What it means
The bank's records and the company's records of the same account should agree, but at any moment they rarely do. The company records a cheque on the day it is written; the bank records it when it is presented, days or weeks later.
The company records a customer's payment when it is received; the bank credits it when the funds clear. The bank deducts charges and adds interest that the company will not know about until the statement arrives.
And occasionally somebody, at the company or the bank, makes a mistake. The reconciliation starts from one balance and works to the other.
The usual format takes the bank statement balance, adds deposits in transit (recorded by the company, not yet by the bank), subtracts outstanding cheques and payments (recorded by the company, not yet by the bank), and arrives at an adjusted bank balance. Separately, it takes the company's ledger balance, adds items the bank has credited that the company has not recorded (interest, customer payments made directly to the bank), subtracts items the bank has charged that the company has not recorded (fees, bounced cheques, direct debits), corrects any errors, and arrives at an adjusted book balance.
The two adjusted balances must agree. Items on the book side then become adjusting entries in the ledger; items on the bank side simply wait to clear.
Beyond proving the balance, the reconciliation is a control. Unexplained differences, cheques that never clear, deposits that never appear and adjustments that recur are how many frauds are first detected.
For that reason the reconciliation should be prepared by someone who does not handle cash or record transactions, reviewed by someone senior, and completed within days of the month end rather than weeks. Modern accounting software imports bank feeds and matches most items automatically, but the review of unmatched items and the sign-off remain human work.
In practice
Real-world examples.
Example
A cafe owner reconciles the business account every Monday, matching card takings against the payment processor's settlements and spotting a duplicated settlement fee.
Example
A company's bookkeeper finds an outstanding cheque for $4,000 that has not cleared in four months, investigates and discovers it was sent to an old supplier address.
Example
A charity's treasurer reconciles the account monthly and presents the reconciliation to the trustees as evidence that the cash balance in the accounts is real.
Think of it
“Bank reconciliation is like balancing your checkbook. You're making sure what you think you have matches what the bank says you have.
Formula
Calculation
Adjusted Bank Balance = Bank Statement Balance + Deposits in Transit minus Outstanding Cheques and Payments
Adjusted Book Balance = Ledger Balance + Unrecorded Credits (interest, direct receipts) minus Unrecorded Debits (fees, bounced cheques, direct debits) plus or minus Error Corrections
The two adjusted balances must be equal.
Worked example. At 31 March a company's ledger shows a bank balance of $42,750. The bank statement shows $47,435. Investigation finds:
- A customer deposit of $6,200 recorded on 31 March, credited by the bank on 2 April (deposit in transit)
- Cheques totalling $11,900 written in March that have not yet been presented (outstanding cheques)
- Bank charges of $85 on the statement, not yet recorded in the ledger
- Interest received of $40 on the statement, not yet recorded
- A customer's cheque for $1,300 that bounced, deducted by the bank, not yet recorded
- A direct debit for insurance of $785 on the statement, not yet recorded
- A supplier payment recorded in the ledger as $2,540 that the bank correctly processed as $2,450 (a transposition error of $90 in the ledger, which overstated the payment)
Bank side: $47,435 + $6,200 minus $11,900 = $41,735
Book side: $42,750 minus $85 + $40 minus $1,300 minus $785 + $90 = $40,710
The two sides differ by $1,025. Rechecking the outstanding cheque list shows that one cheque for $1,025 listed as outstanding had in fact cleared on 30 March. Removing it from the outstanding list gives a bank side of $47,435 + $6,200 minus $10,875 = $42,760. That still does not agree with $40,710, so the accountant re-examines the ledger and finds a customer receipt of $2,050 posted twice. Correcting it gives a book side of $40,710 + $2,050 = $42,760. Both sides now agree at $42,760, which is the true cash balance.
The adjusting entries in the ledger are: bank charges $85, interest $40, bounced cheque $1,300 (reinstating the customer's receivable), insurance $785, the $90 correction to the supplier payment and the $2,050 reversal of the duplicated receipt. The deposit in transit and outstanding cheques need no entry; they will clear in April.Case study
Seen in the real world.
A building contractor's office manager handled invoicing, banking, bill payments and the bank reconciliation for twelve years. The reconciliation was prepared, but nobody reviewed it. When she went on extended leave, her replacement could not get the reconciliation to balance and found $210,000 of "outstanding cheques" dating back several years, none of which corresponded to real suppliers.
The office manager had been writing cheques to herself, recording them in the ledger as supplier payments, and carrying them as outstanding items on the reconciliation so that the ledger balance appeared to agree with the bank. The fraud had continued for at least seven years. The company recovered a fraction of the loss through insurance, separated cash handling from recording, moved to a reconciliation prepared by the external accountant and reviewed monthly by a director, and set a rule that no outstanding item could remain on the reconciliation for more than 60 days without written explanation.
Watch out
Common mistakes.
- Forcing the reconciliation to balance with an unexplained "reconciling difference". Every item must be identified.
- Letting outstanding items sit for months. Stale cheques should be cancelled and reissued; unexplained deposits investigated.
- Having the same person receive cash, record it and reconcile the bank. That is the classic fraud opportunity.
Questions
People also ask.
How often should a bank reconciliation be done?
Monthly at minimum; weekly or daily for businesses with high transaction volumes or tight cash.
What if the bank has made an error?
Record nothing in the ledger; note the error as a reconciling item on the bank side and contact the bank to correct it.
Does accounting software make reconciliations unnecessary?
No. Bank feeds automate the matching, but someone still has to investigate unmatched items and sign off the result.
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