What is Bank Reconciliation statement (BRS).

A Bank Reconciliation Statement (BRS) is a vital financial internal control tool used by businesses to compare their cash records with the bank’s records of their account. Essentially, it is a process that explains the difference between the cash balance in an entity’s accounting records (typically the Cash Book or ledger) and the corresponding balance shown on the bank statement at a particular point in time. This reconciliation is crucial because, at any given date, the balance shown in a company’s cash account rarely matches the balance shown on the bank statement. These disparities arise due to various factors, primarily timing differences and errors made by either the company or the bank.

The primary objective of preparing a Bank Reconciliation Statement is to ascertain the true and accurate cash balance that should be reported on the company’s balance sheet. By meticulously identifying and explaining these discrepancies, businesses can ensure the reliability of their financial statements, detect potential errors or irregularities, and maintain robust internal controls over their cash resources. It acts as a bridge, bringing clarity to the cash position by adjusting both the company’s book balance and the bank’s reported balance to a single, correct figure, which represents the actual cash available to the business.

Purpose and Significance of a Bank Reconciliation Statement

The preparation of a Bank Reconciliation Statement serves several critical purposes, extending beyond simply matching numbers. It is an indispensable practice for sound financial management and internal control.

Firstly, a BRS is a powerful error detection mechanism. Discrepancies between the cash book and bank statement often signal errors. These could be errors made by the company, such as incorrectly recording the amount of a deposit or withdrawal, omitting a transaction, or posting an entry to the wrong account. Similarly, the bank might make mistakes, like crediting a deposit to the wrong account or debiting an incorrect amount. The reconciliation process forces a systematic comparison, allowing for the identification and rectification of these errors promptly, preventing them from propagating into future financial reports.

Secondly, it is an effective tool for fraud detection and prevention. Regular reconciliation can highlight suspicious activities. For instance, if cheques issued by the company are not showing up on the bank statement, or if unauthorized withdrawals appear, it could indicate fraudulent activities by employees or external parties. By maintaining a strict reconciliation process, businesses can deter fraud and swiftly investigate any anomalies, thereby safeguarding their cash assets.

Thirdly, the BRS ensures the accuracy of the cash balance reported in the financial statements. The cash balance presented on the balance sheet must represent the true amount of cash available to the company. Without reconciliation, the cash book balance might be overstated or understated, leading to misleading financial positions. The adjusted balance derived from the BRS is the correct cash figure that should be presented in the company’s financial records and statements.

Fourthly, it helps in identifying unrecorded transactions. Often, the bank processes certain transactions automatically without prior notification to the company. These include bank service charges, interest earned on deposits, direct debits for utility payments, or direct deposits made by customers. The BRS brings these bank-initiated transactions to the company’s attention, enabling them to update their cash book accordingly. This ensures that all cash inflows and outflows are captured in the company’s accounting system.

Fifthly, a BRS facilitates better cash management. By understanding the reasons for differences between the book balance and the bank balance, businesses gain a clearer picture of their liquidity position. They can track the timing of cheque clearances, anticipate incoming funds, and manage their cash flow more effectively. For instance, knowing which cheques are outstanding allows a company to predict when funds will be debited from their account, aiding in avoiding overdrafts.

Finally, BRS contributes to compliance and audit readiness. Most accounting standards and audit procedures require regular bank reconciliations. It provides an essential audit trail, demonstrating that the company exercises due diligence over its cash assets. Auditors heavily rely on bank reconciliations to verify the accuracy of the cash balance and the effectiveness of internal controls.

Parties Involved in Bank Reconciliation

The process of bank reconciliation fundamentally involves two primary parties, each maintaining their own independent record of the cash transactions:

1. The Business/Company: This entity maintains its own internal record of all cash receipts and cash payments. This record is typically kept in the Cash Book (or the cash ledger account within the accounting system). When cash is received, the cash book is debited, and when cash is paid out, it is credited.
2. The Bank: The financial institution where the business holds its account. The bank maintains a record of all transactions that affect the business’s account. This record is periodically provided to the business in the form of a Bank Statement. From the bank’s perspective, the business’s deposit is a liability, so deposits increase the bank’s liability to the business (credited), and withdrawals decrease it (debited). Therefore, a deposit made by the business is a credit entry on the bank statement, and a payment made by the business is a debit entry.

The core objective of the BRS is to reconcile the balance shown in the business’s cash book with the balance shown on the bank’s statement for the same account as of a specific date.

Causes of Differences Between Cash Book and Bank Statement Balances

The discrepancies between the cash book balance and the bank statement balance primarily arise from two categories: timing differences and errors. Understanding these causes is fundamental to performing an accurate reconciliation.

1. Timing Differences

Timing differences occur when transactions are recorded by one party (either the company or the bank) but have not yet been recorded by the other party by the end of the reconciliation period. These are legitimate transactions that are simply in transit or awaiting processing.

• Cheques Issued but Not Yet Presented (Outstanding Cheques): When a company issues a cheque to a supplier or for an expense, it immediately records this as a credit (payment) in its cash book, reducing its cash balance. However, the bank will only debit the company’s account when the payee presents that cheque for payment and it clears. If the reconciliation date falls between the time the company issues the cheque and the time it is presented to and cleared by the bank, this cheque will appear as a reduction in the company’s cash book but not yet on the bank statement.
  • Effect on BRS: Deducted from the bank statement balance (or added to the company’s cash book balance if reconciling the other way).
• Cheques Deposited but Not Yet Cleared (Deposits in Transit): When a company receives cash or cheques and deposits them into its bank account, it immediately records this as a debit (receipt) in its cash book, increasing its cash balance. However, the bank may not process and credit the deposit to the company’s account until the next business day or even later, especially if deposits are made after banking hours or cheques require several days to clear.
  • Effect on BRS: Added to the bank statement balance (or deducted from the company’s cash book balance if reconciling the other way).
• Direct Deposits by Customers (Bank Credits): Sometimes, customers directly deposit money into the company’s bank account through electronic transfers (e.g., EFTs, wire transfers). The bank credits the company’s account immediately upon receipt of these funds. The company, however, may only become aware of these deposits when they receive their bank statement or notification from the bank.
  • Effect on BRS: Added to the cash book balance (as the company needs to record this receipt).
• Direct Payments by Bank (Bank Debits/Charges): Banks often make payments or levy charges directly from the company’s account without explicit instruction from the company at the time of the transaction. Examples include:
  • Bank Service Charges: Fees charged by the bank for maintaining the account or for specific services. The bank debits the account, reducing the balance. The company learns of this only from the bank statement.
  • Interest on Loans/Overdrafts: If the company has a loan or an overdraft facility, the bank may directly debit interest payments.
  • Direct Debits/Standing Orders: Automatic payments set up by the company for recurring expenses like utilities, insurance premiums, or loan repayments. The bank debits the account on due dates, but the company might not have recorded it until they review the statement.
  • Effect on BRS: Deducted from the cash book balance (as the company needs to record this payment).

2. Errors

Errors can be made by either the company while maintaining its cash book or by the bank while processing transactions and preparing the bank statement.

• Errors in the Company’s Cash Book:
  • Transposition Errors: Digits swapped (e.g., $150 recorded as $510).
  • Omission Errors: A transaction (receipt or payment) is completely forgotten and not recorded.
  • Errors in Amount: Recording a cheque issued for $250 as $2,500 or $25.
  • Double Entry: Recording a transaction twice.
  • Wrong Side Entry: Recording a payment as a receipt or vice versa.
  • Effect on BRS: These errors require an adjustment (addition or subtraction) to the cash book balance to correct the company’s records.
• Errors by the Bank:
  • Posting to Wrong Account: The bank might debit or credit another customer’s account to the company’s account by mistake.
  • Incorrect Amount Debited/Credited: The bank processes a cheque or deposit for an incorrect amount.
  • Omission by Bank: The bank fails to record a legitimate transaction.
  • Effect on BRS: These errors require an adjustment (addition or subtraction) to the bank statement balance. The company should also contact the bank to rectify such errors.

3. Transactions Recorded by One Party Only (Often a subset of timing differences but distinct due to knowledge lag)

While often overlapping with timing differences, some transactions are unique in that one party initiates and records them, and the other party only becomes aware when the statement is received.

• Dishonoured Cheques (NSF - Non-Sufficient Funds Cheques): When a company deposits a customer’s cheque, it records it as a receipt in its cash book. The bank initially credits the company’s account. However, if the customer’s account has insufficient funds, or for other reasons (e.g., stop payment, signature mismatch), the bank will “dishonour” the cheque and debit the company’s account, reversing the original credit. The company only learns of this reversal from the bank statement.
  • Effect on BRS: Deducted from the cash book balance.
• Bills Collected by Bank on Company’s Behalf: Sometimes, a company may instruct its bank to collect payments from its debtors (e.g., bills receivable). The bank, upon collection, credits the company’s account. The company will only know about this collection when it receives the bank statement or a special advice from the bank.
  • Effect on BRS: Added to the cash book balance.

Types and Process of Preparing a Bank Reconciliation Statement

There are several approaches to preparing a Bank Reconciliation Statement, but the most common and robust method aims to arrive at an “adjusted” or “true” cash balance.

Common Approaches:

1. Reconciling from Cash Book Balance to Bank Statement Balance: This method starts with the cash book balance and adjusts it to match the bank statement balance. While it shows the difference, it doesn’t clearly reveal the true cash position.
2. Reconciling from Bank Statement Balance to Cash Book Balance: This is the reverse of the first method. It starts with the bank statement balance and adjusts it to match the cash book balance. Similarly, it doesn’t directly provide the “true” balance.
3. The Two-Column (or Adjusted Balance) Method: This is the most widely used and recommended method. It begins with both the cash book balance and the bank statement balance, and adjusts each independently until they both converge to the same “true” or “corrected” cash balance. This adjusted balance is the amount that should appear on the balance sheet.

Process of Preparation (Using Two-Column Method):

The preparation of a BRS involves a systematic approach:

1. Obtain Records: Gather the company’s Cash Book (or cash ledger account) for the period and the latest Bank Statement from the bank. Both documents should cover the same period, usually a month.
2. Compare and Tick Off Matching Items: Go through each transaction listed in the bank statement and match it against the corresponding entry in the cash book. As items match, tick them off in both records. This step helps identify transactions that have been recorded by both parties.
3. Identify Unticked Items in Cash Book: These are transactions that the company has recorded, but the bank has not yet processed or recorded by the reconciliation date.
   • Common examples: Outstanding Cheques (cheques issued by the company but not yet presented to the bank for payment).
   • Action: These will be adjustments to the bank statement side of the reconciliation.
4. Identify Unticked Items in Bank Statement: These are transactions that the bank has recorded, but the company has not yet recorded in its cash book.
   • Common examples: Deposits in Transit (deposits made by the company but not yet cleared by the bank), Bank Service Charges, Interest Earned, Direct Deposits by Customers, Dishonoured Cheques, Direct Debits/Standing Orders.
   • Action: These will be adjustments to the cash book side of the reconciliation.
5. Identify Errors: Scrutinize both unticked and ticked items for any errors made by either the company or the bank (e.g., incorrect amounts, wrong account postings).
   • Action: Errors in the company’s cash book require adjustments to the cash book side. Errors made by the bank require adjustments to the bank statement side, and the company should contact the bank to get these rectified.
6. Prepare the Bank Reconciliation Statement: Construct the statement using the identified adjustments.

Format of a Two-Column Bank Reconciliation Statement (Illustrative):

[Company Name] Bank Reconciliation Statement As at [Date]

Crucial Check: The “Adjusted/Corrected Cash Balance” on both sides must be identical. If they are not, it indicates an error in the reconciliation process.

7. Journal Entries for Adjustments: This is a crucial final step. Any adjustments made to the “Balance as per Cash Book” side of the reconciliation must be formally recorded in the company’s accounting records (Cash Book/General Ledger) through journal entries. The bank’s errors are the bank’s responsibility to correct; the company only adjusts its own records for items it was previously unaware of or for its own errors.

   • Example: For Bank Service Charges: Debit: Bank Charges Expense Account Credit: Cash/Bank Account (To record bank service charges discovered on the bank statement)

   • Example: For Direct Deposit by Customer: Debit: Cash/Bank Account Credit: Accounts Receivable (Customer Name) (To record direct deposit by customer)

   • Example: For Dishonoured Cheque: Debit: Accounts Receivable (Customer Name) Credit: Cash/Bank Account (To record dishonoured cheque from customer, re-establishing their debt)

   The adjusted cash balance, after these journal entries are posted, is the correct cash balance that will appear on the balance sheet.

Conclusion

The Bank Reconciliation Statement is far more than a mere clerical task; it is an indispensable control mechanism in financial accounting that ensures the accuracy and integrity of a company’s cash records. By systematically comparing the cash balance in the company’s books with the balance reported by the bank, it identifies and explains discrepancies arising from timing differences and errors made by either party. This meticulous process culminates in the determination of a true, adjusted cash balance, which is the correct figure to be presented in the financial statements, notably on the balance sheet.

Beyond establishing financial accuracy, the BRS serves as a robust internal control, actively deterring and detecting potential fraud or misappropriation of cash. It highlights unrecorded transactions, such as bank charges or direct deposits, prompting timely updates to the company’s accounting records and ensuring a comprehensive view of all cash flows. Regular and diligent bank reconciliation provides critical insights into a company’s liquidity, supporting effective cash management and strategic financial decision-making. Ultimately, it builds confidence in the financial data, underpinning the reliability of a company’s financial reporting and facilitating compliance with auditing standards.