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. 33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 Time deposit may be preterminated or withdrawn on demand or after a certain period of time agreed upon. 34What is a bank reconciliation? Before we answer the question, Iet 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 fundamental transactions affecting the depositor and the bank. Assume that Company X (the depositor) collected P100,000 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. 85In practice, however, the account credited by the bank is demend deposit account but the same ia posted to the subsidiary ledger of Company X. When the bank credits the account of the depositor, Company X, it recognizes its liability to the depositor. Legally, when a deposit is made, there exists a debtor-creditor relationship between the bank and the depositor, the [Link] the debtor, and the depositor being the creditor. Hence, when the account of the depositor is increased the same is credited. t 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 a 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 accotnt 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. 36In practice, however, the account credited by the bank is demend deposit account but the same ia posted to the subsidiary ledger of Company X. When the bank credits the account of the depositor, Company X, it recognizes its liability to the depositor. Legally, when a deposit is made, there exists a debtor-creditor relationship between the bank and the depositor, the [Link] the debtor, and the depositor being the creditor. Hence, when the account of the depositor is increased the same is credited. t 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 a 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 accotnt 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. 36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, if 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 charges 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. 37Bank reconciliation A bank reconciliation is a statement which brings into agreement the cash balance per boox 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 canoe by stamping or punching to show that they have been ald, 38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: 1. 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 incteasing 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. 39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 countersignature, 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 Joan 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, 40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 balance is 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. 41Proforma reconciliation Adjusted balance method Book balance xx Add: Credit memos Xx ‘Total Xx Less: Debit memos Ex Adjusted book balance Bx Bank balance xx Add: Deposits in transit xx Total xx Less: Outstanding checks xX Adjusted bank balance at 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. 42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 book 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, debit memos are deducted from the book 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 bank balance is understated in relation to. the correct cash balance. Hence, deposits in transit are added to the bank balance. 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 bank balance is overstated in relation to the correct cash balance. Hence, outstanding checks are deducted from the bank balance. 43Book to bank method Book balanoe xk ‘Add: Creditmemos iu Outstanding checks ee xx ‘Total “xx Léss: Debitmemos a = Deposits in transit (Xx xx Bank balance mi 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 book 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 methed. 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 t ce, following the book to bank method. monks hele , 44Bank to book method Bank balance xx Add: Deposits in transit xXx Debit memos xx Total xX Less: Outstanding checks xXx Credit memos EX KX Book balance xX I 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 thai 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. 45Tilustration The cash records of Company X show the following for the month of January. CASH RECEIPTS CASH DISBURSEMENTS dan. 5 60,000 Jan. 6 Check No. 721 5,000 18 20,000 7 Check No. 722 10,000 3 30,000. 10 Check No. 723 18,000 31 40,000 14 Check No, 724 2,000 0,00 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 CR 150,000 Jan. 31, CD 100,000 ‘The balance of the cash in bank on the depositor’s book is P50,000. 46Bank statement The following is the bank statement for January received from the First Bank: In account with: No. 775 Company X FIRST BANK Quezon City Manila, Philippines Date CheckNo. Withdrawals Deposits Balance Jan. 6 * 60,000 60,000 8 721 = 6,000 55,000 ll 722 » 10,000 45,000 2 723 18,000 27,000 4 + 20,000 47,000 vv 724 2,000 45,000 26 30,000 75,000 26 15,000CM 90,000 30 5,000 RT 85,000 30 1,000 SC 84,000 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. - 47General procedures in preparing the reconciliation. a. Determine the balance per book and the balance ner 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 on 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 checks issued to the bank statement to ascertain whether there are checks not yet presented [Link]. 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 are bank credits or bank debits not yet recorded by the depositor. In the illustrative problem there is CM of P15,000 and DM for returned check of P5,000 and service charge of P1,000. 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 becaus? all the reconciling items have already been determined. 48Adjusted balance method Balance per book ‘Add: Note collected by bank Total Less: NSF customer check 5,000 Service charge 1,000 Adjusted book balance 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 10 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 bank 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 ¢. 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. 49Book to bank method COMPANY X Bank Reconciliation January 31 Balance per book Add: Note collected Outstanding checks No. 725 37,000 No.726 _28,000 Total Less: NSF check Service charge Deposit in transit Balance per bank Bank to book method COMPANY X Bank Reconciliation January 31 Balance perbank Add: Deposit in transit NSF check Service charge Total Less: Outstanding checks: , No. 725 375000 « No. 726 28,000 Note collected by bank Balance per book 50 40,000 5,000 _ 1,000 65,000 15,000 ie iS isQUESTIONS re . Define cash. 2. Explain the meaning of unrestricted cash. 3. Define cash equivalents. 4. Explain the measurement of cash. 5. Explain the financial statement presentation of cash and cash equivalents. 6. Explain the classification of investments of excess cash in time deposits, money market instruments and treasury bills. x . Explain the treatment of foreign currency. 8. Explain the classification of a cash fund. 9. Explain a bank overdraft. 10. Explain a compensating balance. 11. Explain undelivered check, postdated check delivered and stale check. 12. Explain the accounting for cash shortage or cash overage. 13. Explain the imprest system of internal control. 14, What is a petty cash fund? 15. Explain the two methods of accounting for petty cash fund. 17