Reconciliation and verification

A business's own record of its bank transactions, the Cash Book (bank column), and the bank's official record, the Bank Statement, are two independent records of the same funds. It is very common for their closing balances to differ on any given day. These differences are not necessarily errors; they usually arise from two main causes: 'timing differences' and 'items omitted'. A bank reconciliation is the process of identifying and accounting for these differences to verify that both records are fundamentally correct. The main reasons for discrepancies are:

Items in the Cash Book but NOT on the Bank Statement:

• Unpresented Cheques: Cheques the business has written and sent to suppliers, but which the suppliers have not yet deposited or 'presented' at their bank for payment.
• Outstanding Lodgements (or Deposits): Cash or cheques the business has paid into the bank, but which have not yet been processed and credited to the account by the bank. This often happens with deposits made at the end of the business day.

Items on the Bank Statement but NOT in the Cash Book:

• Bank Charges: Fees charged by the bank for services like account maintenance or processing transactions.
• Bank Interest: Interest paid by the bank on a positive balance (interest income) or charged by the bank on an overdraft (interest expense).
• Direct Debits & Standing Orders: Automatic payments made directly from the bank account to a third party, set up by the business (e.g., for rent or utility bills).
• Credit Transfers (or Direct Credits): Payments made directly into the business's bank account by customers.
• Dishonoured Cheques: A cheque received from a customer and deposited by the business, which the bank returns unpaid. This is usually because the customer has insufficient funds in their account.

Before you can reconcile the two balances, you must first ensure your own records are fully up-to-date. This is done by updating the Cash Book. You must go through the Bank Statement and identify any items that the bank has recorded but you haven't. These items are then recorded in the Cash Book (bank column) to produce a new, 'updated' or 'adjusted' balance. All money received by the bank (e.g., credit transfers, interest received) is debited in the Cash Book. All money paid out by the bank (e.g., bank charges, standing orders, dishonoured cheques) is credited in the Cash Book. The final balance of this updated Cash Book is the true, correct bank balance that will be reported as 'Cash and cash equivalents' in the Statement of Financial Position.

After updating the cash book, its balance should represent the true cash position. The Bank Reconciliation Statement is a report that proves this by linking the updated cash book balance to the balance shown on the bank statement. This statement deals only with the timing differences: unpresented cheques and outstanding lodgements. It does NOT include items like bank charges or direct debits, as they have already been dealt with in the updated cash book. The most common format starts with the balance as per the bank statement and adjusts it to prove it equals the updated cash book balance.

A bank overdraft is a negative bank balance, where the business has withdrawn more money than it had in its account. It is treated as a current liability. When performing a reconciliation with an overdraft, the principles are identical, but you must be very careful with negative numbers and the correct terminology. An overdraft will be a credit (Cr) balance in the Cash Book. On the bank statement, it may be shown with 'OD', 'DR', or simply as a negative figure. When preparing the reconciliation statement, think about the effect of each item on the overdraft. An outstanding lodgement will reduce the overdraft (so you add it, making the negative number smaller). An unpresented cheque will increase the overdraft (so you subtract it, making the negative number larger).

Preparing a bank reconciliation is a fundamental internal control procedure with several key benefits for a business:

1. Detection of Errors: It systematically checks for and allows correction of errors, whether made by the business's accounts staff (e.g., a transposition error in the cash book) or by the bank (e.g., crediting a deposit to the wrong account).
2. Fraud Prevention and Detection: It is a powerful tool against fraud. For example, if an employee takes cash that was meant to be deposited, this will show up as an outstanding lodgement that never clears. Regular reconciliation can also uncover unauthorised payments or withdrawals.
3. Accurate Cash Management: It provides managers with the true, up-to-date cash position of the business. This is vital for making informed decisions, such as knowing if there are sufficient funds to pay suppliers or whether the business needs to arrange an overdraft.
4. Assurance of Record Accuracy: It confirms that the cash balance to be reported in the Statement of Financial Position is correct and has been verified against an external source (the bank), adding credibility to the financial statements.