Introduction to Preparing a Bank Reconciliation

What you’ll learn to do: Recognize the significance of the bank reconciliation as an internal control

Most companies use checking accounts to handle their cash transactions. The company deposits its cash receipts in a bank checking account and writes checks to pay its bills. Keep in mind—a bank account is an asset to the company BUT to the bank, your account is a liability because the bank owes the money in your bank account to you. For this reason, in your bank account, deposits are credits (remember, liabilities increase with a credit) and checks and other reductions are debits (liabilities decrease with a debit).

For example, here’s the first transaction from NeatNiks’s from the company perspective:

Two T accounts side by side. On the left is a checking account with a debit balance carried forward of 0 dollars. There is also a debit entry of 20,000 dollars. There is an ending balance of 20,000 dollars. On the right side is the Owner's Capital account. It has a balance carried forward of 0 dollars and a credit entry of 20,000 dollars. It has an ending credit total of 20,000 dollars.

Here’s the same transaction as recorded by the bank:

Two T accounts side by side. On the left is the Cash reserves account. It has a debit balance carried forward of 50,000,000 dollars. There's a debit entry of 20,000 dollars. There is an ending debit balance of 50,020,000 dollars. On the right side is the Due to NeatNiks account. Its balance carried forward is 0 dollars and there is also a credit entry of 20,000 dollars. The ending credit balance is 20,000 dollars.

NeatNiks’s demand deposit (checking account) is a liability to the bank. If Nick Frank spends $150 at Home Depot using the business debit card, the bank will make the following entry when it sends the payment to Home Depot on your behalf:

Two T accounts side by side. On the left is the Cash reserves account. It has a debit balance carried forward of 50,000,000 dollars. There's a debit entry of 20,000 dollars. There is also a credit entry of 150 dollars, leaving an ending debit balance of 50,019,850 dollars. On the right side is the Due to NeatNiks account. Its balance carried forward is 0 dollars and there is also a credit entry of 20,000 dollars. It has a debit entry of 150 dollars. The ending credit balance is 19,850 dollars.

That’s why it’s called a debit card. Because the bank debits your account when you use it.

The bank sends the company a statement each month that is really just a printout of the bank’s ledger for your account, which is really a subsidiary ledger because the bank doesn’t have a general ledger (GL) account for every depositor. The company checks this statement against its records to determine if it must make any corrections or adjustments in either the company’s balance or the bank’s balance. A bank reconciliation is a schedule the company (depositor) prepares to reconcile, or explain, the difference between the cash balance on the bank statement and the cash balance on the company’s books. The company prepares a bank reconciliation to determine its actual cash balance and prepare any entries to correct the cash balance in the ledger.

And that is the main internal control for our “cash” accounts. If the owner of the coffee shop had simply used a basic internal control, she would have noticed that the deposits being recorded by the bank were different (smaller than) the ones being recorded in the company’s records, unless the thief was somehow able to manipulate the cash register and other sales records.