit. The passbook is required when making deposits and
withdrawals.

Withdrawals are made anytime but the bank sometimes may

require notice of withdrawal.

A saving deposit is interest bearing.

Time deposit

The time deposit is similar to saving deposit in the sense that it is

interest bearing.
A time deposit is evidenced, however, by a formal agreement
embodied in an instrument called certificate of deposit.

Time deposit may be preterminated or withdrawn on demand or

after a certain period of time agreed upon.

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 What is a bank reconciliation?
Before we answer the question, let us have a background on the matter of
opening a demand deposit or checking account,

Incidentally, of the three kinds of deposit, a bank reconciliation is necessary

only for a demand deposit or checking account.

When an account is opened at the bank, the person authorized to draw checks
against the account will be required to Sign cards furnished by the bank, to show
the specimen signatures to be used on the checks.

These specimen signatures will be filed by the bank so that any teller who may
be unfamiliar with a depositor's signature can test the authenticity of a check by
comparing the depositor's signature on the card with the signature on the check.

If the depositor is a corporation, the bank will

request that the directors pass a resolution
authorizing certain officers of the corporation
as signatories of checks and that a copy of this
resolution be filed with the bank.

Let us now illustrate some transactions

affecting the depositor and the bank.

Assume that Company X (the depositor) collected P 100,000 from a customer in

settlement of an account. The collection is deposited at the First Bank.

The journal entry to record the collection and the subsequent deposit is:

Cash (or cash in bank) 100,000

Accounts receivable 100,000

On the books of the bank, the journal entry is:

Cash 100,000
Company X 100,000
The journal entry on the books of the bank shows the credit is Company X account.
This is made, for our purpose to facilitate the illustration.

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 In practice, however, the account Credited by the bank is demand deposit
account but the same is posted to the subsidiary ledger of Company X.

When the bank credits the account of the depositor, Company X, it recognizes
its to the depositor

Legally, when a deposit is made, there exists a debtor-creditor relationship

between the bank and the depositor, the bank being the debtor, and the
depositor being the creditor.

Hence, when the account of the depositor is increased the same is credited.

Let us assume further that Company X subsequently issued a check for P30,000
in payment of an account payable. On the books Of Company X, the journal
entry is.
Accounts payable 30,000
Cash 30,000

The journal entry on the books of the bank is:

Company X 30,000
Cash 30,000

When check is issued, the payee will present the same to the bank for payment,

The depositor is actually ordering the bank to pay the payee out of its deposit in
the bank.

This is the reason the bank debits the account of the depositor thereby reducing its
liability to the depositor.

Thus, when the depositor’s account is decreased, the same is debited.

At this point, when balances are extracted, the cash in bank account on the
depositor’s book has a balance of P70,000, and the Company X account on the
book of the bank has also a balance of P70,000

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Explanation

The two accounts have equal or the same balances because they are reciprocal accounts.

This means that when one account is debited, the other account is credited or vice versa.

The reason for this is that the two accounts cover or reflect the same items or transactions.

Thus, of no errors are committed in recording, and the same information has been recorded by

both accounts, the two should have equal or the same balances.

But very frequently, there are items on the depositor’s book which do not appear on the bank

records as of the same date.

For example, checks issued by the depositor are not yet presented for payment to the bank or

deposits may have been made after the bank records are sent out to the depositor.

And less frequently, there are items on the bank records which do not appear on the depositor’s

book.

For example:

a. The bank may have charged the depositor’s account with service charge which the

depositor may not know about until a report is received from the bank.

b. Notes endorsed to the bank for collection have been collected by the bank and credited to

the depositor’s account but notice of collection is not yet received from the bank by the

depositor.

In the light of the foregoing, it becomes necessary to prepare a bank reconciliation.

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Bank reconciliation
A bank reconciliation is a statement which brings into agreement the cash balance per book
and cash balance per bank.

The reconciliation is usually prepared monthly because the bank provides the
depositor with the bank statement at the end of every month.

A bank statement is a monthly report of the bank to the depositor showing:

a. The cash balance per bank at the beginning

b. The deposits made by the depositor and acknowledged by the bank

c. The checks drawn by the depositor and paid by the bank

d. The daily cash balance per bank during the month

Actually, the bank statement is an exact copy of the depositor’s ledger in the
records of the bank.

When the bank statement is received, attached thereto are the depositor’s
canceled checks and any debit or credit memoranda that have affected the
depositor's account.

The canceled checks are the checks issued by the depositor and paid by the bank
during the month.

These are called canceled checks because they are literally canceled by
stamping or punching to show that they have been paid.

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Reconciling items
At the end of every month, comparison between the cash records of
the depositor and the bank statement received from the bank will yield
the following reconciling items:
l. Book reconciling items:
a) Credit memos
b) Debit memos
c) Errors
2. Bank reconciling items
a) Deposits in transit
b) Outstanding checks
c) Errors
Credit memos
Credit memos refer to items not representing deposits credited by the
bank to the account of the depositor but not yet recorded by the
depositor as cash receipts.
The credit memos have the effect of increasing the bank balance.
Typical examples of credit memos are:
a. Notes receivable collected by bank in favor of the depositor and
credited to the account of the depositor.
b. Proceeds of bank loan credited to the account of
the depositor
c. Matured time deposits transferred by the bank to the current
account of the depositor

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 Debit memos
Debit memos refer to items not representing checks paid by bank
which are charged or debited by the bank to the account of the
depositor but not yet recorded by the depositor as cash
disbursements. The debit memos have the effect of decreasing the
bank balance.

Typical examples of debit memos are:

a. NSF or no sufficient fund checks — These are checks deposited but
returned by the bank because of insufficiency of fund. The other name
for NSF is DAIF or "drawn against insufficient fund".
b. Technically defective checks— These are checks deposited but
returned by the bank because of technical defects such as absence of
signature or countersignatures erasures not countersigned, mutilated
checks, conflict between amount in words and amount in figures,
c. Bank service charges — These include bank charges for interest,
collection, checkbook and penalty,
d. Reduction of loan — This pertains to amount deducted from the
current account of the depositor in payment for loan which the
depositor owes to the bank and which has already matured.
Deposits in transit
Deposits in transit are collections already recorded by the depositor as
cash receipts but not yet reflected on the bank statement,
Deposits in transit include:
a. Collections already forwarded to the bank for deposit but too late to appear
in the bank statement.

b. Undeposited collections or those still in the hands Of the depositor. In effect,

these are cash on hand awaiting delivery to the bank for deposit
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Outstanding checks
Outstanding checks are checks already recorded by the depositor as
cash disbursements but not yet reflected on the bank statement.
Outstanding checks include:
a. Checks drawn and already given to payees but not yet
presented for payment,
b. Certified checks — A certified check is
one where the bank has stamped on its
face the word "accepted" 'or "certified" indicating
sufficiency of fund.

When the bank certifies a Check, the account of the depositor is

immediately debited or charged to insure the eventual payment of the
check.
Certified checks should be deducted from the total outstanding checks
(if included therein) because they are no longer outstanding for bank
reconciliation purposes.
Forms of bank reconciliation
The following formats may be used in reconciling the book balance
and the bank balance•
•a. Adjusted balance method — Under this method, the book balance
and the bank balance are brought to a correct cash balance that must
appear on the balance sheet.
b, Book to bank method — Under this method, the book balance is
reconciled with the bank balance or the book balance is adjusted to
equal the bank balance.
c, Bank to book method —Under this method, the bank reconciled
with the book balance or the bank balance is adjusted to equal the book
balance,
 The first method is preferred over the other two.
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Proforma reconciliation
Adjusted balance method
Book balance
Add: Credit memos
Total
Less: Debit memos
Adjusted book balance
Bank balance
Add: Deposits in transit
Total
Less; Outstanding checks
Adjusted bank balance

The reconciling items of the book are simply termed as credit memos and debit memos,

No details are shown to simplify the illustration.

In actual formal reconciliation, details will have to be shown.

Moreover, errors are excluded because no definite rule can be made whether these are to
be added or deducted,

Errors will have to be analyzed for proper treatment.

However, errors are reconciling items of the party which committed them.

It will be observed that under the adjusted balance method, the credit memos are
always added to the book balance and the debit memos are always deducted from
the book balance.

Deposits in transit are always added to the bank balance and the outstanding
checks are always deducted from the bank balance.
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Explanation
The foregoing procedures can be explained as follows:
The adjusted balance method means that the book balance and the
bank balance are adjusted to equal the correct cash balance.
Credit memos already increased the bank balance but have no effect
on the bank balance because the credit memos are not yet recorded by
the depositor.
Consequently, the book balance is understated in relation to the
correct cash balance.
Hence, credit memos are added to the book balance.
Debit memos already decreased the bank balance but have no effect
on the book balance because the debit memos are not yet recorded by
the depositor.
Consequently, the book balance is overstated in relation to the correct
cash balance.
Hence, deposits in transit are added to the bank balance.
Outstanding checks have already decreased the book balance but have
no effect on the bank balance because the checks are not yet paid by
the bank.
Consequently, the bank balance is overstated in relation to the correct
cash balance.
Hence, outstanding checks are deducted from the bank balance.
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Book to bank method

Book balance
Add: Credit memos
Outstanding checks
Total
Less: Debit memos
Deposits in transit
Bank balance

When the reconciliation starts with the book balance and ends with
the bank balance, the usual book reconciling items are treated in the
same manner they are treated in the "adjusted balance method", that is, credit
memos are added and debit memos are deducted.
However, with respect to the bank reconciling items the treatment is simply
"reversed."
Thus, since the deposit in transit is added to the bank balance, it is now
deducted from the book balance, and since the outstanding check is deducted
from the bank balance, it is now added to the bk balance.

Explanation of reversal rule

The book to bank method means that the. book balance is adjusted to equal the
bank balance.

Deposits in transit already increased the book balance but have no effect on the
bank balance because the deposits are not yet recorded by the bank.
Consequently, the book balance is overstated in relation to the bank balance.

Hence, deposits in transit are deducted from the book balance following
the book to bank method.

On the other hand, outstanding checks already decreased the book balance but have
no effect on the bank balance because the checks are not yet paid by the
bank. Consequently, the book balance is understated in relation to the
bank balance.
Hence, outstanding checks are added to -the book balance, following the book to
bank method.

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Bank to book method
Bank balance
Add: Deposits in transit
` Debit memos
Total
Less: Outstanding checks
Credit memos
Book balance

When the reconciliation starts with the bank balance and ends with the book balance, the usual
bank reconciling items are treated in the same manner they are treated in the “adjusted balance
method”, that is, deposit in transit is added and outstanding check is deducted.
However, with respect to the book reconciling items, the treatment is simply “reversed”.
Thus, since the credit memos are added to the book balance, they are now deducted from the
bank balance, and since the debit memos are deducted from the book balance, they are now
added to the bank balance.

Explanation of reversal rule

The bank to book method means that the bank balance is adjusted to equal the
book balance.
Debit memos already decreased the bank balance but have no effect on the book
balance because they are not yet recorded by the depositor.
Consequently, the bank balance is understated in relation to the book balance.
Hence, debit memos are added to the bank balance.
On the other hand, credit memos already increased the bank balance but have no
effect on the book balance because they are not yet recorded by the depositor.
Consequently, the bank balance is overstated in relation to the book balance.
Hence, credit memos are deducted from the bank balance.

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Illustration
The cash records of Cornpany X show the following for the month Of January.

CASH RECEIPTS CASH DISBURSEMENTS

Jan. 5 60,000 Jan. 6 Check No. 721 5,000

13 20,000 7 Check No. 722 10,000
25 30,000 10 Check No. 723 18,000
31 40,000 14 CheckN0. 724 2,000
150,000 28 Check No. 725 37,000
31 Check No. 726 28,000
100,000

The general ledger of the company Shows the cash in bank account for January as follows:

Cash in bank — First Bank

Jan. 31 CD 100,00
Jan. 31 CR 150,000
0
The balance of the cash in bank on the depositor's book is P50,000
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Bank statement

The following is the bank statement for January received from the First Bank:
Code: CM – Credit memo SC – Service charge
DM – Debit memo RT – Returned check

The following data are gathered in connection with the CM and DM appearing on the bank
statement:
a. The CM of P15,000 on January 26 represents proceeds of note collected by the bank in
favor of the company.
b. The RT of P5,000 represents check of customer deposited previously but returned by
the bank because of “no sufficient fund” or NSF.
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General procedures in preparing the reconciliation

a. Determine the balance per book and the balance per bank,

As mentioned earlier, the cash in bank account on the book of the

depositor has a debit balance of P50,000.

The bank balance is shown Oh the bank statement as the final item,
P84,000

b. Trace the cash receipts to the bank statement to ascertain whether there are
deposits not yet acknowledged by the bank.

In the illustrative problem, the cash receipt of P40,000 on January 31 does

not appear in the bank statement. This represents deposit in transit.

c. Trace the cheeks issued to the bank statement to ascertain whether there
are checks not yet presented for payment.

In the illustrative problem, Check Nos. 725 for P37,000 and 726 for
P28,000 do not appear in the bank statement. These are outstanding checks.

d. The bank statement should be examined to determine Whether there aree

bank credits or bank debits not yet recorded by the depositor.

In the illustrative problem there is CM of P 15,000 and DM for returned

check of P5,000 and service charge of Pl,000.

e. Watch out for errors. Again, errors are reconciling items of the party which
committed them. In the illustrative problem, there are no errors committed,

At this point, a formal reconciliation may be prepared because all the reconciling
items have already been determined.
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Adjusted balance method
Balance per book 50,000
Add: Note collected by bank 15,000
Total 65,000
Less: NSF customer check 5,000
Service charge 1,000 6,000
Adjusted book balance 59,000
Balance per bank 84,000
Add: Deposit in transit 40,000
Total 124,000
Less: Outstanding checks:
Check No. 725 37,000
Check No. 726 28,000 65,000
Adjusted bank balance 59,000
Preparation of adjusting entries
Only the book reconciling items require adjusting entries on the book of depositor. This is but
understandable.
The adjustments are necessary to bring the cash in back balance to its correct balance for
statement presentation purposes.
a. To record the note collected by bank:
Cash in bank 15,000
Notes receivable 15,000
b. To record the NSF customer check:
Accounts receivable 5,000
Cash in bank 5,000
c. To record the bank service charge:
Bank service charge 1,000
Cash in bank 1,000
In the preparation of adjustments, an item added to the book balance is debited to
cash and an item
deducted from the book balance is credited to cash.
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Some errors and their correction

a. Understatement of cash receipts on the book of depositor

For example, the from customer which is deposited amounts to P10,000

but recorded in the book only as P1,000

There is an understatement of cash receipt of P9,000. error is added

to the book balance and adjusted as follows:

Cash in bank 9,000

Accounts receivable 9,000

b. Understatement of checks drawn by depositor.

For example, a check in payment of account payable amounting to is

recorded in the book as P2,000.

There is an understatement consequent overstatement of book balance in

the amount P18,000. The error is deducted from the book balance
adjusted, ag follows•

Accounts payable 18,000

Cash in bank 18,000

c. Deposit of another entity is credited by the bank to the account of the

depositor.

This is a deduction from the bank balance because it erroneously increased

the account balance of the depositor in the bank. No adjustment is
necessary on the book of the depositor.

d. Check of another entity charged to the account of the depositor.

This is an addition to the bank balance because it erroneously decreased the

account balance of the depositor in the bank. No adjustment is necessary on
the book of the

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QUESTIONS

1. Explain the three kinds of bank deposits.

2. What is a bank reconciliation?

3. What is a bank statement?

4. What are credit memos?

5. What are debit memos?

6. What are deposits in transit?

7. What are outstanding checks?

8. Define a Certified check.

9. What is the treatment of certified check for bank reconciliation purposes?

10. Explain the three forms of bank reconciliation.