I am re-posting this blog from a few years back. Many business owners, bookkeepers and accountants struggle with performing bank reconciliations and resolving variances. And yes, there are times when I can do a bank reconciliation in 10 minutes, even for clients with hundreds of transactions per month.
Over the years, I have developed a number of techniques to help me quickly identify bank reconciliation errors and potential causes. But before I get to the “how” of performing bank reconciliations, what are they and why should you do them?
The purpose of a bank reconciliation is to allow you to determine the accuracy of cash balances on a specific period-end date (usually monthly) as recorded in your general ledger. You should always perform your bank reconciliation as of the last day of the accounting period, not mid-month, because that’s not the date that you are closing the accounting period. So, get the bank to give you statements with a month-end cut off. The bank statement tells you which transactions have cleared the bank, regardless of whether such transactions are known to you. Your books have the complete record of all of your known transactions, but items can appear on your bank statement that you don’t know about. These are, generally: NSF checks, interest earned, bank fees, other automatic debits, and deposit errors. Likewise, items that you know about may not be known to the bank, such as outstanding checks and deposits in transit. So, the bank reconciliation ties together these two separate sets of records, with your own books trumping everything, because that’s what will be reflected in the general ledger.
Bank reconciliations before the existence of accounting software were often performed in a “4 column” format, with the following column headings: Beginning Balance, Deposits, Checks, Ending Balance. This format allowed the accountant or bookkeeper to quickly identify reconciliation issues because each column would then be totaled to agree to the bank’s totals. This would mean that you could tell if your error was in the checks or in the deposits section of your bank reconciliation. With accounting software, even though the process is the same, your ability to identify errors is reduced. A lot of software packages will try to give you hints, but sometimes the hints add to the confusion. In addition, with accounting software, you can fail to mark items that have cleared and still appear to have correctly performed a bank reconciliation. This occurs when you or your CPA make journal entries to correct errors, but the journal entries and the errors themselves never get marked as cleared. I have seen bank reconciliations with un-cleared transactions going back 5 years! Obviously, this cannot be even factually true, and it means that whoever is performing the bank reconciliations does not understand their function very well.
Aside from ensuring the accuracy of your general ledger cash balances, timely and accurate bank reconciliations are one of the most important elements of your internal control system. Stale items or unusual outstanding items at period end can indicate financial fraud. Cash accounts are involved in 93% of all frauds, which is why auditors are trained to search for and identify unusual transactions when reviewing bank reconciliations. Management review of bank reconciliations is a critical function, but often managers don’t actually know what to look for. If this describes you, contact your CPA and ask them to show you how to perform this kind of review and what to document, and I’ll offer a few tips below.
Now, back to the 10 minutes I have allotted for the bank reconciliation: open up your reconciliation tab in your accounting software and enter the period end date and the bank statement balance where indicated. Make sure that you have the software set up NOT to show transactions for periods after this date. Mark all of the transactions as cleared. Now, working backwards, take your bank statement and identify the last check which cleared, and breaks in the check sequences and unmark those checks which haven’t cleared. Then, enter any automatic debits that you haven’t yet recorded in your books, but which are shown on your bank statement. Check the last deposit in your books to see if it has cleared the bank. If not, unmark deposits that have not cleared. Enter your interest earned and any bank charges shown on the bank statement. Not in balance yet? Scan the bank statement for any surprises, such as NSF checks and deposit errors. Most of the time, the bank reconciliation has now been balanced and is ready to be printed (yes, always print or pdf it because certain software may not allow you to do this later, and your CPA wants it and so does the IRS if you are ever audited).
If you are still out of balance at this point, it is now time to check each item from the books to the bank, one by one. Again, I usually start backwards because it is generally the month-end transactions that are the culprit. Remember that your books trump all, so you use your book transactions as your source and compare that to what has cleared the bank, not vice versa.
Once in balance, the bank reconciliation is now ready for management review. The business owner or manager should confirm that only current transactions are listed in the outstanding checks. Checks older than 6 months are considered stale. Usually, these are errors or duplicates that have not been corrected, but if not, Oregon businesses are required to turn over any unclaimed payments to the State Department of Lands. If you see any unusual outstanding checks, or any “corrections” entered immediately after month end, this could indicate fraud. Likewise, outstanding deposits or transfers among accounts that are from a prior period or are immediately reversed after month end could also indicate fraud. Scan through all the transactions listed and make sure that the totals appear reasonable in comparison to your typical monthly volume and dollar amounts of transactions, and that check sequences make sense. Scan check payees to make sure you recognize the vendors. Review the payroll entries and trace them back to the payroll reports provided by your service bureau. And, even though most bank reconciliations are performed by the same person who recorded the transactions (your bookkeeper), make sure that this person IS NOT a check signer.
The internal control function of the bank reconciliation is where you should spend your time. The routine part involving doing the reconciliation itself should not be a hassle, and if it is – get in touch with your accountant for their advice on how to make the process more efficient.